Two Approaches to Airport Financial Management - Term Paper Example

AIRPORT OPERATIONS AND FINANCIAL MANAGEMENT Abstract This study is about the operational activities and financial management practices related to airport business in general. A brief overview about the various types of revenue sources available at the airports have been discussed here. Along with this, different types of expenses incurred by the airports and the means of financing those expenses have also been discussed here. The airport-airline relationship is found to be very important for the sustenance of airport business. Two major approaches towards airport financial management have been identified as the residual cost approach and the compensatory approach. The operational activities carried on in airports include both airlines related and non-airlines related business activities that help in generating revenues for them. These revenues are normally utilized to incur the operational and maintenance expenses incurred in the airport business. Other capital expenses are normally funded through either the grants received by the airports or through means of short term and long term debt financing. Table of Contents Table of Contents 2 Airport Operations and Financial Management 4 Introduction 4 Approaches to Financial Management 4 Residual Cost Approach 5 Compensatory Approach 6 Airport Revenues 7 Airport Improvement Fees 8 Airfield Area 8 Terminal Area 9 Parking 10 Rentals or Leased Property 10 Other Revenues 10 Airport Expenses 10 Capital Expenses 11 Operations and Maintenance Expenses (O&M) 11 Airport Financing 12 Conclusion 12 References 14 Airport Operations and Financial Management Introduction Airports are a type of facility which is offered to the passengers to get connected from ground to air transportation. Aircrafts like helicopters and airplanes land and take off in airports. Storage facilities for aircrafts are also available at airports. Buildings like terminal buildings and hangars and runways for landing and takeoff of aircrafts are all present in the airports. Airports can be divided into different divisions based on the various types of operational activities performed by each of the divisions. Some of those divisions are a) Airport development and planning division, b) Airport operations division, and c) Airport financial division. Some of the primary objectives of each of these airport divisions are to ensure safety of the passengers, increase its operational efficiency, and performing the cargo and aircraft operations effectively. Airport financial management is one of the important aspects of managing the operating expenses and revenue balances of airports. The revenues that are generated from operating the airports are generally utilized in the process of covering up its operating expenses. This study entails about the financial management practices followed by the airports. All the different types of sources of revenues for the airports along with the different kinds of expenses incurred by them have also been identified in this study. Approaches to Financial Management Airlines-airport relationship is critical to the success of any kind of airport business (Graham, 2012, p. 98). It is so because the airports need the revenues generated through different types of payments made to them by the airlines and the airlines in turn need to depend on the airports to utilize the facilities available to them at the airports which are required by them. Legal agreements generally specify the methods through which responsibilities and risks related to running an airport are shared and thus creating a relationship between the airlines and airport operators. These types of contracts are generally termed as "airport use agreements"(Princeton, 1984, p. 125). It helps establishment of the terms and conditions related to airlines and specifying the methods for determining the rates that are needed to be paid by the airlines for utilizing the services and facilities that are offered to them at the airports. The approach towards financial management practiced by different commercial airports is found to differ. However, most of the major airports are found to have airline-airport relationship that can be defined through either of the two approaches that will be discussed here. This has a significant impact on the pricing strategies followed by the airports. Two of those common approaches to financial management of airports are: a) The residual cost approach and b) The compensatory approach. Both of these approaches have been discussed in details as given below. Residual Cost Approach Majority of the airports are found to follow this financial management approach. In this type approach the financial risk is assumed collectively by the airlines (Odoni, 2002). Collectively they have the agreement to maintain the airport and keep it sustainable financially by making up for the residual cost. Residual costs are those costs which remain after the costs related to the airport users are offset through the revenues generated from the non-airline sources like the revenues generated from automobile parking, and various kinds terminal concessions like snack bars and restaurants present in the airports, etc. This type of residual cost is applied in various forms in different airports. A number of various cost caters can be identified in most of the airports like, airfield, terminal buildings, grounds and roads, air freight regions etc. Total costs incurred annually that includes costs related to administration, operations, maintenance, and debt service can all be measured and calculated for each of the cost centers in a residual-cost airport. Then these costs are offset through the revenues generated from non-airline business activities carried on in those respective cost centers. The residual costs that remains after offsetting the costs through non-airline activities then helps in determination of the rates that are to be charged to the airlines for utilization of services and facilities available in those cost centers. Any kind of revenues that are generated in surplus are credited to the airlines. Any type of deficits is again charged to the airlines in the form of different types of fees like the landing fees in the subsequent financial year. Compensatory Approach The financial risk related to the operation of airport is assumed by the airport operator in case of compensatory approach. The charges and rates that is equivalent to the costs related to the utilization of facilities by the airlines are paid by them. These costs are determined using cost accounting techniques. This type of approach is different from the situation corresponding to the residual cost airports in a way that the airlines relative to the compensatory airport do not offer guarantee that the rents and fees would help in meeting all the debt service and annual operating requirements of the airport (Doganis, 1992, p. 199). This type of approach towards financial management is not that common amongst the major airports. In the case of compensatory approach of financial management in airports, first of all the total annual expenses related to the cost center is calculated. It takes into account all the costs related to running the cost center like, administration costs, maintenance costs, operations costs and the debt service costs. Part of these costs which are required to be shared by the airlines are measured and calculated on the basis of utilization of facilities by the airlines within each of the cost centers of the airport. The airlines would not be required to pay for the costs related to public space like terminal lobbies. In addition to this, the airlines would not be receiving any share of credit for the revenues generated through non-airline activities carried on in the airport. Airport Revenues Airport revenues are generated through various means in an airport. The major sources of revenues generated by an airport vary significantly based on the volume of operational activities carried on in an airport and its supporting infrastructure. Airlines are the major source of revenues for any airport. Besides this various other non-airline sources also contribute to the generation of revenues by the airports. Those non-airlines business activities that help in generating revenues for the airports include activities like, rents associated with the parking areas, gift shops, restaurants, industrial parks that are located in places separate from the airport grounds, hotels, etc (Kaps, 2000, p. 233). In some of the situations, a portion of gross revenue associated with the airport business is collected through compensation received above the applicable standard rates. In cases of certain small sized airports, revenues are sometimes generated from the fees or rents that are charged to the farmers who are engaged in activities related to growing crops in some parts of the airport grounds. However, the majority of the revenues are generated by the airports through fees, charges and rents that are paid by the airlines. The major operating revenues that are collected by the airports can be grouped together into various categories. They are: a) Airport improvement fees (AIF), b) Airfield area, c) Terminal area, d) Concessions, e) Parking area, f) Rental or leased areas, and g) Other operating revenues (Mos.uwo, n.d.). Airport Improvement Fees Airport Improvement Fee (AIF) is a type of fee that is charged to the departing passengers and is imposed by the airport authority. It is included in the airline ticket fee that is paid by the passengers. This type of fess is meant for the purpose funding capital improvements that are needed to be undergone in the airports. AIF is a type of additional fees charged to the airplane passengers in an airport. Airfield Area Different types of sources of revenues can be identified that are generated in the airfield area in an airport. Some of those revenue sources collected at the airfield of an airport include landing fees, terminal fees aircraft parking fees and others. They are discussed as given below. Landing Fees Landing fees are imposed on the basis of landing of each of the aircrafts in a particular airport. This type of revenues is usually considered to be the largest income source for an airport. Landowning charges are normally charged to jet aircrafts. In the recent years, some of the airports have started charging landing fees for the piston aircrafts also. The rate of landing fees is same for both the domestic aircraft and international aircraft arrivals at the airport. The landing fees are based on the aircraft's gross weight at the time of its takeoff. Terminal Fees Terminal fees are imposed the aircrafts which are engaged in the activities related to carrying charter or scheduled passengers and makes use of the terminal building present in the airport. It is also one of the largest sources of revenue for an airport. The rate of terminal fees is different depending on the aircraft being domestic or international. These fees are calculated based on the maximum number of sitting capacity of a particular aircraft. Aircraft Parking Fees The parking fees are charged to those aircrafts that are parked in a particular airport for duration of more than one day. This type of fees is calculated on the basis of the gross weight of an aircraft at the time of its takeoff. The parking fees are rated normally on per day, per month or on per year basis (Grothaus, 2009, p. 14). Others There are some other types of revenue sources associated with activities performed in the airfield area of an airport. One is the loading bridge fees which are normally charged at flat rates. Other fees associated with the airfield area are customs pre-clearance fees, flight information display fees, aircraft plug in fees, security fees, etc. Terminal Area Various types of revenue sources can be identified in the terminal area of an airport. Some of those revenue sources include office rentals, baggage handling charges, ticket counters, and rentals related to ground equipments, etc. Various concessions offered in the terminal area of an airport are also an important source of revenues for the airports. Those includes food concessions, beverage concessions, specialty stores and shops, amusements, display advertising and other outside terminal concessions like auto parking, hotels, ground transportation, etc. Concession fees also come in various forms. Some of the concessions are associated with contractual agreements that exist between the airport authorities and private operators who are engaged in some kind of activities that utilize the facilities offered at the airport. Parking Fees are charged for vehicles parked at the parking lots which are operated by the airport authorities. The revenues generated from such parking lots are earned by the airports. In some airports parking lots are contracted to some other companies and thus revenues are generated by the airports in the form of rentals. Rentals or Leased Property Rentals or lease rentals from some airport owned properties like hangars which are used for both private and commercial purposes, manufacturing plants, freight warehouses, etc. also forms part of the revenues generated by the airports. Other Revenues Other types of revenues sources for airports include consulting fees, subsidiary companies and consulting fees. Airport Expenses The expenses incurred by the airports can be categorized into two different broad types. They are: a) Capital expenses, and b) Operations and management expenses (O & M). Capital expenses incurred by the airports are categorized as those expenses which are of large amounts and other expenses incurred on a periodical basis that help in contributing towards significant expansions or improvements of the infrastructure facilities in airports. On the other hand, operations and management expenses are categorized as those types of expenses that are found to occur regularly in the airports and are required to be incurred to facilitate its daily operational activities. Capital Expenses Major sources of capital expenses incurred by the airports relates to items like, aprons, taxi ways and runways. Capital expenses are also incurred in the form of expenses related to utilities, fencing, electrical equipments, parking lots, roads, equipments, vehicles, buildings such as fire hall, maintenance, etc. and different types of other miscellaneous expenses. Thus the capital expenditures incurred by airports relate to different types of capital assets owned by them. Operations and Maintenance Expenses (O&M) These types of expenses can be further subdivided into different types based on the sources and nature of such expenses incurred by the airports. One type of operations and maintenance expenses can be in the form of wages, salaries and benefits offered to the employees of the airports. Other types of operations and management expenses can be in the forms of municipal taxes, amortization, municipal taxes, supplies and materials that are related to terminal and airfield, office and administration costs, contracted services, expenses related to promotional activities and advertisements, bad debts, financing costs, insurance costs, etc. Airport Financing Airports need to finance mainly its capital expenses which require significant amount of capital that could not be obtained from the traditional sources of revenues generated through normal operational activities performed in an airport business. Airport financing can fall into two broad categories, namely debt and grants (Kaps, 2000, p. 245). The funds which are generated as surplus while revenues generated exceed the expenditures are accumulated in the form of capital reserve fund. The financing requirements of airports which are of short term in nature are mainly obtained through loans from banks and using line of credit. Financing requirements of airport business which are of long term in nature are obtained through issue of various debt instruments like secured and unsecured bonds, revenue bonds, etc. As mentioned earlier, airports receive funds in the form of grants also and these grants come in the form of various types of provincial and federal grants received by them. In order to help certain eligible applicants for the purpose of financing capital projects that are related to asset protection, safety and reduction in operation cost, the airports receive funding through a special program called Airport Capital Assistance Program. These are some of the ways through which financing requirements are managed by the airports. Conclusion The business operations carried on in the airports include a wide range of activities that are performed in different airports. Airports are actually a type of facility that are offered to the passengers to travel fast through airlines which takeoff and land at the airports. The relationship that exists between the airport and the airlines are found to be critical towards the success of airport business. Two major types of financial management practices followed by the airports have been identified as the residual cost approach and the compensatory approach. There are different types of expenditures that are needed to be incurred in the airports like, the capital expenditures and the operations and maintenance expenses. The financing of the operational and maintenance expenses are generally done through the performance of various types of activities that generate revenues of different which have been discussed in this study. Further financing requirements are generally met through grants and debts by the airports. Thus a brief overview about the operational activities followed at airports and the financial management practices followed there have been discussed in this study. References Doganis, R. (1992). The Airport Business. London: Routledge. Graham, A. (2012). Managing Airports. (2nd ed.). London: Routledge. Grothaus, J. H. (2009). Guidebook for Managing Small Airports. Washington D. C.: Transportation Research Board. Kaps, R. W. (2000). Fiscal Aspects of Aviation Management. Illinois: SIU Press. Mos.uwo. (no date). Financial Management of Airports. Retrieved from http://mos.uwo.ca/PDFs/MOS%204405F/Financial_Management_Oct3rd.pdf. Odoni, A. R. (2002). Airport User Charges and Financing. Retrieved from http://ardent.mit.edu/airports/ASP_current_lectures/Airport%20User%20Charges%201.pdf. Princeton. (1984). Airport System Development. Retrieved from http://www.princeton.edu/~ota/disk3/1984/8403/840308.PDF. Read More