Capital Expenditure – Profit Busters You Never Noticed

Did you know that a simple decision by you resulting in revenue expenditure instead of capital expenditure could make a huge dent in your bottom line?

The consequences could be serious.

In this blog post, I will lay out a case for how something as seemingly trivial as expenditure classification could impact your profit negatively.

This blog post will cover:

• Capital Expenditure - an intrigue
• Revenue Expenditure - obvious one which ain’t so obvious
• Capital or Revenue Expenditure - what’s the big deal?
• The Profit Busters
• What are Profit Busters?
• Unnoticed Profit Busters
• It will Pay to understand Capex Vs Rev Exp
• Your Takeaways

 Capital Expenditure - an intrigue

If you were to ask a hotel manager (other than an accounting or finance person) what they understood as capital expenditure, the response could shock you.

Not because they were wrong.

But because of the sheer number of different interpretations of that term.

Capital expenditure is an intriguing concept.

The use of the word capital in the term makes it confusing to put it mildly.

Particularly if you did not have an accounting or finance background.

You are already giving me that confused look.

The most simple way to explain capital expenditure is as follows:

An expenditure the benefit of which will extend beyond one financial year.

You are not impressed!

How is that simple and how can that be an explanation you ask?

Bear with me.

I shall clear the storm clouds quickly.

Benefit is used in non-accounting language to refer to the life of an asset.

You are really baffled now!

I have not finished and I shall deliver.

So, for example:

Say you purchased a Laser Printer for your Front Office department.

Is that capital expenditure?

You are nodding your head.

It is capital expenditure.

The fact is that an equipment like a printer is a common item of capital expenditure.

You may not have realized however that the laser printer is considered capital expenditure because of one accounting reason.

That the benefit or its life is more than one financial year.

There are however items which you purchase that may not have such a clear cut classification.

I will explain how later in this post.

For the moment, just take it that when the life of an item of equipment is beyond one financial year they are called capital expenditure.

They are known as Fixed Assets more commonly.

Capital expenditure is a much broader term than Fixed Assets though.

And now on to more intrigue.

Let us see what revenue expenditure is all about.

Revenue Expenditure - Obvious which ain't so Obvious

I will clear the storm clouds immediately on this one.

The best way to distinguish revenue expenditure from capital expenditure is:

• Capital Expenditure or Fixed Assets belongs in the Balance Sheet
• Revenue expenditure belongs in the Income Statement [or Profit and Loss Statement as it is also known as].

This distinction by itself brings out what I was saying in the previous section on capital expenditure.

That the benefit of capital expenditure or a Fixed Asset extends beyond one financial year.

Using the same basis, revenue expenditure gets used up or its benefit or life is less than one financial year.

The real confusion starts when you have a piece of equipment or what looks like one but its life can be less than one financial year.

In that case, it will be considered revenue expenditure even if it is an item of equipment.

Consumables are typically considered revenue expenditure.

However the confusion arises because often they do not appear to be consumables.

They look like small pieces of equipment.

For example, when the kitchen buys sternos for their chafing dishes, they get used up in a meal period.

But since they are cans they look like pieces of equipment.

However, they principally are consumables.

Sternos are therefore revenue expenditure.

They belong in the Income Statement.

So, remember this.

If you do not have storage facilities and buy too much of sternos, they will hit your Income Statement - whether you have consumed them or not!

Aha! that got your attention.

Even if you have a central store and sternos are issued through requisitions, whatever issues are made will be charged to the Income Statement.

Irrespective of whether you consumed the sternos or not.

This principle applies to all items issued.

Keep that in mind.

Managers often are surprised why expenses in their Income Statement are higher than what they consumed.

But actual consumption is irrelevant once issued.

Capital or Revenue Expenditure - What's the Big Deal?

If you are following my line of thought you will now be thinking: where is this all leading?

Hang in there.

The juicy stuff is coming right now.

So, let me pose the question which is still perplexing most hotel managers:

• What does it matter whether an expenditure is capital or revenue?
• What’s the big deal?

Well, let me tell you a quick story [a real one].

In the year 2002, WorldCom, one of the World's Largest Companies in the Telecommunications industry made $3.8 Billion disappear

Yes, literally disappear.

How, you ask in disbelief?

Worldcom carried out bad accounting, meaning they didn't treat capital expenditures and revenue expenditure properly.

WorldCom took billions of dollars in operating expenses and spread them out across so-called property accounts.

Now do you get it?

Do you now realize what the big deal is?

Let me explain it in clear terms.

When you purchase an item whose benefit or life is more than one financial year, that item must go to the Balance Sheet.

On the other hand, when your hotel incurs expenses like consumables and other running expenses, those items must go to the Income Statement [Worldcom committed fraud by not doing this].

So, what happens when you take an item of expenditure that belongs to the Income Statement to the Balance Sheet?

You understate profits to the extent of cost of those items.

That is considered a fraud.

This is the reason corporations get audited.

Auditors check whether any Income Statement expenses have been parked in the Balance Sheet [like Worldcom did - obviously their auditors did not do their jobs!].

However, leave all this hullabaloo aside.

I am now going to tell you something which is even more shocking.

It impacts your hotel bottom line.

And it is based on something you did.

I call them the Profit Busters.

Want to know more?

Let us get to it.

The Latent Profit Busters

Have you heard of Profit Busters?

No, they bear no relation to the Ghost Busters!

You would, as a hotel manager definitely benefit from knowing about profit busters.

Profit Busters are revenue or expense items that cause a dent in your hotel profit.

How, you want to know impatiently?

Hang on, we are getting there.

Let me tell you first about expense items which are profit busters.

Remember the Worldcom saga.

Well, there is an exact opposite occurrence that will cause damage to your hotel bottom line.

And it is not illegal.

It is not fraud (like what Worldcom did!).

More importantly, it can be prevented.

How, you ask?

Here is how.

When you purchase items during the course of normal hotel operation, you would do that through purchase requisitions/orders.

When was the last time you checked to see if any purchases whose benefit or life is beyond one year DOES NOT go to your Income Statement?

Aha, I got your attention now.

But is that not the job of accounting you ask?

Yes, it is and they do it diligently too.

However, as a hotel manager you are responsible for your department’s performance.

That includes profitability.

And if an item of expense gets into your Department Income Statement which should not be there, who is ultimately held responsible?

You, as the department head.

So, here is a tip from an accountant [oh boy, my accounting brethren are going to love me for this!!].

Each month, go to the Finance department as soon as your departmental Income Statement arrives.

Sit with a Accounting/Finance person and ask them to show you every item of expense in your department Income Statement.

Compare with Purchase Requisitions you authorized during that month.

Are there any items you do not know about?

If there are, it is your responsibility to find out what they are.

Remember they are impacting your profit for the month.

You may sometimes be shocked by what you find charged as expenses to your department.

These are expenses either not authorized by you or worse do not belong to your department.

Be smart about your own profit performance and be on top of things.

And do all this before the monthly performance meeting.

You will feel liberated like never before.

In another blog post, I will lay out a strategy to find out if your food cost is accurately reflecting what it should?

Or is wastage, spoilage and other losses getting loaded on to your expenses?

So, what is the moral of the story?

Know your capital expenditure from your revenue expenditure.

It may be the best road to better profit performance.

Your Takeaways

So, how do you approach capital and revenue expenditure in your hotel?

Do you sit with the Accounting department to ensure all expenses are accurately reflected?

Comment in the section below.

I will be keen to know how you do it at your hotel.

It may mean a higher bottom line achievement that you can be proud of.

Want to get clear about capital expenditure and revenue expenditure and prevent dents to your bottom line?

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