Chapter 9

Airline Financial Management

Dr. Rohafiz binti Sabar

Transport and Logistics Department
College of Business
Room 257 , Main Building of COB
D/l: 04-9283664
email: rohafiz@uum.edu.my
1 Transport and Logistics Department July 2009
Presentation Outline

 Planning context
 Budget preparation
 Cash budget
 Working capital
 Long-term cash flow
 Start-up airline business plan
 Financial fitness: EU requirements
 Airline Planning
 Mission statement
 Corporate objectives
 Corporate strategy
 Goals and plans
Marketing
Production
Finance
Staff support
 Financial Planning

 Evaluation of future financial condition of the

airline
 Future financial needs
 Impact of alternative options on above
 Standards against which to evaluate actual
results
 Airline budget preparation

 Passenger and market share forecasts

 Cargo forecasts
 Yield / revenue projections
 Schedules planning
 Resource needs / manpower
 Cost estimates
 Budget finalisation
 Sept 2006 September 2007
Actual Actual Budget Variance
Passengers carried 28,520 21,547 21,124 423
Passenger-km (000) 4,363 3,306 3,718 -412
Seat-kms (000) 6,601 5,654 5,767 -113
Passenger load factor (%) 66.1 58.5 64.5 -6
Average stage kms 320 345 350 -5
Aircraft hours/day 7.5 7.3 8 1
Passenger yield (cents) 45 55 50 5
Airline Management
Cost per seat-km (cents) 29.7 33 30 3
Accounts
Breakeven load factor 66 60 60 0
Operating ratio (%) 100.2 97.5 107.5 - 10.0pts
Expenditure by department ($m)
Marketing 9.1 9.3 -0.2
Operations 13.5 12 1.5
Engineering 4 3.5 0.5
Personnel 6.5 6 0.5
Other 3.3 3.7 -0.4
Total 36.4 34.5 1.9
Expenditure by type ($m)
Staff costs 23.2 20 3.2
Depreciation 4.7 4.7 0
Aircraft rentals 0.5 0 0.5
Agent commissions 3.9 4.1 -0.2
Fuel costs 3.5 4.2 -0.7
Other materials/services 4.1 5.7 -1.6
Total 36.4 34.5 1.9
 Cash budget

 Operating cash requirements

 Need for short-term finance?
 Management of cash surplus
 Relationship with bankers
 Update and monitor balance sheet items
 Check financial ratios
Example of a cash budget
US$ 1,000 January February March April

Total revenues 1,000 1,300 2,100 2,800

Direct costs 1,500 1,450 1,600 1,800

Payroll costs 50 50 50 50

Aircraft rentals 250 - - 250

Other costs 20 30 30 40

Net cash from operations -820 -230 420 660

Net capital movements -200 -150 - -

Net cash surplus/(shortfall) -1,020 -380 420 660

Opening balance 1,500 480 100 520

Monthly movement -1,020 -380 420 660

Closing balance 480 100 520 1,180

 Composition of Working Capital
 Current assets
Stocks
Accounts receivable (trade & other debtors)
Liquid assets (cash and deposits)
 Current liabilities
Bank overdrafts
Accounts payable (trade & other creditors)
Accruals (wages. taxes etc)
Current part of long-term debt
 Working Capital Definitions

 Gross working capital

Total current assets
 Net working capital
Total current assets less total current liabilities

 Current ratio
Current assets divided by current liabilities
 Quick ratio (acid test)
Current assets less stocks divided by current liabilities
(also cash and deposits divided by current liabilities)
 Balance Sheet Structure
 Net Working Capital (NWC)
Permanent capital less fixed assets
Permanent capital is equity and long-term debt
 Working Capital Needs (WCN)
Receivables/stocks less accounts payable/accruals
 Net Liquid Balance (NLB)
NWC less WCN
or Liquid assets less callable liabilities
Permanent vs Fluctuating Current Assets

 Accounts receivable
Seasonal peaks and troughs
(Especially European charter carrier)

 Stocks
Normally low for an airline or service industry;
high for manufacturing plant
Current Asset Financing Policies
 Moderate approach
Maturity matching

 Aggressive approach (high NWC)

Dangers of rising interest rates and non-renewal of loans

 Conservative approach (low NWC)

Excess liquidity in off-peak periods (better use of funds?)
 Long versus Short-term Debt

 Short-term money generally costs less

than long-term
and interest rates can be locked in for longer period

 Short-term money more risky than long-

term
Unable to meet repayments, or loan facility withdrawn
 Average Collection Period

 Trade debtors (receivables) divided by

average daily credit sales
Credit sales = turnover (approximately)
Trade debtors from current assets
 Average Settlement Period

 Trade creditors (payables) divided by

average daily credit purchases
Credit purchases are approximately operating expenses less staff
costs and depreciation
 Longer term cash flow forecasts

 Capital projects appraisal

 Capital budget
 Financing plan
 Need for long-term finance?
 Need for venture capital
 Equity versus debt?
 P&L to cash flow statement
 Scheduled revenues: + 30 days
 Charter revenues in month of flight
 Fuel expense in month of flight
 Other expenses: normal 30 days’ credit
 Aircraft lease cost: monthly in advance or arrears
 Aircraft deposits: say, $100,000 on contract signature, $150,000
per aircraft on delivery
 Aircraft and pax insurance: 40% after 2 months, 40% after 4
months, rest after 6 months
 Commission payable after 30 days (15 days in some regions)
 Wages and salaries in actual month
Depreciation & amortisation??
Business Plan
 Defines your business
 Identifies your goals, and serves as your firm's resume
 Current and pro forma balance sheet
 Income statement
 Cash flow analysis

Are resources allocated in the best way?

Enables the handle unforeseen complications
Framework for good business decisions

Crucial part of any loan or financing application: provides

information about how loan will be repaid, and profits generated
for shareholders
 Investment evaluation
 Performance or earnings
Operating ratio
Return on investment & equity
 Risk or solvency
Debt/equity & interest cover
 Liquidity
Current & quick ratios
 Stock market ratios

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Operating ratio
Operating revenues as a % operating expenses
British Airways 2004/05 2005/06
Op. revenues £m 7,772 8,515
Op. expenses £m 7,216 7,810
Op. profit £m 556 705
Operating ratio % 107.7 109.0
Op. expenses plus
Interest paid* £m 7,481 8,031
Adj. operating ratio % 103.9 106.0

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 Operating margin
(Alternative to Operating Ratio)

Operating profit as a % operating revenues

British Airways 2004/05 2005/06
Operating profit £m 556 705
Op. revenues £m 7,772 8,515
Operating margin % 7.2 8.3
Op. profit less interest pd £m 291 484
Adj. op. margin % 3.7 5.7

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 Return on Invested Capital (ROIC)
or Return on Capital Employed (ROCE)

Profit before net interest and tax as % of total long-term capital

employed
US$ million BA: 2005/06 AMR: 2005
Pre-interest/tax profit 1,505 96
Av. capital & reserves 3,107 (1,030)
Av. long-term debt 6,845 13,490
Av.total long-term capital 9,952 12,460
________________________________________________
Return on Investment % 15.1 0.0
UK£ to US$ conversion rates?

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 Return on total assets
Profit before net interest and tax as % of total assets employed

British Airways £m 2004/05 2005/06

Pre-interest/tax profit 778 841

Average total assets 11,717 11,923

Return on assets % 6.6 7.1

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 Asset turnover

Ratio of total revenue or turnover to total assets employed

British Airways £m 2004/05 2005/06

Turnover 7,772 8,515

Av. total assets 11,717 11,923

Asset turnover 0.66 0.71

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 Return on Equity (ROE)

Profit after net interest and tax as % of total shareholders’ funds

US$ million BA: 2005/06 AMR:2005

After tax/interest profit 836 - 861
Av. shareholders’ equity 3,107 - 1,030

Return on Equity % 26.9 n/a

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 Interest cover

Profit before net interest and tax divided by net interest expense

British Airways £m 2004/05 2005/06

Pre-interest/tax Profit (A) 681 748
Net interest payable (B) 169 128
Interest cover (A/B) 4.1 5.8

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 Debt / Equity ratio

Long-term debt or borrowing divided by shareholders’ funds

£m end March: 2005 2006

Long-term debt 4,045 3,602
Shareholders’ funds 1,397 2,074

Debt/equity ratio 2.90 1.74

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 Debt / Capital ratio

Long-term debt or borrowing as a % of total long-term capital

employed

£m end March: 2005 2006

Long-term debt 4,045 3,602
Shareholders’ funds 1,397 2,074
Total long-term capital 5,442 5,676
Debt as % l-t capital 74.3 63.5

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 Net Debt / Equity ratio

Long-term and short-term debt less cash and deposits

divided by shareholders’ funds
£m end March: 2005 2006
Long-term debt 4,045 3,602
Current portion of debt 447 479
Cash/deposits (1,682) (2,440)
Net debt 2,810 1,641
Shareholders’ funds 1,397 2,074
_____________________________________________________

Net Debt/equity ratio 2.01 0.79

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 Financial gearing or leverage: low profits

Airline A Airline B
Shareholders’ funds 200,000 400,000
Long-term debt 300,000 100,000
Total long-term capital 500,000 500,000

Pre-interest profit 30,000 30,000

Interest payable @10% (30,000) (10,000)

Net profit 0 20,000

Net profit as % equity 0% 5%

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 Financial gearing or leverage: high profits

Airline A Airline B
Shareholders’ funds 200,000 400,000
Long-term debt 300,000 100,000
Total long-term capital 500,000 500,000

Pre-interest profit 60,000 60,000

Interest payable @10% (30,000) (10,000)

Net profit 30,000 50,000

Net profit as % equity 15.0% 12.5%

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 Current ratio

Ratio of current assets to current liabilities

£m end March: 2005 2006

Current assets 2,752 3,666
Current liabilities* 3,269 3,432

Current ratio 0.84 1.07

* Includes sales in advance of carriage liabilities

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 Quick ratio

Ratio of quick assets to current liabilities

£m end March: 2005 2006

Quick assets 1,682 2,440
Current liabilities 3,269 3,432

Quick ratio 0.51 0.71

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 Dividend cover

Net profit attributable to shareholders divided by dividend payable

£m 2004/05 2005/06
Profit/(loss) for the year - 21 251
Dividend payable 195 193
Dividend cover n/a 0.59

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 Other important ratios

 Dividend yield
 Earnings per share
 Price/earnings ratio (historical or prospective)
 Price/cash flow
 Market capitalisation
 Net assets per share
 Enterprise value or EV / EBITDA

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 Other ratio definitions

 Enterprise Value (EV)

Equity market capitalisation + Net debt (book and market value of
debt less cash/deposits in current assets) – non-core assets
 EBITDA(R)
Earnings (profits) before interest, tax, depreciation, amortisation
(and rentals)
 Maintenance capex
The notional expenditure required to allow growth and maintain a
constant fleet age
 Operating free cash flow (OpFCF)
Gross cash flow less maintenance capex

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 Value ratios
 Price/Earnings ratio
Ratio of market price of ordinary shares on a particular day to the
earnings per share for the latest year (can also be prospective)
BA share price on 31 March 2006: 353.3 p
BA earnings per share for 2005/06: 39.8 p
BA P/E ratio on 31 March 2004: 8.9
 Enterprise Value (EV) to EBITDA
Expresses the cash return on the adjusted market value, but
charge for replacement of assets excluded
 Cash Value Added (CVA)
Sustainable cash profit less return on gross assets (at current
prices) based on weighted average cost of capital (WACC)

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 Airline Valuation
 Value of firm should equate to net present value of future cash
flows
 P/E ratio or EV multiples?
 P/E ratio assumes future capex needs equal depreciation charge
(see FT Lex column, 6/1/03)
 EBITDA includes neither depreciation nor capital expenditure (see
FT Lex column, 6/1/03)
 EV / EBITDA useful in comparing firms with different capital
structures and depreciation policies

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 Timing of cash flows
 Cash inflows:
Trade debtors (receivables) divided by average daily credit sales
Credit sales = turnover (approximately)
Trade debtors from current assets
2005/06: BA 29 days; Ryanair 6 days
 Cash outflows:
Trade creditors (payables) divided by average daily credit
purchases
Credit purchases are approximately operating expenses less
staff costs and depreciation
2005/06: BA 58 days; Ryanair 28 days

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BA Targets 2002:
 Operating margin: 10%
 Cash Value Added (CVA) positive
 Debt/equity: towards 50%
 Cash flow: positive

Air France-KLM Target for 2008:

8.5% for ROCE

Austrian Airlines (2006):

Stockholders’ equity as % total liabilities of 25% (medium-term)
Outperform MSCI Europe Airlines index by 3% over 3 year period
Continuous improvement in CVA

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