Question

What impact do lower fuel cost and other changes have on airlines net income? American Airlines group ( AAL ), the world's biggest Airline, has been reporting record profits in recent quarters. United Continental Holdings and Southwest Airlines also reported record profits. Part of what has contributed to the record it profits has been the decline in the cost of oil. the price of oil has fallen during 2014; we are spending much less at the gas pump to fill out cars. The airlines are also experiencing the effects of low oil prices; the price of jet fuel is down 18% since August 2014. Increased revenues have also contributed to the high profits in the airline industry. Overall, Airfares are up 3% for 2014. according to airlines for America, an Industry trade group. In addition, planes have been about 85% full in 2014, which is a record high for the airline industry. On the other hand, Airline spent more on fuel in 2014 than in 2010. Airlines also spent more on labor due to higher renegotiated labor contracts. Questions: A. what each of the following changes Increase or Decrease an Airlines net income (consider each item independently)? B. What income statement account would be impacted by each item? 1. The 3% increase in airfare (ticket prices). 2. The 18% decrease in the price of per gallon of jet fuel. 3. The increase in the number of seats sold. 4. The increase in the total spent on Jet fuel. 5. The increase in the cost of Labor contracts. 6. Have you experienced hirer or lower ticket prices over the last 2 years? 7. What are other ways that Airlines use to increase Revenue? 8. What are other causes for decline in the revenue of airlines? What are other factors that increase or decrease expenses of Airlines?

Answer 1

1. 3% increase in airfare - (A) An increase in airfare is the increase in the income i.e. the credit column of the Income statement, this will increase the Net Income. (B) Ticket price is related to Sales, so Sales Revenue item will increase.

2. 18% decrease in price per gallon of jet fuel - (A) Jet fuel is the material (fuel) that the Airlines use to fly aircraft. So, the purcases will decrease with the same proportion, this will again increase the Net Income. (B) Cost of Sales (Purchase) item in the Income statement will reduce.

3. Increase in the number of seats sold - (A) Number of tickets sold is directly proportional to the sales volume generated. So, the sales will increase leading to an increase in Net Income. (B) Sales Revenue will increase in the Income Statement.

4. Increase in total spent on Jet fuel - (A) Increase in the amount spent on jet fuel will increase the debit column of Income statement, so it will reduce the Net Income. (B) Cost of sales (Purchases) item will increase in the Income Statement.

5. Increase in the cost of Labour contracts - (A) cost of Labour contracts will increase the debit column of Income statement, so it will reduce the Net Income. (B) Labour cost is a part of Salaries & Wages (Operating expenses).

6. There has been an increase in the ticket prices over the last 2 years. Question also suggests an increase in ticket prices by 3%.

7. Other ways that Airlines use to increase revenue -

Services fee - It is also called convenience fee. It is applied whenever a passanger books the flight with an agent or directly through the airline website. It is generally 10% of the basic fare.

Food and beverage services - Most airlines provide food and beverage services with good profit margins. This also increase the revenue of the industry.

Premium services - Most airlines also have services like business class or premium class which which charges much higher than the economy fares with additional services.

Inventory - If the company is expecting that all the seats will not be sold, the company reduces price in order to increase the demand. This increase in volume of sales increase the revenue.

8. Other causes for decline in revenue of airlines -

Promotion schemes - Airline companies give my discount schemes in order to get more volume, but this does impact the revenue generated per seat.

Competition - Due to the increasing competition, they have to keep their prices reduced in order to keep a decent market share.

High fixed and variable costs - Huge costs involved taking large loan and lease payments, salaries of staff, security expenses which is a huge cause for decline in airline revenue.

Exogenous event - Events such as 09/11 attacks or other terrorist activities in different countries declines the demand for travel causing a huge toll on the revenue.

9. Other factors that increase or decrease expenses of Airlines - Security expenses, salary increases, other staff benefits provided, etc can increase the expenses of Airlines. Decrease in expenses can be due to research and development activities leading to the cuts in fuel prices, hiring freshers at lower salaraies, etc.