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Cash Struggles for Airlines Mean Refund Struggles for Passengers
With the travel industry coming to a grinding halt, there a lot of people not taking their vacations or traveling for business. This has brought up a big problem for the industry beyond some of the most obvious reasons: customers want and are generally legally entitled to cash refunds.
Largely, this is a result of forward bookings, reservations for travel in the future. If there were fewer forward bookings, there wouldn’t be so many people looking for refunds, but forward bookings are a part of the industry. And those forward bookings have become a cash drain.
Forward bookings are a result of people planning out trips months, even years, in advance. This is guided by the fact that when booking early, people can generally score better deals on their travel. Travel providers are willing to cut rates for advance purchases in exchange for a few restrictions such as no cash refunds upon customer cancellation, hefty fees and strict change restrictions. They’re willing to capture the price-sensitive market by making these concessions.
It’s an effective tool that allows airlines to compete against each other. It’s a practical solution, and revenue management departments worldwide have fine-tuned their strategies to sell cheap rates in advance while still saving availability for last-minute bookings where people will be less price-sensitive.
The Importance of Cash Flows
However, there also is one additional benefit, cash flows. An airline doesn’t recognize revenues until the airline’s service is actually provided. That means, when a passenger buys a forward ticket, the airline doesn’t count the money from that ticket as revenue until the passenger flies. All money earned a the time of sale is unearned revenue which is designated a liability, and only when the flight happens can it be classified as earned revenue. In addition, the airline’s liabilities also include estimates for potential refunds when customers don’t fly. Airlines usually base that figure on historical data.
Usually, when the industry is operating as normal, the airline gets money upfront for forward booking and books it as air traffic liability. This cash is then thrown in with everything else coming in and going out as a cash flow. It can further be categorized as operating cash flow which is cash the airline brings in before expenditures on capital, commonly referred to as CapEx. Then there is free cash flow which is cash left over after CapEx, which can then be allocated for uses such as distributing dividends and buying back outstanding stock.
Most airlines in the U.S. have proven to be relatively conservative in managing their cash in recent years. However, one airline sticks out in comparison to others: American Airlines. They have generally been in the negative free cash flow territory due to aggressive fleet modernization programs, mainly paid for through debt issuance. During this time, the airline also returned cash to shareholders through dividends and buybacks, justifying the policy by pointing to low-interest rates and consistent profitability.
The airline’s share price before the COVID-19 crisis speaks to how unsuccessful that strategy was, as its growth consistently lagged behind the industry average in the U.S.
What’s happening now is that people want their money back. Those air traffic liabilities aren’t being converted to earned revenue, and cash is going out the door. Even the most financially prudent airlines have finite cash piles. As revenue dries up, the unprecedented demand for refunds has put airlines in a cash bind.
The current situation is akin to a Great Depression-era run on a bank. Everyone — in this case, potential travelers — are going to the bank to withdraw their cash — or the airline to get their refund — but the bank can’t honor all the withdrawals because they simply don’t have that much cash.
Airlines are stuck with poor cash flows. Delta’s cash flow statement for the past quarter shows just that. Airlines are cutting costs to reduce cash burn, but there are still many unavoidable fixed costs. In addition, if the government continues to require airlines to fly the majority of their routes when planes are empty in exchange for government aid, airlines will continue to spend money without earning revenue.
The U.S. Department of Transportation has reiterated the requirement of airlines to refund passengers, but this doesn’t stop airlines from playing games. Luckily for American consumers, however, there is a way of beating compliance out of the airline. People in other countries aren’t so lucky.
Many airlines are offering vouchers for future travel instead in order to preserve cash, which is a rational idea but not one that should sit well with customers. Airlines are avoiding paying out refunds as much as they can. And there is no reason for the customer to become provide an interest-free loan to the airline, which is effectively the result of accepting those vouchers. If a customer needs their cashback, which right now is a high possibility, they legally are entitled to it.
Potential to Make Money
However, if customers can live without the cash, there is an opportunity to profit off the airline. By not taking, a voucher for the face value and instead demanding 10 or 20 percent more, airlines will instead be paying customers to a degree. Some airlines have actually begun that process. Unsurprising to many, American Airlines is actually one of the few pioneering this method as they’re the most likely to be facing the most severe cash crunch.
Elsewhere in the travel industry, hotels aren’t in any better situation. Some reports have suggested hotels refusing to refund large deposits. There’s a pretty good chance they don’t have that cash to refund in the first place.
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