What if I said that you can begin immediately in leveraging financial ratios to improve revenue and profit performance!
That you are leaving money on the table in this pandemic era where every dollar saved adds more to profit than every dollar earned! [I will prove it shortly].
All from your hotel Balance Sheet!
At the end of this blog post are some action steps you can take right after reading this post!
This blog post will cover:
Did You Miss This Easily Preventible Loss?
Consider this scenario!
Your Department Monthly P&L takes a sharp hit with a particular type of loss which is easily preventible.
Would you have seen that coming?
What am I talking about, you ask?
Your hotel Financial Controller informs you that your Food and Beverage Department P&L this month will take a sharp hit of $16,000 on spoilage cost.
The timing could not have been worse.
This month is a low revenue month.
The hotel restaurant is battling to boost revenue and bring customers back after the damage caused by covid-19.
Did you miss something?
Indeed, you have!
What is that you ask, annoyed?
I am coming to that.
However, before that, let me ask a question.
When Was the Last Time You Looked At Your Hotel Balance Sheet?
There are immediate and often unpleasant consequences of ignoring a Balance Sheet.
Make no mistake about this.
It is what I said earlier about leaving money on the table.
At its simplest, you may not see a calamity approaching.
The spoilage hit is just one such example.
I will lay out 3 Balance Sheet financial ratios which every hotel manager must regularly pay attention to.
They will allow you to catch calamities before they hit you.
This will also literally ensure the short term health in terms of the financial position of your hotel business.
Wow, that is indeed something to aspire for!
Moreover, this is something your profit and loss statement can never show.
Isn’t that a good reason?
Do you remember Part 2 of this 3 Part blog post series?
Click here if you have not.
In that post, you learned about long term assets also known as Fixed Assets.
The Balance Sheet has another powerful category of asset in it.
That category is known as Current Assets.
What are Current Assets you ask puzzled?
Secrets of Financial Ratios of Current Assets
Current Assets are assets which have a useful life of less than twelve months.
A major source of revenue generation for the hotel business are current assets.
Illustration
For example, the food and beverage revenue of a hotel business comes from the selling of food and beverage inventories which form part of the current asset category.
Current Assets are shown in the accounting books and financial statements (Balance Sheet) at cost.
The most common Current Assets which as a hotel manager you should know about are:
- Cash / Bank Balances
- Accounts Receivable
- Inventories
Cash and Bank Balances are rather obvious.
We will come back to this later in this blog post.
But the next two categories are critical for hotel managers to understand.
And remember, they reside in the Balance Sheet.
Not in the Profit and Loss Statement.
Make it a point to look them up every month.
And now let us go back to the question I asked about the spoilage item in your departmental P&L.
My question was:
Would you have seen the sharp hit on your P&L coming?
You could not have if you did not look at the Balance Sheet and in particular one category of current asset.
Now, on to that category in the Balance Sheet that you may be familiar with in your hotel.
And that category of current asset is Inventories.
Inventories - Your Gateway to Revenue and Expenses Management
Inventories are an integral part of current assets of a hotel.
They get used up with a period of twelve months and are replaced by new purchases.
Did you know that there are two types of inventories in a hotel:
- Sales based or revenue related (food and beverage) and
- Consumption based or expenses related (guest room supplies and operating equipment)
Financial Ratios on Current Assets - Inventories
Food and beverage inventories when sold become part of revenue.
Guest Room Supplies and operating equipment when consumed become part of expenses.
So, there you have it - the sources of both revenue and expenses in one single item.
And that item sits in the Balance Sheet!
Which you probably do not get to see much.
Now, do you realize why I am hyping up Balance Sheet so much?
But there is more.
What did I mean by saying that spoilage is a preventible loss?
Well, let us consider the reasons why spoilage happens:
- Food and Beverage Inventory ofitems subject to expiry dates
- Inventory of Food and Beverage items over ordered, sitting idle and not usable
- Food Inventory Items that have been stored inappropriately and gone bad
- Inventory of Food and Beverage Items that are not selling or getting consumed
If you spend some time on the above reasons, you will see that all are totally preventible.
In a later blog post on loss prevention, I will lay out:
- Why this happens in great detail,
- How to address it and
- Save you tons of money.
Believe me, spoilage is a waste of resources literally.
This is money left on the table.
it is expense you can do without if you become focused on managing inventories better.
Why is it expense that we can do without, you ask?
All right, here we go.
I will lay out a simple illustration that will prove the value of saving expenses particularly those preventible.
The Magic of Bottom Line Boost from Expense Decrease
Did you know about the magical effect of an expense decrease on the bottom line compared to a revenue increase?
It is life changing in this Pandemic Era where revenue is under tremendous strain.
Absorb this illustration and benefit from it!
Illustration
Original Situation
Revenue → $100
Expense → $80
Profit → $20
Profit % → 20%
Result: Profit achieved is 20% on revenue
Situation When Revenue Increases by 10% From Original Situation
Revenue → $100 → 10% Inc → $110
Expense → $88 → 80% of $110 [Assume same Expense % to Revenue for this illustration]
Profit → $22
Profit % → 20%
Result: Profit goes up by $2 from original situation when revenue goes up by 10%
Pandemic Situation When Revenue Cannot Be Increased, However, Expense Decreases by 10% From Original Situation through Process Improvement
Revenue → $100
Expense → $80 → 10% Dec → $72
Profit → $28
Profit % → 28%
Result: Profit goes up by $8 from original situation when expense decreases by 10% compared to $2 when revenue goes up by 10%!!!
Moral of the Story
Like in this Pandemic era revenue increase is a struggle.
As such, focus all your energy into expense decrease.
This can boost bottom line even better than revenue increase as seen above.
What is the Magic here?
When revenue increases (except for a pure price increase which is even more difficult in this Pandemic era), it brings with it expense.
So bottom line gets diluted.
However, when expense decreases, it GOES STRAIGHT TO THE BOTTOM LINE!!!
Do you now realize how powerful a small expense saving can be compared to even revenue increase
That is indeed the magic of an expense decrease over a revenue increase.
And now on to how to manage inventories better and prevent losses like spoilage.
Financial Ratios - Inventory Turnover Ratio
Financial Ratios - Inventory Turnover Ratio
Inventories are familiar to you.
You plan to buy them, buy them, store them and then issue to the operation.
Did you know that you did all that and still may leave money on the table as I mentioned before.
What, you ask angrily?
How would you know if your inventory management is efficient?
I must say here that most hotel managers are indeed familiar with inventories.
However, still that will not provide information on something critical.
Let us see what the first of the 3 Balance Sheet Financial Ratios is all about.
The Inventory Turnover Ratio literally tells you how many times your inventories turned over.
That means, how many times sold or consumed in the operation.
It is the productivity measure for inventory management.
Believe me, you do not want a low inventory turnover ratio.
It requires more storage, is susceptible to loss, spoilage (remember that earlier) or pilferage.
And it locks up precious cash flow.
That last one you will not know if you are looking only at the Profit and Loss Statement!
A high price to pay indeed!
Remember, the reasons I laid out earlier on why spoilage is preventible.
Hotel Current Assets
You should be regularly looking at the Balance Sheet Current Assets and reviewing Inventory Turnover Ratio.
If you did, the chances of preventing spoilage are good.
Note that I said good and not perfect.
This is because, merely looking at the Inventory Turnover Ratio is not good enough.
You should drill down and find out which of the inventory categories have a low turnover ratio.
In other words, which inventory items are moving slowly.
Your hotel should already be generating a Slowing Moving Inventories Report every month.
If you do, you can use that to prevent spoilage and other losses.
On the other hand, if you do not have that report, your first priority is to generate one immediately.
Remember how expense saving is more powerful to the bottom line than even revenue increase.
You should then follow up and look at your entire process of inventory ordering, storing and the works.
In a later blog post, we will explore how to use a concept called par stock to manage inventories efficiently
Now on to the second Balance Sheet financial ratios.
This is one which is linked to your revenue.
Aha, that earned your attention!
Financial Ratios - Accounts Receivable Turnover Ratio
Financial Ratios - Accounts Receivable Turnover Ratio
You may be throwing the kitchen sink at generating revenue.
But are you ensuring this translates to money in the bank?
This balance sheet ratio is about the efficiency with which your accounts receivables turn over.
In other words, how quickly revenue translates to cash inflow!
Normally, hotels tend to pursue accounts receivables better than many other assets.
More possibly because owners are also switched on about collecting receivables fast.
The Accounts Receivable Turnover Ratio compares average accounts receivables with Net Credit Sales.
Why credit sales?
Basically because cash sales have accomplished the money in bank simultaneously with the sales.
It is only the credit sales, or billed / invoiced revenue that needs to be collected.
When accounts receivables fail to be collected beyond 180 days or six months, there is danger that they might go bad.
In other words, remain uncollected.
And will need to be written off.
A write off is a loss to the hotel.
It will hit your Profit and Loss Statement.
And a failure of the collection effort.
Not to mention the revenue cycle remaining incomplete (no money in bank!)
Believe me, you do not want to be the general manager to tell the owner about a debt gone bad! Ouch!
So, there you go!
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Financial Ratios - Working Capital Ratio
Financial Ratios - Working Capital Ratio
Remember earlier I said I would come back to the cash flow for our third and last balance sheet financial ratio.
Well, this one brings all the current assets together.
Plus Current Liabilities as well.
What is that you ask?
Current Liabilities are monies that you owe third parties which need to get paid within one financial year.
Current Liabilities examples are Sales and Wages, Supplier invoices and so on
It is strange that on the one hand you focus on revenue but not the source - asset.
What about a situation when your revenue is decreasing sharply?
Or your profit.
These are all Profit and Loss Statement related.
You will still not know if this decrease is causing other kinds of problems.
Problems that do not show up on Profit and Loss Statements.
Where do they show up then and what problems, you ask angrily?
In the Balance Sheet (note, I am not the gloating type!).
And the problem could be cash flow related.
The Working Capital Ratio literally tells you the short term position of cash flow.
Cash Flow needed to run the day to day business.
You could continue focusing on revenue and even profit but not know about the cash flow.
Working Capital deducts Current Liabilities from Current Assets.
Remember Current Assets?
If Net Worth shows you the long term financial position, Working Capital shows you the short term position.
For an opening hotel with no revenue earned yet, working capital is what the Owners approve as cash flow to run the pre-opening stages.
If you are the general manager of a managed hotel, your Hotel Management Agreement will lay out the Working Capital specifically.
Cause and Effect
You will see a pattern in all the 3 Balance Sheet Financial Ratios we discussed.
That we know about the effect but not the cause (which is more important!).
Effect is the Profit and Loss Statement through revenue, expenses and profit.
Cause is the Balance Sheet through Fixed and Current Assets.
Looking at the cause is more important than effect.
Cause allows correction through decision making.
Effect is static.
It has already happened.
Cause is dynamic.
You can use it to influence business results.
You would want that wouldnt you?
That wraps up our 3 part blog post series on the power of the Hotel Balance Sheet.
Action Steps You Can Take Immediately
In a later blog post, I will discuss how the Inventory Turnover Ratio should be read and interpreted followed by action plans to manage inventory more effectively.
Your Key Takeways
What did you think about the losses that are preventable?
Did you find the magic of expense decrease useful?
What kind of review are you doing of your hotel current assets in the Balance Sheet?
Comment below.
I am keen on knowing your thoughts.
See you in the next blog post.
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