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Managing bizjet & TP direct operating costs

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As ever greater demands are placed on business aviation efficiency and effectiveness, cost management becomes an increasingly important aspect of aircraft ownership and operation.


By Don Van Dyke
ATP/Helo/CFII, F28, Bell 222.
Pro Pilot Canadian Technical Editor

Business aviation is a vital component of the global economic network, providing mobility, benefits, and connectivity to remote nodes, and serving needs of the commercial community. Well-managed costs associated with these operations underpin their continued ability to serve with efficiency and effectiveness.
Business aviation has 3 current priorities – to provide safe, efficient connectivity, to advance competitiveness, and to foster environmental stewardship by meeting aspirational goals for reduction of CO2 emissions and carbon-neutral growth.

In meeting these goals, studies have shown that companies using business aviation outperform those that don’t. Successful owners and operators draw on wide-ranging expertise to meet business needs, resolve related challenges, and overcome adversities.

In every sense, professional pilots are asset managers who can apply their experience, knowledge, and oversight to inform and influence decisions related to aircraft financial management.

With the requisite desire, analytical experience, and relevant skills (or the ability to acquire them quickly), involving flightcrew can lead to just the insights needed to restore a favorable economic foundation.

General concepts of identifying, managing, and minimizing major operating costs of business jets and turboprops were discussed in Pro Pilot (Feb 2021, p 38).

Given their direct impact on cash flow, a brief review of these operating costs is merited, after which another consideration in acquiring, owning, and operating new or used business aircraft is discussed – depreciation.

The example DOCs shown don’t include tax or market depreciation – a non-cash expense designed to reduce the recorded cost of an asset over its useful life. Essentially, when an income tax return is prepared, depreciation is listed as an expense. This reduces the amount of taxable income which must be reported to government. While it does not affect cash flow, depreciation does affect the residual or market value of the aircraft.

Aircraft operating costs

Expenses relating to business aircraft are traditionally categorized as non-operating, indirect operating, or direct operating costs (NOCs, IOCs, and DOCs, respectively). The following cost examples are each allocated to a distinguishing category and may be reallocated as circumstances warrant or change.

NOCs are administrative overheads (accounting, human resources management, legal and litigation services, restructuring expenses, etc) for general services often provided by a parent organization and which cannot be attributed more specifically to core business aviation activities.

IOCs include, but are not limited to, administrative services, office rent, leases, office/hangar utilities (electricity, gas, etc), furniture, supplies, equipment rental, and office technology (desktop computers, cellphones, etc) provided by a parent organization.

IOCs are not easily traceable to a specific aviation activity or aircraft type, and are incurred for a defined period (or an operating season).

DOCs comprise the largest and most impactful share of the 3 aircraft cost categories. DOCs are easily and accurately attributable to a given aircraft, type, aviation activity, or product.

At the operating level, DOCs are related to either aircraft (insurance, training, capacity, cabin subscriptions, etc) or traffic (personnel/cargo transport, aerial observation, humanitarian, etc). These may be fixed or variable, depending on application or demand.

Variable DOCs fluctuate in proportion to flight activity but at a constant rate (per flight hour), tending to dominate the total cost structure, particularly in small organizations.

Commonly, the 3 largest variable DOCs are consumables (fuel, oil, fluids), maintenance (labor/parts), and reserves (parts replacement, overhaul), amounting together to 83%. To recover a variable DOC, the organization must charge a corresponding rate per flight hour.

Fixed DOCs are calendar-based, remaining relatively constant for a given period or level of activity.

In our illustration, the 3 largest fixed DOCs are salaries and benefits, recurrent training, and insurance, comprising together roughly 94% of the total.

The fixed DOC share typically increases with organizational size due to the demands of greater infrastructure and related support needs. Total DOCs comprise aggregated variable and fixed costs. For operations with one or few aircraft, this is straightforward.

For operations involving larger fleets of multiple aircraft, traceability is critically important to allocate costs properly (hangarage, technical records maintenance, etc). Accurate and consistent allocations are essential for purposes of comparison (benchmarking), reporting, and review.

As operations grow, mature, and evolve, allocations may change. Allocation of DOCs must be considered in context. For example, salaried flightcrew would be accounted for as a fixed cost, while remuneration of contract flightcrew, on the other hand, would be a variable cost.

Depreciation

A primary question is whether or not depreciation is an operating expense. When an asset such as an aircraft is part of normal business operations, depreciation is considered an operating expense. Depreciation is one of the few expenses for which there is no associated outgoing cash flow.

It is for this reason that depreciation is not usually presented in discussions of DOCs. However, the benefits of depreciation as an aircraft financial management tool merit close examination. The values of long-term assets like aircraft are greatest when they are acquired and will likely decline over their useful economic life.

Depreciation accounts for this in 2 different ways – one offering tax relief and the other affecting aircraft residual value, albeit in ways which differ according to tax jurisdictions.

Table 1Tax depreciation. Aircraft owned and operated by businesses under qualifying conditions are often depreciable for US income tax purposes under the Modified Accelerated Cost Recovery System (MACRS), shown in Table 1.

Tax depreciation is a method by which the acquisition (capital) cost of qualifying aircraft can be recouped via income tax deductions over an allowed recovery period. MACRS permits greater depreciation allowances to be taken in the earlier years of operational life.

This permits assets to be depreciated as quickly as possible to benefit from earlier tax savings. Some uses of aircraft, such as non-business flights, may have an impact on the allowable depreciation available for deduction in any given year.

In certain cases, aircraft not qualifying under MACRS must be depreciated under the less favorable Alternative Depreciation System (ADS). This involves dividing the difference between the aircraft acquisition cost and the expected residual value by the allowable recovery period shown in Table 1. The straight-line method of depreciation is used to calculate the amount of annual deduction permitted.

Bonus depreciation. In October 2020, the US Department of the Treasury and the IRS released the final set of regulations implementing the 100% additional first year depreciation deduction, which allows businesses to write off the cost of qualifying depreciable business assets in the year they are placed in service by the business.

Broadly, these bonus provisions have no dollar cap nor net income requirement, and apply to aircraft placed into service after September 27, 2017 and operated at least 50% for business.

The industry notes longstanding opinions of economists and other experts that tax policies on accelerated depreciation encourages companies to invest in modern and more fuel-efficient aircraft, further supporting business aviation’s record of emissions reduction and its commitment to carbon-neutral growth. Tax depreciation is a complex subject.

Operators are encouraged to consult resources available through NBAA at nbaa.org/flight-department-administration/tax-issues/depreciation/, JSSI Consulting, Conklin & de Decker, and others.

Market depreciation. Decreases in aircraft value are a consequence of age, wear, or market conditions. Market depreciation is a method to account for this decline by fairly determining aircraft value at any point in time from acquisition to end-of-life. However, unlike tax depreciation, the market depreciation rate, useful life, and residual value may be nominated by the owner/operator.

In businesses operating a limited number of aircraft, financial statements often disclose a single asset category (aircraft) in their reconciliations of plant and equipment. Larger fleets usually require additional categorization to identify depreciable assets separately.

Table 2Table 2 summarizes market depreciation policies applied to detailed categories of depreciable assets and disclosed by a range of airlines, business aircraft operators, and military organizations.

Generally Accepted Accounting Principles (GAAP) sanction several depreciation methods, including straight-line, double-declining balance, sum-of-years’ digits, and others, again left to the owner/operator to nominate.

Interestingly, unlike most other forms of transport, aircraft values can appreciate over their useful life, but treatment of this aspect of their economic lives will be left for another time.

Managing DOCs

Restrictions relating to the global Covid-19 pandemic have had several adverse consequences for air transport, and for business aviation in particular.

Among these are charges related to maintenance of airworthiness, sustaining crew qualification, prolonged parking or storage, cabin cleaning, disinfection, sanitizing, associated taxes, and a myriad of similar costs.

Low aircraft utilization has increased the impact of these charges on per-flight-hour revenues. Moreover, inefficiencies related to an aging fleet are consequential to the projected decline in new deliveries.

Invoice assurance. DOCs for items like refuelling, ground handling services, airport taxes, and navigation expenses constitute significant expenditures, and overpayment of related invoices is surprisingly common.

The European Commission CORDIS project has pioneered its cloud-based Airsensus software, which detects errors in invoices raised by many suppliers at different airports, typically weeks or months after a flight occurs. Surveys reveal that 40% of affected invoices cannot be verified but are paid if they are within about 5% of what’s expected.

Duplicate invoicing is rarely evaluated. Using blockchain technology for transactions, Airsensus monitors charges and avoids overpayments. While the software was initially targeted at airlines, an association could host related services to the consolidated business aircraft market.

This would further boost its competitiveness and reduce the time-consuming manual processes that so far have failed to resolve this problem. Additional details are available at cordis.europa.eu/article/id/430264-aircraft-direct-operating-costs-heading-into-a-smooth-and-rapid-descent.

Over time, aircraft maintenance reserves account for as much as 35% of an aircraft’s annual operating budget. How this is allocated depends on whether the expense covers wear and tear, and the extent to which the asset value of the aircraft is restored.

Fuel alternatives. Sustainable aviation fuel (SAF) is produced from 100% renewable waste and residue raw materials. It is similar in chemistry to traditional fossil jet fuel. Over its life cycle, its use reduces carbon emissions by up to 80%.

Business aviation original equipment manufacturers (OEMs), fuel producers, academia, airports, and non-governmental organizations (NGOs) are being called on to advance the manufacture and wider use of SAF. Currently, fuel represents just under 30% of variable DOCs.

SAF is currently roughly 3–5 times more expensive than fossil jet fuel, which keeps the demand for SAF low and affects its production costs. Production and availability of SAF will not meet demand without the incentive of long-term tax credits.

The Sustainable Skies Act was introduced in the US House of Representatives in mid-September, proposing a tax credit which incentivizes blenders to achieve at least a 50% reduction in life cycle greenhouse gas (GHG) emissions, and continues to the end of 2031.

Taxes levied specifically on aviation fuel harm business aviation’s socio-economic contributions and connectivity, and are an ineffective way to pursue environmental goals. Moreover, until SAF refuelling points become more widely available, many will simply be overflown.

The costs of diverting to uplift SAF could be recovered through tax credits as an incentive for business aviation to patronize SAF resellers, thereby increasing demand. Motivating this requires collaboration among many trade associations and their members.

Conclusions

Tracking, reporting, and understanding DOCs is critically important to an aviation department’s financial health, especially recognizing that finite financial resources must be allocated and employed as efficiently as possible.

On delivery, engines represent roughly 20% of new aircraft value, while the remainder of the aircraft comprises the remaining 80%.

Approaching end-of-life, the ratios reverse, with engines accounting for 80% of the aircraft value and the remainder of the aircraft representing 20%. For this reason, aftermarket maintenance budgeting tends to focus on provisions for engine MRO.

Maintenance reserves, typically comprising 34% of variable DOCs, represent significant financial commitment. By engaging in hourly cost maintenance programs (HCMPs), previously discussed in Pro Pilot (Sep 2021, p 38), or predictive aircraft maintenance programs (Pro Pilot, Nov 2020, p 32), maintenance reserves could be converted from a variable to a fixed DOC, not unlike an insurance portfolio.

While variable DOCs are allocated to the operator of the subject flight, fixed DOCs are allocated according to ownership percentage. By converting maintenance reserves in this way, responsibility for maintenance reserves would be shared among owners. Eternal vigilance of aircraft DOCs is the price for business aviation’s future financial stability and security.


DonDon Van Dyke is professor of advanced aerospace topics at Chicoutimi College of Aviation – CQFA Montréal. He is an 18,000-hour TT pilot and instructor with extensive airline, business and charter experience on both airplanes and helicopters. A former IATA ops director, he has served on several ICAO panels. He is a Fellow of the Royal Aeronautical Society and is a flight operations expert on technical projects under UN administration.