It seems that in aviation there are some who think finances are scary (read as job threatening) and those who think finances are just simply boring. Both groups try their best to avoid the subject. There is a middle way, those whose knowledge of finances gives them a powerful and convincing tool for making the right aircraft decision!
To do a proper financial analysis, you will need the initial investment required, the variable and fixed costs of operation, and the estimated residual value of the aircraft at the end of the term. Taxes and revenue potential can also play an important part in the analysis. The objective of a financial analysis is to determine which of the qualified aircraft provides the optimum combination of these elements.
Before doing a financial analysis, you will need to establish financial criteria and options. This process starts in the same manner as when you are selecting an aircraft. First you choose the criteria by which you will select an aircraft. With aircraft, we think in terms of things such as range, payload and cabin size. In aircraft financial analyses, we think of things like:
Amount of utilization. For point to point travel, do this in miles (or kilometers). Trips from Point A to Point B have a set distance. Add up those trips' distances. Then divide by the aircrafts' typical trip speeds to arrive at the utilization in hours. 160,000 nautical miles is 400 hours at 400 knots or 500 hours at 320 knots. This will have an impact on the fleet size as well. A large amount of utilization (in miles) can spell three slower aircraft or two faster ones.
Type of ownership. Full ownership, co-ownership, fractional ownership. Maybe not even owning at all. Utilization under 200 hours per year can suggest a form of charter or perhaps fractional ownership. Between 200 to 300 hours, fractional ownership and full ownership should be considered. Over 300 hours tends to favor full ownership. There may be extenuating circumstances to consider as well.
New versus used. Do the lower maintenance costs, added tax depreciation benefits, and the ability to specify the exact configuration of the new aircraft outweigh the used aircraft's lower acquisition cost? There may be other considerations favoring the new aircraft such as updated avionics.
Lease or Purchase? A lease typically has a very low initial payment, and depending on the type of lease, may not be considered "long term debt" on the corporation's balance sheet. Purchase includes both finance and full payment up front. With a purchase, you do have ownership and after the payment(s), have an asset with a definite value.
Trade-in Value. If you currently own an aircraft, you need to get an idea of its current worth in the market. Price guides such as the Aircraft Bluebook Price Digest, Vref , and The Official Helicopter Bluebook offer a good starting point for determining the value of an aircraft. Nothing beats an appraisal by a qualified appraiser. The National Aircraft Appraisers Association is one place to start. An appraiser will give you the real-world value in today's market that will aid you in negotiations with buyers.
Acquisition Price. For used aircraft, see the references above. You can also look at aircraft-for-sale web sites to see what the "asking" prices are. Keep in mind that there can be a considerable margin between asking and final selling price. An appraiser can also give you some information on used aircraft prices as well. For new, start with the manufacturer's list price. In today's market, most sellers are willing to make a deal, so don't count out a new model that is "just a little bit" outside of the target acquisition price.
Length of ownership. When you analyze each aircraft, use an equal length of ownership. Looking at cash flows and costs over different lengths of time can give you a distorted picture. This is very important when considering the time value of money. When income or expenses occur can be as important as how much.
The methodology to do all the calculations is called Life Cycle Costing. The Life Cycle Costing includes acquisition, operating costs, depreciation, and the cost of capital. Amortization, interest, depreciation, and taxes also play a part in what it costs to own and operate an aircraft and can be included in the Life Cycle Costing as appropriate.
Once you have calculated the life cycle costs of the various options, you can compare the total costs. However, this may not be enough. While the magnitude of expenses and revenues is critical, their timing is important, too. In general, it is preferred to pay the bills as far into the future as we can without penalty.
The next step is to use the concept of the time value of money. We all can agree that being paid today and paying our bills next week is the preferred way to manage our finances. This is the simple version of the time value of money. Next month, we will explain it in detail and complete the financial analysis.