Sell and lease back is strategic financial positioning.
The first thing on the table is get the definitions out
of the way;
Winging It Made Simple
Wet Lease:
A wet lease is a leasing arrangement whereby one airline (the
lessor) provides an aircraft, complete crew, maintenance, and insurance (ACMI)
to another airline or other type of business acting as a broker of air travel
(the lessee), which pays by hours operated.
Dry Lease:
A dry
lease is a leasing arrangement whereby an aircraft
financing entity (lessor), such as GECAS or AerCap, provides an aircraft
without crew, ground staff etc.
Sell-Lease back:
Selling an entity aircraft asset to a leasing company and then
lease back from same lessor for the same aircraft is usually results in a long term dry lease. The action turns the lease into an
income statement type expense coming from its operation. At which point the former asset can no longer depreciate during its limited depreciation term allowed in the balance sheet (assets = liabilities) otherwise stopping any interest expense accrued.
Blithering discussion:
Example: Tax worksheet modeling takes advantage of depreciation during a five-seven year depreciation schedule allowed, where it has has a limited duration of time for income tax write-offs claimed. In this case a 787 worth hundreds of millions is depreciated with the majority of its value during the first years of ownership. An entity can take a significant portion of any airplane value applying it towards the Income Tax liability during its early years of service.
However, to maximize cash flows and make efficient use of its assets an entity can sell its asset to a leasing company thus eliminating the remaining depreciation towards asset value. The lease back portion of the deal moves the aircraft out of its balance sheet status (which has a limited remaining depreciation advantage with a longer term loan interest expense value remaining) into an operational expense condition by the amount of the periodic lease payment amount.
Instead of having an asset under generally accepted accounting principles, it morphs the asset into a lease expense on the Income statement. The leverage of this transaction reduces assets and reduces liabilities at the same time while moving cash flows to a monthly leasing expense line found on the Income statement for profit and loss and becomes an EBIT item affecting any Income Tax liability down the road.
The relationship of having aircraft for revenue routes and operating expense is greatly changed. Rather than asset and liability relationship for company valuations, the move has an immediate change in the relationship affecting the profit loss condition reported each year. Cash (liquid assets) is freed up for making more purchases using a leveraging lease back move for its inventory.
What occurs by this example: an airline buys the aircraft
valued at purchase price through paying cash and borrowing money for the aircraft.
The aircraft value is the asset while the cash is a reduction of its liquid assets.
The money borrowed for the purchase is a corresponding liability amount equaling the
asset balance reduced by cash plus adding the airplane’s valuation to the asset
balance.
There is much more occurring with this example that can be explained reasonably and with limited information. The important point is aircraft companies needing fast access to more airplanes often divide its inventory up with buying and leasing its inventory. An entity can take advantage of both its assets for income tax purposes and/or its profit and loss record growing its retained earnings into an asset value.
Finding error is to human. Accounting is inhuman.
"T" Accounting Example:
Transactions for balancing assets = liabilities
Cash reduced: -10 million down payment
Airplane Value: + 100 million
Loan: -90 million
Asset Balance: 100 million
Loan of: 90 million equals the Asset Balance of 100 million via its -10 million cash reduction combined with $90 million loan.
THE LAST BUT NOT LEAST ITEM: Sale of asset to leasing company at a higher amount than the original purchase price from the manufacturer can become a significant capital gain for an entity strapped for cash.
More definitions and More Coffee Needed
Asset:
Inventory or property owned by a person or company, regarded as
having value and available to meet debts, commitments, or legacies.
"growth in net assets"
"For every asset there as an equal liability for said person or company or corporation. Assets equal liabilities and
remain in balance of value concerning each person, company, or
corporate entity."
Depreciation:
noun
1. A reduction in the
value of an asset with the passage of time, due in particular to wear and tear.
synonyms:
|
devaluing, decrease
in value, lowering in value, reduction in
value, cheapening,
|
o Decrease in the
value of a currency relative to other currencies.
Plural noun: depreciations
Expense:
offset
(an item of expenditure) as an expense against taxable income.
Income Statement:
Also known as the profit and loss
statement or statement of revenue and expense, the income statement is the one
of three major financial
statements in the annual report and 10-K. All public companies must submit these
legal documents to the Securities and Exchange Commission (SEC) and investor
public. The other two financial statements are the balance
sheet and the statement of cash flows. All three provide investors with
information about the state of the company's financial affairs, but the income
statement is the only one that provides an overview of company sales and net
income.
Profit or loss:
An income statement or profit
and loss account (also
referred to as a profit and
loss statement (P&L), statement of profit or
loss,
revenue statement, statement of financial performance, earnings statement, operating statement, or statement of operations) is one of the financial statements of a company and shows the ...
Balance sheet:
noun
1. A statement of the
assets, liabilities, and capital of a business or other organization at a
particular point in time, detailing the balance of income and expenditure over
the preceding period.
Taxes:
What’s left over goes to the government J
The incredible mess above requires a 4-5 years of
accounting and another 10 years for understanding. Having the 4-5 years down
there remains another ten years for understanding. Therefore, keeping it
somewhat simple is the goal and only for making a point. Understand what a “wet
lease” and “dry lease” are and then understand what and “asset” and “expense” can do
for a company.
If an airplane is an asset then there is a liability
offsetting the asset such as loans and stockholder ownership. However, if an
airplane is a lease it is not an asset, but an operational expense. No asset,
no depreciation expense and no liability. An airline who is strapped for cash
when expanding its fleet will buy, sell and leaseback aircraft leveraging its
capital support its expansions at the same time.
Moving an asset off the books allows an airline to
expense the total aircraft, crew and maintenance applied to a revenue stream as
expenses. If the airline makes a profit (P/L), it can add that profit to a
retained earnings process. Tax advantages arise in this flow. An asset is not part of the P/L revenue statement, only
through depreciation expense, which is limited to Tax laws on depreciation
schedules over time.
However when leasing, it becomes an expense item as
described in the above paragraph. This condition allows airlines to leverage its cash
stream of uses for down payments and increase its fleet of revenue producing
aircraft at the same time. No longer will it have to borrow billions of dollars
for aircraft purchases and come up with the cash for entering into those types
of financing. The lease becomes a pay as you go proposition matching revenue
streams coming from each aircraft it leases with revenue and expenses.
It must remain
competitive with its peers during growth periods and leasing leverages a competitive position extending its inventory. When economic times change in
the travel industry, drop those leases within a shorter time period rather than
having to sell any owned aircraft risking a severe discount and experiencing a loss.
