How much information do you need to effectively manage your costs? Part 1

TLDR (1): If you don't have time to read the entire post, I'll summarize it for you: To manage your costs, you need all the cost information available. It needs to be organized and presented in a manner that has meaning for you.

 

Step one with the costs is to collect them. You have to pay the bills, so the collection is part of making sure the bills are valid.  Information is in the invoice, the credit card receipt, and in your email. But just having collected this information does not lead to effective management. You have to make some sense of it. 

Step two is to organize the costs into accounts, or categories: fuel, insurance, hotels, parking fees, catering, salaries, taxes, and so on. If you have more than one aircraft, then you should separate the costs by aircraft, even if they are the same model. If your maintenance costs for two jets are $1,000 per hour, are they $500 per hour per aircraft, our $300 per hour for one, and $700 per hour for the other? There is a difference. Once organized into categories then next step if to also organize by behavior.

To manage the costs collected, you also need to understand how they behave. In further organizing your costs, consider the behavior of the cost. How will costs change with changes in utilization? How does the cost behave with a change in activity? Two categories are variable and fixed costs.

A Variable Cost will vary in proportion to the level of activity. As activity increases, the total cost will increase but the cost per unit will remain constant. A good example of this is fuel. An increase in hours flown will have a corresponding increase in fuel consumed. However, the cost per gallon of fuel will not be affected. Hourly guaranteed maintenance programs will also vary in relation to the hours flown. If you use contract flight crew, that would also be considered as a variable cost.

A Fixed Cost as the name implies, remains essentially constant for a given period or level of activity. A pilot's annual salary is a fixed cost. Whether you fly a little or a lot, the pilot still is paid their same salary. The cost per unit will change with a change in activity. A pilot making $100,000 annually and flying 250 hours would be a cost of $400 per hour. If the pilot flies 300 annual hours, the salary as a per hour cost is $333.33. Your hangar cost, hull and liability insurance, cost of refresher training, and property taxes are all considered as fixed costs.  

Two other ways to differentiate the behavior of a cost is to look at how well you can connect the cost to a particular function. If the elimination of the function would also eliminate the cost, then that cost is directly associated with that function, and thus, is a Direct Cost. If the cost is not closely tied into that function, then it is an Indirect Cost. If the function is eliminated, the Indirect Cost won't go away. Depending on the function, or the levels within the organization, a cost can be classified as Direct and Indirect.

Consider the pilot salary from before. If that pilot flies a single aircraft, say a Hawker 800, then the pilot salary of $100,000 is a direct cost for the Hawker 800. If the pilot also flies a Bell 206, then the pilot salary is not directly associated with just the Hawker 800 as it is also associated with the Bell 206. If the Hawker is sold, but the pilot still is flying in the Bell 206, the pilot still gets paid. So with regard to the Hawker 800, the dual-rated pilot salary is an indirect cost. 

If the aviation department consists of the Hawker 800 and Bell 206, the $100,000 pilot salary is a direct cost. Close the aviation department and the pilot salary goes away. If your aviation department is just a single aircraft, then the direct versus indirect distinction can be ignored. But for operations of two or more aircraft, the distinction will be important as you track, allocate, and budget your costs.

Now that these costs are collected and organized by cost category and behavior, you are ready to start the process of managing these costs. It is necessary for creating a budget, for planning for future costs, and for understanding what changes in costs will have on your total cost of operations. Next month we'll continue the article.