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WEEK# 4 BAMM 5 A & B 7th Sep, & 8th Sep, 2020

Airport Financial management: (Continued)

Course Topic:

Airport accounting strategies are described, as are issues concerning airport insurance,
revenue generating strategies, airport budgeting, and airport funding and financing
strategies
Sub-topics: I revenue generating strategies, airport budgeting,
Sub-topic: II airport funding
Sub-topic: III financing strategies
Airport accounting strategies:
The nature of airport expenses depends upon a number of factors including the airport’s
geographic location, organizational setup, and financial structure. Airports in warmer
climates, for example, do not experience the sizable snow removal and other cold weather–
related expenses that airports in colder climates must face. Some municipalities, counties,
or local authorities absorb the costs of certain staff functions, such as accounting, legal,
planning, and public relations.

Certain operating functions such as emergency service, policing, and traffic control might
also be provided by local fire departments and local law enforcement agencies at some
airports. In addition, the ever-changing demand characteristics of passengers, service
characteristics of air carriers and other aircraft operators, as well as aircraft, navigation,
communication, and information technologies affect the need to invest in projects involving
airport capital improvements.

Airport accounting involves the accumulation, communication, and interpretation of

economic data relating to the financial position of an airport and the results of its operations
for decision-making purposes. It differs from accounting procedures found in business firms
because airports vary considerably in terms of goals, size, and operational characteristics.
As such, it is very difficult to derive a unified accounting system that can be used by all
airports. A system tailored to the needs of a large commercial airport might be impractical
for a small GA airport or vice versa. Many airports have different definitions of what
elements constitute operating and non operating revenues and expenses and sources of
funds for airport development. A good accounting system is needed for a number of
reasons:

• Financial statements are needed to inform governmental authorities and the local
community regarding details of the airport’s operations.

• A good accounting system can assist airport management in allocating resources,

reducing costs, and improving control.
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• Negotiating charges for use of airport facilities can be facilitated.

• Financial statements can influence the decisions of voters and legislators.

Operating expenses can be divided into four major groupings: airfield; terminal; hangars,
cargo, other buildings and grounds; and general and administrative expenses.

Factors for pricing and financial management.

The distribution of operating revenues differs widely according to factors such as

passenger enplanements, the nature of the market served, and the specific objectives and
features of the airport’s approach to pricing and financial management.

Airport size generally has a strong influence on the distribution of revenues. The larger
commercial airports typically have a more diversified revenue base than smaller airports.
For example, they tend to have a wider array of income-producing facilities and services in
the passenger terminal complex. In general, terminal concessions can be expected to
generate a greater percentage of total operating revenues as passenger enplanements
increase. On average, concessions account for at least one-third of total operating
revenues at large, medium, and small commercial airports, compared to about one-fifth at
very small (non hub) commercial airports and a smaller fraction still at GA airports.

Factors other than airport size also affect distribution of operating revenues. At commercial
airports, for example, parking facilities generally provide one of the largest sources of non
aeronautical revenues in the terminal area. Airports that have a high proportion of
transferring passengers might, however, derive a smaller percentage of their operating
income from parking revenues than do so called origin and destination airports. Other
factors that can affect parking revenues include availability of space for parking, the volume
of air passenger traffic, the airport pricing policy, availability and cost of alternatives to
driving to the airport (mass transit and taxicab service), and the presence of private
competitors providing parking facilities at nearby locations off the airport property.

The approach to financial management, because it governs the pricing of facilities and
services provided to airlines, significantly affects the distribution of operating revenues.
Because so many other factors play an important role in determining revenue distribution,
however, the mix of operating revenues at an airport cannot be predicted on the basis of
whether the airport employs a residual cost or compensatory approach. The mix of
revenues varies widely among residual cost airports. With airline landing fees
characteristically picking

up the difference between airport costs and other revenues at residual cost airports, airfield
area income differs markedly according to the extent of the airport’ other revenues, and the
volume of air traffic.

Airport financial burdens have been driven primarily by the following factors:
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• Governmental mandates, including new security, environmental, and noise-related

compliance costs

• Renewal and replacement of old facilities and equipment

• Airline requirements for support facilities

• Changing airline demand patterns that require consolidation of hub facilities and reduction
of activity at non hub airports

Apart from the average rate of growth of airport costs, there is also a significant disparity in
cost growth by airport size. Larger airports have a greater need for infrastructure and,
consequently, have experienced the greater cost increases.

However, the significant increase in operating expenses at large airports is a concern,

because it suggests that their expansion and modernization programs have not been
accompanied by any increase in operating efficiency.

Airlines generally agree that infrastructure needs have driven a significant portion of airport
cost increases, most recently with respect to the need for increased security infrastructure.

Other federal funding soures

Facilities and equipment program

The facilities and equipment (F&E) program provides funding for airports for the
installation of navigational aids and control towers, as necessary. It funds 100 percent of
the costs of these requirements in the interest of navigation and the construction of control
towers.

State grant programs

In addition to federal funding, many individual states in the nation offer grant programs for
airport capital improvements. These sources are typically found within state Departments of
Transportation, funded from the general tax base of the state, as well as state user fees on
transportation-related facilities such as highway tolls, automobile and other vehicle
registrations, and fuel taxes. State and local funding is offered as supplemental funding to
federal grants

In addition to individual state grant programs, some states have developed block grant
programs. Under a block grant program, individual states apply for federal funding on
behalf of their represented airports. In turn, the states may allocate the funds received from
the federal government to the individual airports as they see fit.

Grant assurances

Almost all federal and state grant programs come with some measures of obligation by the
airport to its funding source with respect to the operation of the airport.
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These obligations are known as grant assurances. Grant assurances provide the funding
source that the funds will be used in accordance with the source’s rules and regulations,
design standards, and operational policies. In addition, most grant assurances include that
the airport maintain overall standards of operation for a certain period of time (typically 20
years) following funding.

Airline rates and charges

Airline rates and charges generate a significant portion of total airport revenues. Because
airport revenues are the sole backing for revenue bonds, the nature of airline rates and
charges has a significant impact on an airport’s credit rating.

Liability insurance

An increasingly large percentage of airport expenses are derived from required insurance
to cover various areas of liability. Airports and their tenants have the same general type
and degree of liability exposure as the operator of most public premises. People sustain
injuries and damage their clothing when they fall over obstructions or trip over concealed
obstacles, and their automobiles are damaged when struck by airport service vehicles on
the airport premises.

Claims from such accidents can be for large amounts, but claims stemming from aircraft
accidents have even greater catastrophe potential. The occupants of aircraft might be killed
or severely injured and expensive aircraft damaged or destroyed, not to mention injury to
other persons or other types of property at or near an airport. Liability in such instances can
stem from a defect in the surface of the runway, from the failure of airport management to
mark obstructions properly, or failure to send out the necessary warnings and to close the
airport when it is not in usable condition.

Airports and their tenants are liable for all damage caused by their failure to exercise
reasonable care. The principal areas in which litigation arises can be summarized under
three main headings:

• Aircraft operations. Liability to tenants and the general public arising out of aircraft
accidents, fueling, maintenance and servicing, and rescue efforts.

• Premises operations. Liability to tenants and the general public arising out of automobile
and other vehicle accidents, elevators and escalators, police and security enforcement,
tripping and falling, contractual obligations, airport construction, work performed by
independent contractors, and special events such as air shows.

• Sale of products. Liability to tenants and the general public arising out of maintenance
and servicing, fueling, and food and beverage services.

Airport operators require that all tenants purchase their own insurance as appropriate for
their particular circumstances and with certain minimum limits of liability. Generally, the
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airport operator is included as an additional insured under the tenant’s insurance coverage;
however, this does not relieve the airport operator from securing its own liability protection
under a separate policy.

The comprehensive coverage and limits of liability needed by most major airports far
exceed what is required by the average tenant.

Airport liability coverage

The basic airport premises liability policy is designed to protect the airport operator for
losses arising out of legal liability for all activities carried on at the airport. Coverage can be
written for bodily injury and property damage.

A number of exclusions apply to the basic policy, and consequently the insuring
agreements must be amended to add certain exposures. By endorsement, the basic
contract can be extended to pick up any contractual liability the airport might assume under
various agreements with fuel suppliers, railroads, and so forth. Elevator liability and liability
arising out of construction work performed by independent contractors might also be
covered. The basic policy can also be extended to provide coverage for the airport that
sponsors an air show or some other special event.

For those airports engaged in the sale of products or services, the premises liability policy
can provide coverage for the airport’s products liability exposure.

Aircraft accidents arising out of contaminated fuel originally stored in airport fuel storage
tanks or even food poisoning from an airport restaurant would be examples. Aircraft
damaged while in the care, custody, or control of the airport for storage or safekeeping can
be covered by extending the premise’s liability policy to provide hangar keepers coverage.

The growth of aviation and airports during the past 30 years has increased the industry’s
exposure to liability claims. Airports invest thousands of dollars in purchasing adequate
insurance coverage and limits of liability to protect their multimillion-dollar assets. The
courts have consistently held airport operators responsible for the safety of aircraft and the
public as well as for the issuance of proper warning of hazards. In many cases,
municipalities have not been immune, with courts determining that the operation of an
airport is a proprietary or corporate function rather than a government responsibility.

Revenue strategies at commercial airports

At most commercial airports, the financial and operational relationship between the airport
operator and the air carriers serving the airport is defined in legally binding agreements that
specify how the risks and responsibilities of running the airport are to be shared. These
contracts, commonly termed airport use agreements, establish the terms and conditions
governing the air carriers’ use of the airport. The term airport use agreement is used
generically to include both legal contracts for the air carriers’ use of airfield facilities and
leases for use of terminal facilities. At many airports, both are combined in a single
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document. A few commercial airports do not negotiate airport use agreements with the air
carriers, but instead charge rates and fees set by local ordinance. The airport use
agreements also specify the methods for calculating rates air carriers must pay for use of
airport facilities and services; and they identify the air carriers’ rights and privileges,
sometimes including the right to approve or disapprove any major proposed airport capital
development projects.

Although financial management practices differ greatly among commercial airports, the
airport-airline relationship at major airports typically takes one of two very different forms,
with important implications for airport pricing and investment:

• The residual cost approach, under which one or more air carriers collectively assume
significant financial risk by agreeing to pay any costs of running the airport that are not
allocated to other users or covered by all other sources of revenue.

• The compensatory cost approach, under which the airport operator assumes the major
financial risk of running the airport and charges the air carriers fees and rental rates set so
as to recover the actual costs of the facilities and services that they use.

Comparing residual and compensatory approaches

Residual cost and compensatory approaches to financial management of major commercial

airports have significantly different implications for pricing and investment practices. In
particular, they help determine:

• An airport’s potential for accumulating net income for capital development.

• The nature and extent of the air carriers’ role in making airport capital investment
decisions, which can be formally defined in majority-in-interest clauses included in airport
use agreements with the airlines.

• The length of term of the use agreement between the airlines and the airport operator.

Concluding remarks

Financial planning of an airport is not a static activity. Continuous planning and

management is required to adapt to the changing levels in demand, needs for maintaining
and improving facilities, and especially the changing levels of revenues and other funding
available to the airport.

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