8 Comparison Reports and Financial Analysis Learning Objectives 1. To understand the importance of hotel revenue and profit analysis and how they are explained and analyzed. To understand what variation analysis is and how it is used. To learn the key formulas and uses of variation analysis.
To understand the format and uses of the STAR Market Report. To understand and be able to use internal and external financial reports. Chapter Outline Profitability: The Best Measure of Financial Performance Definition The Difference Between Analyzing Profits and Analyzing Revenues The Impact of Department Profits on Total Hotel Profits Maximizing and Measuring Total Hotel Profitability Review of Chapter 2: Foundations of Financial Analysis Comparing Numbers/Results to Give Them Meaning Measuring and Evaluating Change in Financial Analysis Percentages as a Tool in Financial Analysis The Importance of Trends in Financial Analysis Variation Analysis Definition Formulas and Ratios Used in Variation Analysis Key Hotel Ratios That Measure Hotel Financial Performance 153 CHAPTER 8 COMPARISON REPORTS AND FINANCIAL ANALYSIS STAR Market Report Definition What the STAR Market Report Contains How the STAR Market Report Is Used Summary Hospitality Manager Takeaways Key Terms Review Questions In the previous chapters we have presented material on numbers and how they are used to measure financial performance. At this point, students should be forming a solid foun- dation of financial knowledge and a good understanding of what financial analysis is, what it tells you, and how it is used in explaining hotel operations.
The next concepts that we will discuss are other financial reports and methods of financial analysis used to compare and analyze hotel operations. This chapter refers back to earlier chapters that presented basic accounting concepts and methods of financial analysis. A solid foundation of these fundamentals should now be in place. The next step is to learn about some helpful internal and external reports that can be used in analyzing and comparing operating results.
Notice that we always start with operating performance, followed by the analysis of the financial results that opera- tions produce. Internal comparisons are made to company budgets, forecasts, previous months or periods, and established goals or standards. External reports are market or economic reports that are useful in comparing hotel operating and financial results with a compet- itive set, the industry average, or other external financial information. Profitability: The Best Measure of Financial Performance Definition Profits are defined as revenues minus expenses—a rather simple formula that is very important in measuring financial performance.
In actual hotel operations, this formula is used in a variety of ways that result in specific profitability measures. Profits can be mea- sured at several levels of any business. Let’s review some of the key profit levels that are included in hotel Profit and Loss Statements (P&Ls): 154 PROFITABILITY: THE BEST MEASURE OF FINANCIAL PERFORMANCE Department Profit = All of a Department’s Revenues - All of a Department’s Direct Expenses Total Department Profits = The Sum of All Hotel Department Profits, Which Is the Same as the Sum of All Revenue or Profit Centers House Profit or Gross Operating Profit = Total Department Profits - the Total of All Expense Departments or Total Department Profits - Deductions from Income Net House Profit or Gross Operating Profit = House Profit - Fixed Expenses Profit before Taxes = Net House Profit or Adjusted Gross Operating Profit - Owner Fees or Management Fees Profit after Taxes = Profit before Taxes - Taxes Profits are the best measure of financial performance because they include the two major factors of financial performance: maximizing revenues and minimizing expenses. Maximizing total hotel revenues is important, but it is only one step.
Controlling and min- imizing expenses is also important and is the second step. Maximizing profits requires management to be efficient in both areas. Together, revenue and profit analysis explain virtually everything about the financial performance of a hotel or restaurant. The Difference between Analyzing Profits and Analyzing Revenues Analyzing revenues is totally focused on the relationship between rate and volume in the effort to maximize total hotel revenues.
It involves establishing rate structures, defining market segments, utilizing yield management information, setting selling strategies, and comparing rate and occupancy results with internal and external reports. Specific hotel managers are responsible for maximizing hotel revenues. Analyzing profitability not only includes revenue analysis but also expense analysis in all department and expense line item accounts. Each specific expense category is eval- uated on the effect it has on the hotel’s ability to efficiently provide products and services for its customers.
These expenses include fixed and variable expenses, direct and indirect expenses, and operating and overhead expenses. Specific hotel managers have the direct responsibility for managing specific revenue segments and controlling specific expense line accounts to maximize the profits of their departments. The most important expenses to be analyzed and controlled are food cost and wage cost. These are two big expense accounts and can become major problems and drains on profits if they are not properly managed and controlled.
Wage costs are even more impor- tant because they directly affect the benefit costs. If wage costs go up and are over budget, benefit costs will also go up and be over budget. 155 CHAPTER 8 COMPARISON REPORTS AND FINANCIAL ANALYSIS Finally, there are many more expense line accounts to be managed than revenue line accounts. This requires the attention of all hotel managers in every department in the hotel.
Each must be effective in managing and controlling expense accounts if hotel profits are to be maximized. If each manager effectively controls his or her department expenses, the total hotel expenses will be in line and total hotel profits will be maximized. The Impact of Department Profits on Total Hotel Profits As we mentioned earlier, all department profit dollars are not created equally. This means that each department that is a profit center has a different expense structure.
Some have more expenses that result in lower department profits, and some have fewer expenses that therefore result in higher department profit. The larger convention hotels and resorts have more profit departments and profit centers than typical full-service hotels and therefore can generate a larger Total Department Profit. Let’s look at two examples of full-service hotels and identify the profits associated with each department. Remember that a revenue center and profit center are the same and we can use these terms interchangeably.
They are two terms that describe operating depart- ments that produce revenues and profits. Also remember that the department profit percentage shows how much of a department revenue dollar will make it to the “bottom line” as a profit dollar. Profit Center Full-Service Hotel Convention Hotel Resort Rooms department 65%–75% 70%–80% Banquets/catering departments 25%–35% 30%–40% Full-service restaurant 0%–10% 5%–15% Specialty restaurant None 10%–20% Bar and lounges 30%–40% 30%–45% Gift shop 25%–30% 25%–35% Golf club None 25%–35% Spa None 25%–35% Let’s examine the impact that these examples have on profitability: 1. The Rooms Department has the highest profit percentage because there is no cost of sales.
The rooms are re-rented every night, not consumed (like food and bever- age items) or purchased (like gifts and clothing); therefore, there is no cost of sales. In other revenue departments, cost of sales can range from 30% to 40% for food and be about 50% for clothing, so it is a major expense category. This explains why the Rooms Department profit is so much higher than the other profit departments. The room rates of the Rooms Department generally are much higher than the average checks in restaurants or gift shops.
This also increases the Rooms Depart- ment profit percentage. 156 PROFITABILITY: THE BEST MEASURE OF FINANCIAL PERFORMANCE 3. Convention hotels and resorts generally have higher average room rates and higher food and beverage menu prices that help to increase their department profit percentages. The more revenue departments in a hotel, the more sources of profits to increase Total Department Profits, House Profits/Gross Operating Profit, and Net House Profit/Adjusted Gross Operating Profit.
Restaurant departments have the lowest profit percentage because of the many expenses required to prepare and serve food. Both food cost and wage cost will run between 30% and 40% each, benefits will range between 10% and 15%, and other direct operating costs will range between 10% and 15%. This leaves little room for error if the restaurant is to be profitable. Specialty restaurants are generally more profitable because they have higher average checks.
It is financially beneficial for restaurants to serve liquor because liquor has lower wage costs and lower cost of sales, resulting in higher liquor profitability. This helps the overall financial performance of the total food and beverage outlets including banquets. The Banquet or Catering Department is more profitable because its food functions can be planned with specific prices and customer counts, resulting in more efficient operations and higher profitability. For example, a dinner banquet for 500 people with a set menu and $30 average check can be planned for and produced with greater efficiency than opening a restaurant for the evening and waiting to see how many customers come, what the average check will be, and what the total revenues will be.
The Director of Finance and the General Manager of a full-service hotel generally spend a great deal of their time on the rooms and food and beverage operations for two very different reasons. First, the Rooms Department is important because it generates the most revenues and profits. A well-run Rooms Department means there will be higher cash flow and greater financial resources to operate the rest of the hotel successfully. The Rooms Department is a good example of a department that focuses on maximizing revenues.
Second, the Food and Beverage Department is important because of the complexity and detail of its operations. Food and beverage operations have to be well managed to control all of the different expenses to achieve a profit. If this department is not operated well, operations could produce a loss rather than a profit. Restaurant departments are good examples of departments that focus on controlling and minimizing expenses in addition to maximizing revenues.
The different department profit percentages discussed here provide a good example of mix percentages, presented in Chapter 2. One dollar of revenue in each of these 157 CHAPTER 8 COMPARISON REPORTS AND FINANCIAL ANALYSIS departments will produce different dollar amounts of profit. The management team of a well-operated hotel knows and understands this and plans daily operations to consider the department profit that will result from the forecasted department revenues for the week. To maximize hotel profitability, expenses must be minimized and revenues maximized.
Maximizing and Measuring Total Hotel Profitability There is a partnership in a hotel that enables the hotel to use all the operating and finan- cial resources available to maximize profitability. This partnership is between the staff departments and the operating departments. The goal of the four staff departments (Sales and Marketing, Repairs and Maintenance, Human Resources, and Accounting) is to provide specialized support for the operating departments (Rooms, Food and Beverage, Golf, Spas, Retail). The operating departments are responsible for taking care of guests and generating revenues and profits for the hotel.
Their focus should be on providing the best products and services to the guests of the hotel and ensuring that the guests want to come back. The partnership and support that the Accounting Office and the Director of Finance provide are the operating managers is extremely important in successful hotel operations. Because accounting and finance can become complicated and demanding, it is important that the Director of Finance provide these services and knowledge to both department managers and senior management. It is equally important that the department managers provide accurate numbers to the Director of Finance so that together they have all of the knowledge and resources necessary to identify problems and trends, develop corrective action, and determine the best way to implement changes so that improvements are made and goals met.