Aviation Training Programme

AIRLINE FINANCE AND ACCOUNTING MANAGEMENT

The basic assumption underpinning modern financial theory is that

companies will manage their money and run their operations, while
also seeking to make a return for owners and investors. In other
words, the field of finance naturally assumes that the primary
objective of any business is to make a profit.

Therefore, this course assumes that being and remaining profitable

is the primary concern of all airlines in todays highly competitive
environment. With this in mind, this course aims to provide learners
with an overview of the major tasks, issues and tools of financial
management in relation to todays airline industry. A thorough
understanding of these will enable you to make informed analyses of
the financial positions of your own airline and of others.

For those with little or no experience in the field of finance, this

course aims to provide you with a basic understanding and
appreciation of the role of finance in an airline. It will also introduce
you to basic accounting principles and the most important company
accounts.

For those already engaged in financial activities, the course will

outline the main issues and problems facing the airline industry as a
whole, and indicate how efficient financial management can help
overcome these problems.

Course Structure
To help you successfully complete and enjoy the course, we have
structured the content into nine modules. Each module has the
following parts:

Module Overview
At the beginning of each module you will see an introduction that
provides an overview of the content of the module and highlights its
learning objectives.

Introduction 1
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Lessons
Each module is made up of three to nine lessons, and each lesson
includes the following:

Lesson Overview
The beginning of each lesson provides you with an overview of the
topics to be covered and its learning objectives.

Units
Each lesson covers from one to seven units.

Review Questions

Each lesson includes review questions covering the main points of

the lesson. These questions enable you to assess your
understanding of the concepts discussed and will help you review the
material covered in preparation for the Progress Checks. The
answers to these Review Questions are included in a separate
section at the back of the manual.

Progress Checks
At the end of each lesson is a short exercise, made up of multiple
choice, short answers, or matching questions. These are designed to
provide you with the opportunity to see if you understood the
material. An Answer Key is provided so that you can check your
responses.

Lesson Summary
Each lesson ends with a summary of the main points.

Module Summary
Each module ends with a summary drawing together the main points
of each lesson.

2 Introduction to the Airline Industry

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Key Learning Points

Key Learning Points are highlighted throughout the text and are
designed to emphasise particularly important issues and
conclusions.

Apply Your Learning

This section follows the Module Summary and provides you with the
opportunity to apply what you have learned within your own context.
You will get the most from this course if you make the effort to
complete these exercises.

Case Studies
Factual and fictitious case studies are presented at various points
throughout the course. They will often consist of both general
information about an airline, and the carriers statutory accounts.
The purpose of these case studies is to provide you with an
opportunity to relate what you have studied to real world situations,
and to supply you with further information on some of the best and
worst ways of running an airline. Each case will present you with a
number of questions and exercises. You can check your answers by
referring to the section Case Study Solutions at the back of the
manual.

Recommended Reading
Should you wish to further research a given topic, a list of
recommended readings is included at the end of each module.

Glossary
This section at the back of the manual explains the most important
terms used throughout the modules. The words that are in italics
throughout the text are defined in the glossary.

Introduction 3
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Examination Procedures

To obtain the IATA Certificate in Airline Finance and Accounting

Management, you must pass a written examination. The examination
must be taken within 18 months of registering for the course.

The course fee covers the training material and examination fees for
two (2) exam attempts as well as the issuance of the course
certificate to successful exam graduates. Candidates are required to
bring identification to the examination.

As a newly enrolled student, you are automatically registered to sit

your examination in the first eligible examination session, as
indicated in your Student Enrolment Letter. You are able to change
your registered exam session to a later one within your 18 month
enrolment period by writing to IATAs Distance Learning
Examinations Centre at training.sin@iata.org. All exam registration
changes must be made before the exam registration deadline posted
on IATAs website. Please refer to our website
http://www.iata.org/training/register_aviation_dl for more information
on registration deadlines and examination details.

Examinations are held twice a year during a worldwide examination

session week. You may be required to take examinations at an
exam centre that is not in your home city or country of enrolment. All
travel and personal expenses and travel documentation are your
responsibility.

The IATA Local Co-ordinator determines the exact date and location
of the exam during the worldwide examination session week. You
will receive an exam confirmation letter giving you the exact date,
time and location of the exam prior to the examination date. You are
allowed two (2) attempts to pass the examination within your 18
month enrolment period. A second exam failure will cause your
enrolment to be cancelled. If you register for an examination and do
not attend, you will be recorded as no-show and will automatically fail
the examination attempt.

This course is designed to make the study of airline finance and

accounting and its application as enjoyable and as stimulating as
possible. Good luck with the course!

4 Introduction to the Airline Industry

 AIRLINE FINANCE AND ACCOUNTING MANAGEMENT

TABLE OF CONTENTS

Introduction.......................................................................................................................................................... 1

Module 1: Financial Management Within Todays Airlines Industry............................................................ 5

1.1 Key Features of Financial Management ............................................................................................. 6
1.1.1 Financial Management and Its Importance............................................................................ 6
1.1.2 Role of the Financial Manager: Maximising Company Value ................................................ 7
1.1.3 Who is the Financial Manager?.............................................................................................. 9
1.2 Financial Performance of the Airline Industry ................................................................................... 14
1.2.1 Marginal Profitability............................................................................................................. 14
1.2.2 Increased Demand for Lower Fares .................................................................................... 16
1.2.3 Emergence of Low-Cost Carriers......................................................................................... 16
1.3 Short- and Long-Term Strategies...................................................................................................... 19
1.3.1 Short-Term Cost-Cutting Strategies..................................................................................... 20
1.3.2 Long-Term Industry Strategies............................................................................................. 22
1.3.2.1 Modernisation ...................................................................................................... 22
1.3.2.2 Sources of Capital................................................................................................ 23
1.3.2.3 Restructuring........................................................................................................ 23
Module Summary........................................................................................................................................ 27

Module 2: The Role of Accounting in Airlines.............................................................................................. 31

2.1 The Financial Information System..................................................................................................... 32
2.1.1 The Purpose of Accounting.................................................................................................. 32
2.1.2 Financial Accounting and Management Accounting ............................................................ 33
2.1.3 The Bookkeeping System .................................................................................................... 34
2.1.4 External Users of Financial Reports .................................................................................... 36
2.2 Basic Accounting Terminology, Principles and Practices ................................................................. 43
2.2.1 Accounting Terminology....................................................................................................... 43
2.2.2 Double Entry Bookkeeping and the Balance Sheet Equation.............................................. 46
2.2.3 Depreciation Methods .......................................................................................................... 50
2.2.3.1 Straight-Line Method of Depreciation .................................................................. 50
2.2.3.2 Reducing Balance Method of Depreciation ......................................................... 51
2.2.3.3 Current Cost Method of Depreciation .................................................................. 52

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 2.3 Statutory Accounts ............................................................................................................................ 56
2.3.1 The Profit and Loss Account ................................................................................................ 57
2.3.2 The Balance Sheet............................................................................................................... 61
2.3.3 Sources and Uses of Funds Statement ............................................................................... 67
2.3.4 Notes to the Accounts .......................................................................................................... 71
2.3.5 The Auditors Report ............................................................................................................ 73
2.3.6 The Group Accounts ............................................................................................................ 73
2.3.7 Recognising Revenues and Expenses ................................................................................ 74
2.4 Management Accounting .................................................................................................................. 78
2.4.1 Management Accounts ........................................................................................................ 79
2.4.2 Working Capital Liquidity Management ............................................................................ 80
2.4.3 Volume Versus Traffic.......................................................................................................... 80
2.4.4 Key Financial Ratios ............................................................................................................ 83
2.5 Interfaces With Other Functions........................................................................................................ 86
2.5.1 Information Flowing Into the Accounting Department.......................................................... 86
2.5.2 Information Flowing Out of the Accounting Department ...................................................... 87
2.6 Special Accounting Considerations................................................................................................... 89
2.6.1 Service Industry ................................................................................................................... 89
2.6.2 Heavily Regulated ................................................................................................................ 90
2.6.2.1 Economic Regulation ........................................................................................... 90
2.6.3 Tariffs ................................................................................................................................... 90
2.6.4 Trades Internationally........................................................................................................... 91
2.6.5 Airline Cooperation............................................................................................................... 91
2.6.6 Treatment of Income ............................................................................................................ 92
Module Summary........................................................................................................................................ 96

Module 3: Finance in the Organisation ....................................................................................................... 103

3.1 Position of the Finance Function..................................................................................................... 104
3.1.1 Internal vs. External Position.............................................................................................. 105
3.1.2 Types of Internal Positions................................................................................................. 107
3.1.2.1 Equal Status With Other Departments............................................................... 107
3.1.2.2 Controlling All Other Departments ..................................................................... 108
3.1.2.3 Controlled by a Particular Department............................................................... 109
3.1.2.4 Within Every Department................................................................................... 109
3.1.2.5 Determining Factors........................................................................................... 110
3.2 Executive Decision-Making ............................................................................................................. 115
3.2.1 Role of the Senior Vice President of Finance .................................................................... 115
3.2.2 Decision-Making................................................................................................................. 117

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 3.3 Purchasing in the Organisation ....................................................................................................... 121
3.3.1 Objective of Purchasing and Its Impact ............................................................................. 121
3.3.2 Factors Influencing Purchasing Strategy ........................................................................... 122
3.3.3 Centralisation / Decentralisation ........................................................................................ 122
3.3.4 Purchasing Fuel ................................................................................................................. 123
3.3.5 Purchasing Technical Equipment....................................................................................... 124
3.3.6 Capital Costs and Operating Costs.................................................................................... 124
3.3.7 Value Added....................................................................................................................... 126
Module Summary...................................................................................................................................... 130

Module 4: Financial Ratio Analysis ............................................................................................................. 133

4.1 Ratios and Analysis......................................................................................................................... 134
4.1.1 What is a Ratio? ................................................................................................................. 134
4.1.2 Use of Parameters ............................................................................................................. 136
4.1.3 Appraising Past Performance ............................................................................................ 137
4.1.4 Using Figures from the Profit and Loss Account and Balance Sheet ................................ 137
4.1.5 Types of Ratio .................................................................................................................... 138
4.1.6 Categories of Financial Ratios ........................................................................................... 139
4.2 Liquidity Ratios ................................................................................................................................ 143
4.2.1 Working Capital Ratio (Current Ratio) ............................................................................... 144
4.2.2 Liquid Ratio (Acid Text Ratio or Quick Ratio) .................................................................... 146
4.2.3 Debtor Payment Period (Debtor Days) .............................................................................. 147
4.2.4 Creditor Payment Period (Creditor Days) .......................................................................... 149
4.2.5 Inventory Ratios ................................................................................................................. 150
4.3 Longer Term Solvency Ratios......................................................................................................... 156
4.3.1 Debt to Total Funding Ratio ............................................................................................... 157
4.3.2 Debt to Equity Ratio (Debt / Equity Ratio).......................................................................... 157
4.3.3 Interest Coverage Ratio ..................................................................................................... 159
4.3.4 Fixed Charges Coverage Ratio.......................................................................................... 160
4.3.5 Effect of Gearing on Risk ................................................................................................... 162
4.3.6 Limitations of Longer Term Solvency Ratios ..................................................................... 164
4.4 Profitability Ratios............................................................................................................................ 168
4.4.1 Return on Capital Employed (ROCE) ................................................................................ 168
4.4.2 Operating Margin ............................................................................................................... 171
4.4.3 Profit on Turnover (Return on Sales [ROS]) ...................................................................... 172
4.4.4 Return on Equity (ROE or Equity Return) .......................................................................... 173
4.4.5 Earnings per Share (EPS).................................................................................................. 173
4.5 Limitations of Ratio Analysis ........................................................................................................... 177
4.5.1 Some Limitations to Consider ............................................................................................ 177
4.5.2 Helpful Hints ....................................................................................................................... 178
Module Summary...................................................................................................................................... 181

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Module 5: Sources and Uses of Funds ....................................................................................................... 201

5.1 The Sources and Uses of Funds Statement ................................................................................... 202

5.1.1 Need for the Sources and Uses of Funds Statement ........................................................ 202
5.1.2 The Construction of the Statement .................................................................................... 205
5.2 The Cash Basis Approach .............................................................................................................. 210
5.2.1 Using the Cash Basis Approach ........................................................................................ 210
5.2.2 The Cash Basis Analysis ................................................................................................... 213
5.3 The Working Capital Approach ........................................................................................................... 222
5.3.1 Using the Working Capital Approach ................................................................................. 222
5.3.2 Layout of the Sources and Uses of Funds Statement
Using the Working Capital Approach ................................................................................. 226
5.4 Financing Issues in the Airline Industry .......................................................................................... 233
5.4.1 Sources of Finance ............................................................................................................ 233
5.4.1.1 Self-Financing .................................................................................................... 233
5.4.1.2 Long-Term Debt................................................................................................. 234
5.4.1.3 Equity Finance ................................................................................................... 234
5.4.1.4 Government Capital ........................................................................................... 235
5.4.1.5 The Japanese Capital Markets .......................................................................... 235
5.4.1.6 Asset Sales ........................................................................................................ 235
5.4.1.7 Privatisation ....................................................................................................... 236
5.4.2 Uses for Finance ................................................................................................................ 237
5.4.2.1 Equipment.......................................................................................................... 238
5.4.2.2 Operating Costs ................................................................................................. 238
5.4.2.3 Long-Term Debt Repayments ........................................................................... 239
5.4.2.4 Dividends ........................................................................................................... 239
5.4.3 Conclusions........................................................................................................................ 239
Module Summary...................................................................................................................................... 243

Module 6: Financial Control ......................................................................................................................... 275

6.1 Planning .......................................................................................................................................... 276
6.1.1 Financial Control ................................................................................................................ 277
6.1.2 Planning Process ............................................................................................................... 279
6.1.3 Benefits of Planning ........................................................................................................... 280
6.1.4 Types of Planning .............................................................................................................. 281
6.1.4.1 Long-Term Financial Plans................................................................................ 282
6.1.4.2 Route Planning .................................................................................................. 282
6.1.4.3 Aircraft Fleet Planning........................................................................................ 283
6.1.4.4 Capital Project Appraisal ................................................................................... 283
6.1.4.5 Budgeting........................................................................................................... 285

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6.2 Reporting Results............................................................................................................................ 292
6.2.1 Profit Analyses ................................................................................................................... 293
6.2.2 Profit Contribution .............................................................................................................. 294
6.2.3 Marginal Costing and Break-Even ..................................................................................... 298
6.3 Cost Control .................................................................................................................................... 306
6.3.1 Authority to Spend.............................................................................................................. 306
6.3.2 Relating Spending to Activity ............................................................................................. 307
6.3.3 Time Controls ..................................................................................................................... 307
6.3.4 Headcount Quotas ............................................................................................................. 308
6.4 Credit Control .................................................................................................................................. 311
6.4.1 Purposes of Credit Control................................................................................................. 311
6.4.2 Customer Credit ................................................................................................................. 312
6.4.3 Payment Terms .................................................................................................................. 313
6.4.4 Follow-Up Action ................................................................................................................ 314
6.4.5 Reporting............................................................................................................................ 316
6.5 Yield Management and Inventory Control....................................................................................... 319
6.5.1 Yield Management Concepts ............................................................................................. 320
6.5.2 Overbooking Management................................................................................................. 322
6.5.3 Components of Effective Yield Management..................................................................... 324
6.6 Safeguarding Assets ....................................................................................................................... 330
6.6.1 Blank Tickets and Cash ..................................................................................................... 330
6.6.2 Receivables........................................................................................................................ 331
6.6.3 Stocks................................................................................................................................. 331
6.6.4 Fixed Assets....................................................................................................................... 331
6.7 Performance Analysis ..................................................................................................................... 334
6.7.1 Financial Ratios.................................................................................................................. 334
6.7.2 Profit Performance ............................................................................................................. 335
6.7.3 Staff Performance .............................................................................................................. 335
6.7.4 Costs Related to Level of Activity....................................................................................... 336
6.7.5 Budget Variances............................................................................................................... 336
6.7.6 Comparisons with Previous Years ..................................................................................... 337
6.7.7 Comparisons with Other Airlines........................................................................................ 337
Module Summary...................................................................................................................................... 343

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Module 7: Cash Management ....................................................................................................................... 351
7.1 Cash Management Within an Organisation .................................................................................... 352
7.1.1 Reasons for Cash Management ........................................................................................ 352
7.1.2 Implications of Poor Cash Management ............................................................................ 353
7.2 Liquid Assets ................................................................................................................................... 356
7.2.1 Advantages and Disadvantages of Holding Liquid Assets ................................................ 356
7.2.2 Managing the Companys Cash Position ........................................................................... 357
7.3 Cash Management Problems.......................................................................................................... 369
7.3.1 Factors Affecting Cash Flow Management ........................................................................ 369
7.3.2 Managing Cash Inflows and Outflows................................................................................ 372
7.4 Cash Forecasts ............................................................................................................................... 375
7.4.1 Estimating Cash Inflows and Outflows............................................................................... 375
7.4.2 Short-Term Cash Forecasts............................................................................................... 376
7.4.3 Long-Term Cash Forecasts ............................................................................................... 378
7.4.4 The Key Elements of Cash Management: Conclusions .................................................... 380
Module Summary...................................................................................................................................... 383

Module 8: Accounting Trends in the Airline Industry................................................................................ 387

8.1 Current Status of Accounting Practices .......................................................................................... 388
8.1.1 Need for Accounting Standards ......................................................................................... 388
8.1.2 Basis of Accounting............................................................................................................ 389
8.1.3 Consolidation...................................................................................................................... 390
8.1.4 Goodwill.............................................................................................................................. 390
8.1.5 Deferred Charges............................................................................................................... 391
8.2 Accounting for Fleet Assets ............................................................................................................ 395
8.2.1 Fleet Profile ........................................................................................................................ 395
8.2.2 Fleet Procurement.............................................................................................................. 396
8.2.3 Factors Affecting Fleet Financing Decisions...................................................................... 398
8.2.4 Factors Affecting the Availability of Finance ...................................................................... 400
8.3 Aircraft Leasing ............................................................................................................................... 405
8.3.1 Aircraft Leasing Methods ................................................................................................... 405
8.3.2 Advantages of Leasing....................................................................................................... 408
8.3.3 Disadvantages of Leasing.................................................................................................. 408
8.3.4 Aircraft Leasing Accounting Practice .............................................................................. 409
8.4 Aircraft Depreciation........................................................................................................................ 413
8.4.1 Impact on Profit and Loss Account .................................................................................... 413
8.4.2 Approaches to Depreciation............................................................................................... 414
8.5 Reporting of Profit and Loss Items.................................................................................................. 421
8.6 Revenue Accounting ....................................................................................................................... 426
8.6.1 Changes in Revenue Accounting....................................................................................... 426
8.7 Frequent Flyer Accounting .............................................................................................................. 429

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 8.8 Treasury and Foreign Currency ...................................................................................................... 431
8.8.1 Activity and Tools ............................................................................................................... 431
8.8.2 KPMG / IATA Accounting Guideline on Foreign Currency ................................................ 433
8.9 Trends and Developments .............................................................................................................. 438
8.9.1 Critical Financial Issues ..................................................................................................... 438
8.9.2 Debt to Equity Ratios ......................................................................................................... 439
8.9.3 Strategic Investments and Alliances .................................................................................. 440
8.9.4 Financial and Management Information Systems.............................................................. 442
8.9.5 Fiduciary Responsibility and Compliance .......................................................................... 442
Module Summary...................................................................................................................................... 446

Module 9: The Cost Rebalance Program .................................................................................................... 455

9.1 Introduction to Case Study.............................................................................................................. 456
9.2 Choosing a Cost Reduction Approach............................................................................................ 457
9.3 Stage 1: Foundation........................................................................................................................ 460
9.4 Stage 2: Project Planning and Structure......................................................................................... 460
9.5 Stage 3: Activity Mapping................................................................................................................ 463
9.6 Stage 4: Cost Rebalance and Consequence Analysis ................................................................... 465
9.7 Stage 5: Implementation and Stage 6: Reinforcement ................................................................... 467
9.8 Conclusion....................................................................................................................................... 468
Module Summary...................................................................................................................................... 471

ANSWERS TO REVIEW QUESTIONS........................................................................................................... 475

CASE STUDY SOLUTIONS ........................................................................................................................... 507

CASE STUDY 1: Balance Sheet Quiz: Unidentified Business Sectors .................................................... 507
CASE STUDY 2: Lincoln Air ..................................................................................................................... 511
CASE STUDY 3: Skybound Airlines International .................................................................................... 522
CASE STUDY 4: Air Hardup..................................................................................................................... 531

GLOSSARY .................................................................................................................................................... 537

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