Wednesday, June 26, 2013

787 Cost Accounting For Dummies

Cost accounting is an important tool in deciding which make of airline should be purchased, otherwise you could drive the operation under water filling seats with dead weight. This offering won't explain cost accounting in detail, because textbooks start at 600 pages long in business school.  This is just one book per class taken on cost accounting for that matter. But I will hope to explain the strategic importance of knowing what airplane to buy for what business plan in play. That decision has the element of cost accounting and revenue tracking in a seat/unit relationship selling airplanes to airline customers. Its not about the bigger is better, or smaller is cheaper, its more of lining up the line graphs for one seat and finding the sweet spot for profitability. The secret is finding the right tool for the right job.

Its all about the seats not the wings when Cost Accounting is in play.

Analogy: Equipment is the key. If you have a landscaping business what will you buy, a Backhoe, Bobcat, or Bulldozer? Probably a Bobcat, which is a small piece of equipment that can do many things in a client’s back yard. No Bulldozers needed here, for making piles of cash.

Back to cost accounting and Revenue units:

Each Airplane has seats that drives the mechanism for revenue and profit. What diminishes the earnings margin are costs flows against the revenue stream. The question then arises, how much does it cost to fly each seat weather it’s filled or not? A two hundred seat 787 fly's empty for..., what cost? Finally, how many seats sold where the variable cost plus fixed cost are paid for by the margin? There are some variable cost found in the breakeven model such as fuel, maintenance and direct cost related to the flying activity. At this point, bean counters are just opening up briefcases sorting out the financial mechanism of flying the 787. The next question is what are the fixed cost on a 350 seat Airbus vs a 323 seat 787-10?  So far more questions before even one answer.

Fixed costs are defined by my "dummy definition", as a cost of operating that airplane whether it operates or not. Such as salaries, space costs, Administration and so forth. Variable cost are defined as those costs associated with flying those seats every time the 787 leaves the ground on a revenue flight. The variable is seat space or the number of tickets sold, as measured against cost of flying all seats. A filled 200 seat 787 has costs accruing from crew by the hour, fuel as it burns, and maintenance when it lands, and so forth. The complexity deepens as the book turns its pages in cost accounting. This is why accountants always talk to CEO's with the broad stroke of saying "The Bottom Line", or what falls out in the plus column every time we fly a certain route filling 200 seats. That brings it back to what an airplane can do as a profit engine when we fly on a certain route? Do we fly the Bobcat, or the Bulldozer, The 787-10 or the A350-9. Many airlines are buying both types from the two manufacturers to hedge the bet.

Example, a one aircraft airline:
Airline Fix Cost = $1,000,000 a year whether it flies or not.
Variable Cost = $250 per seat. Or the actual cost of flying that seat from point A to B
Ticket Price = $300 value per seat
Contribution Margin (CM) for each seat.= $50. Revenue (Ticket Price)- Variable Cost (VC) of each flight = CM. Or R-VC=CM.

So, if 250 seats sold at $300 each = $75,000
Contribution Margin towards a profit= $12,500 on this flight and for every flight when sold out ($50 x 250 seats) or in formula mode (75,000 R)-($62,500 vc) = $(12,500 cm)

Or using a calculator you figure the $50 CM will take 20,000 seats sold in a year at $300 to breakeven on the fixed cost of 1 million. The airplane must make 80 fully loaded flights to reach its breakeven point in this example, and start making a profit. If the airline doesn't fill to capacity or lowers its seat price in this model, then the big spreadsheet will change progress to a profit at different rate.  Airline ticket prices on an extremely efficient, fuel savings of 20% and maintenance cost reductions of 30% could allow airlines to beat the competition on lower airline ticket prices and make more money than its competitors. The 787-10 will make a dent on competing Boards thinking and its strategy making, which should come in form of 2014 787-10 Order's Books. That should be a great year for the 787-10 on orders, commitments, and options.

Anybody asleep yet? Back to Seats:

Airlines want to know how many gallons of Jet A burned per seat. Boeing claims a 30% maintenance cost reduction in operating the 787 overcurrent aircraft. It reports a 20% fuel reduction compared to current aircraft. This is what the bean counters listen to before inputting information to the CEO's on what aircraft they should buy. The question then becomes how much money do we want to make? A silly question, but one that is answered anyways.

The 600 page book on cost accounting needs to boil down to a one blogger page in a hurry.

All the accounting/cost accounting and revenue accumulation is broken down into little tiny accounting pieces, and then summed up on one gigantic spread sheet. The kind I used to make. Reduce one tiny piece down by 1% and the big spreadsheet's bottom line changes by .00001%  Change a thousand combinations of cost inputs whether fixed or variable, the operations numbers change dramatically by  X%. Bean counters get onto engineering's necks, imploring for financial efficiencies on design parts and innovation. Engineers don't like bean counters! CEO's and VP's are referees between these groups and types of company people. In the meantime buyers listen to the sales spiel on and on.

The thing that makes a difference on the 787-10, as in: Which A350 will it nullify on the cost function, and what is the right size for the right route filling seats? This will take some time to prove out. However when the 777X comes on it will complicate Airbus' sales team or simplify Boeing's sales team job with its Big spreadsheet presentation.

Remember A Seat Is Just Not A Seat. It’s a revenue source towards the Contribution Margin driving the company past Breakeven on a flight. Total Fixed Cost Operations + Total Variable Costs (in seat Units) determines when that point is reached and profitability starts.

The Break Even Point is shown "in a seat that has a green line painted on the floor” for Akbar Al Baker on his 787.

Caption added: (Every seat forward of this keyboard is pure profit (CM) on this aircraft. Everything behind you pays for the flight)