From a financial standpoint, to effectively manage your fleet of aircraft, life cycle cost is the most basic projection of your fleet’s future operating costs.
In the informative video below, Mike Dwyer, Managing Partner of Guardian Jet, discusses the importance of life cycle cost to your aviation organization’s bottom line.
Mike explains how, when you develop models to compare the cost of different aircraft, different ownership options and different utilization levels, life cycle cost is, in fact, the bottom line, the final aircraft finance number that provides what it will cost.
This video also offers details of the variety of inputs and projections that are used to calculate life cycle cost and how it can help you make critical decisions.
Watch on YouTube or read the full transcript below:
Hi! I’m Mike Dwyer.
Thanks for coming to the Guardian Jet Learning Center to talk Aircraft Finance 101, or life cycle costs.
We look at life cycle cost analysis as kind of the foundation of a lot of the financial work that we do, and there’s a couple reasons for that.
First of all, life cycle cost has tremendous analytical merit all on its own to help you understand the impact of what you’re operating or what you’re considering operating in the future.
Second, life cycle cost is a great foundation for all the more complex financial models that you use to consider capital expenditures.
In a fleet plan—whether you have one airplane, five airplanes or 10 airplanes—life cycle cost is a wonderful piece of the puzzle.
Net present value, when you consider cost of capital, the time value of money…
Replacement timing is often looked at through the life cycle cost lens: do I operate an airplane five, 10 or 15 years? Do I make the replacement today, next year, or in two years or three years?
So, life cycle costs gives you a great look at that, and also, ultimately, it is an interval part of asset management, where you look at your airplane like any other assets in the portfolio.
There are lots of reasons to try and understand life cycle cost, so let’s get started and talk about exactly what we mean.
Life Cycle Cost Analysis
In life cycle cost analysis, we’re looking at a financial projection, so it’s usually looking between five and 10 years into the future.
The three components of life cycle costs are the purchase price, the operating costs over the term, and the disposal or residual terminal value at the back end.
Since we’re talking about airplanes I like to call it: “buy, fly, sell.”
Simply put, we build a model where we enter the purchase price of the aircraft. Then we look at what it cost to operate the aircraft over the term, and then we have a terminal value at the end. We sum those numbers into the net cumulative number down in the bottom right-hand corner.
Of the three inputs, two of them are pretty straightforward: the purchase price and the operating costs.
First of all, we can investigate or negotiate purchase price, second of all the operating costs—which are very well published in our industry—and you might have your own direct experience with the operating the aircraft.
The two inputs, “buy” and “fly,” are straightforward. I’d make sure that you get some expert advice on the residual value; it’s the toughest to call because it’s out in the future, and it does vary from model to model.
It’s a learning center discussion topic on its own, so you might want to get some help in the third part of the life cycle cost analysis.
In round numbers, in the actual projection or cash flow or spreadsheet, there’s about a hundred inputs that go into a typical life cycle cost.
It makes great sense to build consensus at the beginning of the process between the people that will interpret the results of the life cycle cost analysis and the people building it.
If everybody gets on the same page early, it makes for a much more efficient process and, of course, a much more effective product at the end.
Examples of those inputs would be the term:
- How far out do we want to look — 5 years, 10 years, etc.?
- Do we want to do a cash flow (which is more typical in life cycle cost) or do we want to do it from a profit-and-loss perspective (as in the more traditional financial reporting statements)?
- Is the model a pre-tax model or is it an after-tax? If it’s an after tax, what’s the tax rate that will we will apply to all the deductible expenses, such as operating costs and appreciation interest if that’s involved?
Once we’ve settled on the inputs, then we say: “Is this going to be a comparative analysis?”
We like to look at the baseline life cycle costs projection as your status quo . . . what if we just kept doing what we’re doing today for 5-10 years to determine the analysis?
Then we can start comparing that to different options of replacing in this interval, looking at different replacement options for what we currently operate, etc. But that’s what we mean about the comparative nature of a life cycle cost.
Now let’s look at an example of a cash flow so we can get an idea of what one looks like.
First of all, there are several pages of inputs, but I’m going to skip past that right now and just get to what the output looks like.
They’re essentially two pages that build on each other. The first page has the operating costs in it, and in my “buy, fly, sell” metaphor this is the fly part. It’s also what I call “If I hand you an airplane, this is what it costs me to operate one.”
So we started out pretty simple, variable costs on top, fixed costs come after that, or you can do it vice versa.
Then we like to have interval costs associated with it, and an interval cost would be when we have a significant expense that occurs at some point during the term of the projection—like an overhaul on an engine or painting an interior refurbishment—a significant maintenance event that would affect the results of the life cycle costs.
That’s page one, and that really deals with what it cost to operate the aircraft.
Page two brings in the “buy” and the “sell” phase, and adds that into the operating expenses. We look at what we buy the aircraft for, so we’re introducing capital, and then introduce the tax impact of the deductible expenses here on this page.
The second page introduces the operating expenses and the capital cost, so we’ve got buying it, (and, by the way, if you’re financing or leasing, that would be representative in page 2), and then you have the operating costs you added from page one.
And then, at the end, you have the residual or terminal value back into the cash flow, so you have a representation of what the value of what the asset was at the end of the period.
That nets down to that bottom right-hand corner, life cycle costs cumulative number.
That is the “buy, fly, sell” life cycle costs in a nutshell.
If you’d like to discuss your personal or particular circumstances in more detail, please give us a call.
We’d love to talk about it. And thank you for listening today on life cycle costs.