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Performing a Financial Analysis: Part 2

by David Wyndham 1. December 2006 00:00
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In last month's we identified the basic financial data needed for the analysis. Remember, the goal of the financial analysis is to identify the aircraft that does the best job for the money.

In a financial analysis you will need to analyze all of the costs associated with the aircraft: acquisition cost, operating costs, depreciation and taxes, and the potential residual value after a set term. If the aircraft is to be used in a commercial operation, you will need to make assumptions regarding potential revenues as well. All of these considerations are important and needed to complete the analysis. Use the same set of assumptions for each aircraft to ensure that you get a true comparison.

Given a set of costs and assumptions, what next? You will need an analysis tool to perform a life cycle cost. A life cycle cost

- Takes into account the total costs and can show the impact of taxes and depreciation.

- Generates a cash flow analysis to show the years of negative cash flow - something a commercial operator wants to avoid.

- Examines the time-value of money for each aircraft and acquisition option.

The time-value of money places importance on the timing of a revenue or expense occurs. Think of interest. If I invest $1,000 at 5% per year, I'll have $1,050 at the end of a year. Similarly, if I owe you a $1,000, and I pay you today, I need $1,000. But, if I can wait a year to pay you, I can invest $953 at 5% and end up with $1,000 after a year. Taking the time-value of money into account allows you to compare different streams of revenues and expenses to see which one has the better time-value.

Terms used to describe the time-value "interest rate" include return on investment (commercial operations) and net present value (non-revenue operations like a corporate flight department of government). These are usually abbreviated as ROI and NPV respectively. For a revenue operation, the higher ROI is preferred. For a non-revenue operation, the "least negative" NPV is preferred.

What is a typical percent to use for the ROI/NPV analysis? You usually don't have to make one up. Government agencies usually look at the cost of borrowing money - Treasury Bill interest rates for example. Corporations have expected returns and use that for all major purchases. If you are in a large organization, just call the financial department, the CFO, comptroller, etc. and ask them for the relevant rate and your organization's marginal take rate. They will be impressed at your level of understanding!
Taxes and depreciation can play a role in the time-value analysis. If used 100% for business, the IRS allows 100% of the aircraft's value to be deducted, or depreciated, in as little as five years.

The final value, the aircraft residual value, is tough to estimate. Essentially it requires guessing at the future value of the aircraft. Looking at historical residual values of pre-existing aircraft can give you some idea of what the future may hold. We've looked at aircraft values for a number of years and, averaging good and poor economic times, will use a reduction in a jet aircraft's value of 3% per year, 4% for a turboprop or piston, and 5% for a helicopter. Right now, it is too much, but over time it is a reasonable estimate.

Now that you have your costs, ROI/NPV rate, and marginal tax rate, how do you perform the analysis? Prior to spreadsheets, it was a time-consuming process. Today, there are spreadsheet applications that, given the proper data entry, will quickly calculate cash flows and ROI/NPV. Just make sure what you use allows you the flexibility to compare the different options. Look for the ability to vary your cost assumptions and to create reports. If you are a pro at Microsoft Excel or other spreadsheet applications, you can even try to do one from scratch.

For a non-commercial operation, the only revenue will be the sale of the aircraft. This will never pay back the initial acquisition cost and all expenses, so the NPV will always be less than zero. In this situation, the "least negative" or value closest to zero is the most favorable NPV.

For a commercial operation, the goal is to recoup your initial investment, pay all your expenses, and generate a return (profit) equal to your stated ROI. Do this and the NPV is zero. If the NPV is less than zero, you have not reached your ROI goal, and if the NPV is greater than zero, you have exceeded your ROI goal.

What the financial analysis will allow you to do is to rank order the mission capable aircraft to find the one that does the best job for the money. Once you have done this, you can easily go back and adjust the assumptions and re-run the analysis for changes in acquisition cost, interest rates and other variables. This will give you a very clear picture of what your options are.

A financial analysis of the aircraft capable of performing your mission is the fairest way to identify the best value for your operation. It takes into account all the cost factors.

As always we welcome your input and experiences please post your questions or replies below.



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