Expenses-Watch this Slow Fuse Profit Drainer in Your Hotel Financial Statements
Have you heard of the slow fuse expenses phenomenon in hotel Financial Statements?
It creeps up on you slowly (hence the slow fuse title!) and before you know it drains your profit!
You may not even be aware that the slow burning fuse is sputtering already.
What am I talking about, you ask alarmed?
Hang on, I am getting there.
I will lay out a case with examples of how you can keep away this slow fuse stealth killer.
So that your bottom line does not take a disastrous hit!
Let’s dive straight into it.
This Blog Post will cover:
In the previous Part 3 of this 5 part post series, you came across inventories and how to avoid profit drainers.
In this Part 4, you will continue to see some ways in which your hotel inventories could do serious damage to your profit through expenses.
It is something often missed by hotel managers.
You will also learn about the non-inventories based slow fuse expenses that drain your profit.
Expenses and The Inventories Triangle
Let us rewind to Part 3 of this 5 blog post series to revisit an important concept.
If you missed Part 3 click below link to read that first
Remember how the Food Cost of 42% was arrived at in the Food and Beverage department Profit and Loss Statement.
The 42% Food Cost is a figure derived after taking into account
- Opening Stock,
- Add Purchases
- Less Closing Stock
- Is Equal to Cost of Goods Sold
Or what we know as Food Cost.
That Food Cost which is 42% this month for Lunch.
That last bullet point: Cost of Goods Sold is what is reflected as expenses in your Food and Beverage department P&L.
So, if you think about it, that expense of Cost of Goods Sold is dependent on 3 other items.
The Inventory Triangle
These 3 Items can be called The Inventory Triangle.
- Opening Stock of Inventories
- Purchases of Inventories
- Closing Stock of Inventories
So, now can you see how that slow fuse I was talking about is burning all the time in the inventory related expenses.
The expenses which we called Cost of Goods Sold!
How is it a slow fuse you ask?
Well, if you are not efficiently managing inventories, you will either run out of an inventories item or over stock it.
Both have consequences.
You learned about what happens when you run out of a menu item in a restaurant.
Read Part 3 of 5 blog post here to revisit it.
The other and possibly more dangerous slow fuse is the overstocking situation.
Let us assume you did not utilize Inventory Turnover Ratio [again read Part 3 of 5 if you missed it] to determine how efficiently you are managing inventories.
And ended up over stocking.
What is over stocking?
It is holding more quantities of items than you are selling and / or consuming.
If the item does not sell, it will gradually move into a Slow Moving Inventories List.
Slow Moving inventories often tend to become part of the Non-Moving Inventories List.
These are items you had ordered without considering what your hotel is actually selling or consuming.
At some point of time they will also hit your Profit and Loss Statement as an expense [Cost of Goods Sold].
See how the slow fuse is burning.
And how will you end up over stocking?
Well, you will if you did not manage your Purchasing function well.
Purchasing is one of the three elements in the Inventory Triangle.
In the end, it is the combination of a well planned purchasing process based on an efficiently managed inventories system that will keep that slow fuse away.
Expenses and The Par Stock Paradise
So, how can you avoid the slow fuse of over and under stocking of inventories?
Is there a remedy for this?
Of course there is.
Have you heard of the concept of Par Stocks?
You are giving me that puzzled look.
Hold on, I will clear the air shortly.
There is one critical factor that many so called inventory management systems do not address at all.
Let me give you an example.
EXAMPLE
One undeniable fact is that of the hospitality industry being a seasonal one.
You could have a low month of 40% occupancy or a high month of 90% occupancy.
All in the same year.
Now, assume that the current month February is a low month while the next month March is a high month.
You will in all probabilities need to plan one month at least in advance for your hotel’s purchase requirements.
In other words, you will need to order in February to have the inventories on hand for March.
However, here is the dilemma.
If you ordered on the same basis as the current month of February, you will find yourself totally out of stock of inventories in March.
Why so, you ask?
Well, if February occupancy is 40% and you ordered on the basis of that for March which has a 90% occupancy, you will get a rude shock.
The shock of under ordering and resulting in under stocking of inventories.
But this is exactly what many hotels end up doing.
Why so?
Because they do not have a system of par stock in operation.
Par Stocks take into account the consumption patterns of each month of occupancy.
So, they are tailored to take care of low and high months.
There you go.
You have just avoided the slow fuse of inventories based expenses landing in your Profit and Loss Statement.
If you want to learn all about how to set up a par stock system for efficient inventory management, enroll in the forthcoming Hotel Performance Analysis Simplified Course.
Click here to learn more.
Purchases Which are Not Expenses
In the earlier sections, you saw how purchases are part of that Inventory Triangle which results in expenses hitting the Profit and Loss Statement.
As Cost of Goods Sold.
However, not all purchases are expenses.
Only purchases of inventory items are considered in accounting terms.
Inventories are part of a category of asset called the Current Assets.
Current Assets are those which are used up during a financial year.
Like inventories do.
When inventories are sold or consumed, they are replaced by new ones.
But purchases of another type of asset do not result in expenses.
These are called Fixed Asset purchases.
Fixed Assets are those assets whose benefit extends beyond a financial year.
For example:
- Kitchen Equipment
- Furniture & Fixtures
- Plant and Machinery
are all considered Fixed Assets.
So, when Fixed Assets are purchased, they do not appear in the Profit and Loss Statement.
They go to the Balance Sheet as part of assets.
So, every time a purchase item is ordered, Accounting department will determine whether it is a Fixed Asset or Current Asset.
If Current Asset, then it will get into inventories and ultimately become Cost of Goods Sold.
They will thus appear as expenses in the Profit and Loss Statement.
If the purchased item is determined a Fixed Asset by the Accounting department, they go directly to the Balance Sheet.
So, the moral of the story is: every purchase does not end up as expenses.
So, all purchases may not result in the slow fuse I talked about.
Now, let us dive deep into expenses and their behavior.
How Your Hotel Expenses Relate to Your Operation
Expenses (yes, the ones which cause the slow fuse!) have a unique relationship with your hotel operation.
How so, you ask?
Well, they have different behavior patterns.
In other words, they are not all the same types.
Let us look at Relationship based expenses
Direct and Indirect Expenses
Direct and Indirect expenses are based on the relationship of the expense to revenue earned.
If the expense is directly linked to the generation of revenue, it can be considered Direct.
For example, if room revenue is earned from a guest room, there are expenses incurred in getting that room ready for occupation by the guest.
These could be amenities placed in the room etc.
Another example is, when a menu item is served as a dish in the restaurant within the hotel, simultaneously, a direct expense called the Food Cost is incurred.
This Food Cost is not only a Direct expense but also a Variable Expense.
The Beverage Cost is another Direct Variable Expense representing beverage that is served along with the food menu item.
Indirect expenses are those that are incurred for generation of revenue.
However, these indirect expenses cannot be identified directly to the revenue or expenses incurred generally in running a department which is related to the revenue being earned.
For example, say, expenses are incurred in running a Shuttle bus for guests to be picked up from the airport.
These cannot be identified directly to revenue earned but form part of the Rooms department expenses.
This would be Indirect expenses of the Rooms department.
Role of Direct Expenses
So, you might ask the question:
What is the big deal about categorizing expenses into Direct and Indirect?
As it turns out, there is a big deal.
Direct Expenses are those which are considered when a Gross Profit calculation is made (this will be discussed in depth in the concluding Part 5 of this 5 part series blog post).
Gross Profit is one of the most powerful KPIs in the context of a hotel.
What is the purpose of a Gross Profit calculation?
It allows you to determine how much it costs directly to earn the related revenue.
Gross Profit is normally converted into a percentage and measured in those terms.
Paradise Hotels Inc Food and Beverage Dept Gross Profit
For example, examine the case of the Taste Buds Restaurant statement in Paradise Hotel shown above.
Notice that the Gross Profit is after deducting Food and Beverage Cost amounting to 66% in the Current Month.
Gross Profit is derived after deducting both Food and Beverage Cost from the Food & Beverage Revenue.
Since Direct Variable Expenses can often be controlled and thereby reduced, the Gross Profit calculation allows a hotel to maximize that KPI to boost overall profit of the hotel.
Expenses - a Slow Fuse to be Watched!
In the earlier section, you read some references to “Variable” expenses.
Like Direct and Indirect expenses, these are another category of expenses.
And yes, they are the slow fuse variety to be watched.
Not all of them, but some of them.
How will you know which ones to watch?
Great question.
I am glad you asked.
We will dive into this in the concluding part 5 of this 5 part blog post series next week.
You will discover how that slow fuse operates and how it can endanger your profit.
To be Continued in Part 5 of 5
This post will be continued in the next week's concluding Part 5 of the 5 part blog post series.
You will learn about:
- How to distinguish between the slow fuse expenses and others
- How do these expenses impact your hotel profit?
- What are strategies you can adopt to steer clear of those slow fuse ones?
- How can you boost your hotel profit through better expense management?
and much more, so stay tuned...
Action Steps You Can Take Right Now
STEP 1
Find out if your hotel is leveraging The Inventory Triangle
STEP 2
Is your hotel planning your purchases based on sales and consumption patterns?
STEP 3
Does your hotel have Par Stock quantities for each inventory item?
STEP 4
Are you aware of Purchases which become expenses and those which do not?
STEP 5
Is your hotel monitoring expenses to avoid the slow fuse profit drain phenomenon?
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