Hotel Financial Ratios are like your car instrument panel dashboard!

You are giving me those looks.

As a manager, you regularly do think about your hotel performance, don’t you?

Or are you skipping this critical process?

What if you could quickly look at some key metrics of hotel performance?

Like the kind you glance at regularly when you drive your automobile.

And keep yourself updated on your progress against say revenue targets.

Let me now ask you a question.

Instrument Panel Metaphor & Financial Ratios

Why do you keep looking at your car’s instrument panel while driving?

So that you can check on some key readings on the panel.

For example

• what is the position of your fuel?
• What speed are you driving at?
• On your GPS, how much more distance and time to your destination and so on.

The idea is to measure progress along with some important indicators.

Well, your hotel operation also has its own set of metrics to watch out for.

But the question is: are you regularly reading those measures?

If you are not, you could be seriously losing out big time.

Let me explain how.

Before that, take a look at the infographic below on the Ultimate Guide on Hotel Financial Ratios.

This Blog Post will answer questions like:

• What are Hotel Financial Ratios that analyze financial statements?
• What are the categories of Hotel Financial Ratios?
• What is the ideal Hotel Financial Ratio?

and more.

Why Should You Care about Hotel Financial Ratios?

So, what is the big deal about hotel financial ratios?

As a hotel manager, why should you care?

Great questions.

Let me clarify.

Would you not want to know if your hotel’s performance is falling behind?

Or worse, some alarming signs are showing up?

Imagine if you get a nasty surprise when the month’s performance is revealed.

It would be quite embarrassing, right?

These are good reasons why you should be on top of performance measures.

Hotel Financial Ratios have the ability to provide you those progress indicators.

They often indicate warning signs of trouble ahead.

Once you get used to these KPIs as they are often known as, you will never let go.

KPIs are incidentally acronyms for Key Performance Indicators.

Let us see what these ratios are.

And how you can utilize them for performance updates.

What are Financial Ratios?

What are financial ratios?

These are comparison measures that tell a story about your hotel performance.

A ratio has got two key elements:

• Numerator and
• Denominator

No, we are not diving into a mathematics lesson.

Bear with me.

This will help us understand how to read these ratios.

A ratio has two numbers (sometimes more!).

One above the line and one below.

Numerator is the number above the line.

Denominator is the number below the line.

Each number is a performance measure by itself.

Often, they are then multiplied by 100 to get a percentage.

Enough of theory, let us see an example.

Financial Ratios Example

Let us first use a common personal example.

Say you earned $8,000 in a month and ended up saving $3000.

What is your savings percentage?

Your savings percentage will be calculated as follows:

$3000 / $8000 *100 = 37.5%

This 37.5% savings percentage is a ratio.

It is the ratio of savings dollars to earnings dollars.

A ratio can be with or without being stated as a percentage.

When you apply this calculation method to hotel KPIs, they result in Hotel Financial Ratios.

For a quick example:

How do you calculate the occupancy % of a hotel for a month?

You divide Rooms Occupied by Rooms Available and multiply by 100

FORMULA

In other words, the formula is:

Rooms Occupied / Rooms Available x 100 = Occupancy %.

This occupancy % is a hotel financial ratio.

It tells you how well the hotel sold its rooms for a month.

Here Rooms Occupied is the Numerator (above the line).

And Rooms Available is the Denominator (below the line).

How do you Read Hotel Financial Ratios?

We have now understood how hotel financial ratios are calculated.

Let us see how we can read them accurately.

To begin with, financial ratios are only indicators.

These indicators can show a positive or a negative picture.

Ratios may require further research into what is causing them to be positive or negative.

Let us use the earlier occupancy % example.

Say a hotel has 500 rooms available daily in the month of January 2024.

It sold 320 rooms each day in that month.

So, the calculation will go something like this.

First, 500 x 31 (days in January) = 15,500 rooms available in the month.

Second, 320 x 31 (days in January) = 9,920 rooms occupied (sold) in the month.

Occupancy % in January 2024 is 9900 / 15500 x 100 = 64%.

Is 64% a good performance or not?

This will depend upon many things.

Let us see a couple of them here.

First, what was budgeted (target) for the month?

If the budget was say 60% occupancy, then the hotel had a positive result (64% > 60%).

Second, what was the occupancy % in January 2023 (previous year same month)?

Again, if the January 2024 occupancy was higher than 2023, then it is positive.

Comparison with budget and previous year are two common ways for financial ratios to be used.

They tell you whether you are progressing at all.

Traps You Must Avoid with Hotel Financial Ratios

Remember, I said earlier that financial ratios are merely indicators.

They need to be verified further in most cases.

This is also where most hotel managers make errors.

It is why you must avoid some typical traps in reading financial ratios.

For instance, is the comparison apples to apples?

Say, the occupancy % budget was set assuming an abnormal event which did not happen.

In this case, the budget might have been set too high.

Comparatively, the actual occupancy % was much lower.

This by itself does not mean that the hotel did a bad job.

Again, I reiterate that this is why financial ratios are merely indicators.

They need to be verified with further factual information.

In chapters of this Ultimate Guide (see below), we will dive deep into understanding this better.

This post is Chapter 1 Hotel Financial Ratios - Why should you care?

Chapters in this Ultimate Guide on Hotel Financial Ratios

This Ultimate Guide is a twelve part series which will cover the following key areas:

• CHAPTER 1 of 12 - Hotel Financial Ratios - Why should you care? [This Post]
• CHAPTER 2 of 12 -Liquidity Ratios Intro - Acid Test Ratio [Next Up]
• CHAPTER 3 of 12 -Liquidity Ratios - Accounts Receivable Turnover Ratio
• CHAPTER 4 of 12 -Liquidity Ratios - Working Capital
• CHAPTER 5 of 12 -Solvency Ratios - Net Worth
• CHAPTER 6 of 12 -Solvency Ratios - Debt Equity Ratio
• CHAPTER 7 of 12 -Activity Ratios - Inventory Turnover Ratio
• CHAPTER 8 of 12 - Profitability Ratios Intro - Gross Operating Profit
• CHAPTER 9 of 12 - Profitability Ratios - Return on Investment Ratio
• CHAPTER 10 of 12 - Profitability Ratios - Return on Equity Ratio
• CHAPTER 11 of 12 - Asset Management Ratios Intro - Asset Turnover Ratio, RevPAR
• CHAPTER 12 of 12 - How to Identify Warning Signs in Hotel Financial Ratios

How to Feel the Pulse of Hotel Performance with KPIs

At the end of the day, it is important to get a hang of your hotel performance.

Rather like the car instrument panel we talked about.

So, how do you get to feel the pulse of your hotel performance?

Great question.

Broadly, hotel KPIs can be categorized as addressing following performance areas:

• Capacity KPIs
• Business Volume KPIs
• Price KPIs
• Revenue KPIs
• Expenses KPIs
• Profitability KPIs
• Guest Loyalty KPIs

This is certainly not an exhaustive list.

However, these are the most commonly measured hotel KPIs.

Then you could also categorize based on:

• Big Picture Overview
• Individual Focus

Big Picture Overview Hotel KPIs are those that cover the entire hotel operation.

For example, Market Share is a hotel KPI that measures a hotel’s standing in the market it operates.

While there are different ways to calculate what market share is, the concept is about the big picture.

Market Share includes some hotel KPI categories which we saw earlier like business volume, price etc.

Profitability Hotel KPIs measure almost the end business result of a hotel operation - the bottom line.

For example, Profitability KPIs include many individual area hotel KPI categories like

• revenue,
• expenses,
• capacity and so on

which we listed earlier.

So, that is the reason hotel KPIs are not all made the same.

It will depend on what your goal is in measuring hotel KPIs.

Moreover, you need to understand what are known as performance triggers.

For example, hotel revenue is contributed by 3 broad triggers:

• Capacity (represented by Available Rooms)
• Business Volume (represented by Occupancy)
• Price (represented by Average Daily Rate)

That should be a good overview on hotel financial ratios.

Next Week

We will dive into the world of Liquidity ratios.

We will see:

• What Liquidity is?
• Why are Liquidity ratios critical?
• How do you read and use Liquidity ratios?

and more…

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Would you Know the Liquidity Ratios for your hotel?

You look puzzled, you want to know what liquidity actually means.

Most importantly, what is the big deal about knowing it, you ask.

Fair enough.

I call financial ratios as an early warning system.

Remember the car instrument panel dashboard metaphor from Part 1?

Click here to read that.

It is like missing a key reading on your dashboard.

Say, you do not notice that the fuel in your car is running low.

The next thing that will happen is your car will stop running.

You can consider liquidity something similar to that.

If your liquidity runs low, you cannot run the hotel efficiently.

However, first, what is liquidity?

Let’s find out.

This is Part 2 of the 12 part Ultimate Guide on Hotel Financial Ratios series.

The blog post will cover:

Liquidity Ratios - Early Warning System

Why do I call hotel financial (and liquidity) ratios an early warning system?

Well, just like the instrument panel reading, you must be on top of hotel performance.

Like running out of fuel, you should not get into a crisis situation.

And one quick way to do that is by knowing which financial ratios to monitor.

There are tons of ratios that can be calculated.

It is not possible or necessary to keep track of all of the ratios.

However, a few major categories bear watching closely.

We will be exploring these major categories in this Ultimate Guide.

Financial Ratios by Major Categories

Financial ratios can be grouped into 5 major categories

• Liquidity Ratios
• Solvency Ratios
• Activity Ratios
• Profitability Ratios
• Asset Management Ratios

Let us take liquidity first.

Recall what I said earlier.

If your liquidity runs low, you cannot run the hotel efficiently.

Time to dive in and understand the liquidity concept.

Liquidity Ratios - Fuel that Runs Your Operation

Liquidity simply means cash.

Not exactly but let me explain.

It means the ability of an asset to turn into cash.

The higher the cash balances in a balance sheet, the more liquid the position.

Such assets are called liquid assets.

Liquid assets generally refer to the current assets category.

Want to know more about current assets?

Read the Ultimate Guide on Hotel Balance Sheet Basics.

Back to liquid assets.

For example, Current Assets (see below) are normally these three common types:

• Cash and Bank Balances
• Accounts Receivable
• Inventories

Current Assets can be of other kinds too.

However, these three feature prominently in most hotel balance sheets.

Now let us learn what Liquidity Ratios are.

Liquidity Ratios and Current Assets

Liquidity Ratios are ratios that measure how liquid hotel current assets are.

In other words, how quickly can the current assets be turned into cash.

Let me bring in again the common types of current assets in a hotel balance sheet:

• Cash and Bank Balances
• Accounts Receivable
• Inventories

The above list has a particular order to it.

This order is mandated by the Uniform System of Accounts.

All hotel balance sheets must follow this mandate.

Current Assets need to be listed in the order of their liquidity.

See Current Assets listing below:

In other words, the most liquid asset must be first and so on.

Notice how this is the case in the above list.

Cash is the most liquid of current assets.

This is because they are already in cash form.

Next comes Short Term Investments (less than 90 days mostly).

Then, Accounts Receivable.

Accounts Receivables are sales made but cash not yet collected.

Finally, we have Inventories (We will touch upon Prepaid Expenses in another post).

Inventories are stocks of goods that will be sold or consumed.

For example, food and beverage supplies are part of inventories.

Food and Beverage items will be issued out from inventories and sold in the hotel’s restaurants.

The inventory thus sold will become revenue.

Accounts Receivables Vs Inventories

Why are Inventories listed after Accounts Receivable?

Because Accounts Receivable represents sales already made but money not collected.

On the other hand, inventories are yet to be sold and hence not as liquid.

Inventories are considered the least liquid of current assets.

Now, we know common types of current assets, let us visit the major categories of liquidity ratios.

Liquidity Ratios

We will examine 3 major categories of Liquidity Ratios in this Ultimate Guide.

Take a look at the infographic below.

These are:

• Acid Test Ratio
• Accounts Receivable Turnover Ratio
• Working Capital

We will be understanding why these are the most important.

In the early warning system, these rank the highest.

We will be discussing Acid Test Ratio in this post.

The other two will follow in forthcoming posts.

Acid Test Ratio

What is Acid Test Ratio?

The Acid Test Ratio is a revised form of the more common Current Ratio.

You could say that Acid Test Ratio is a better indicator than the current ratio.

Let’s see why and how.

Current Ratio is simply the ratio of Current Assets to Current Liabilities.

The formula is:

Current Assets / Current Liabilities

Quick recap of what current assets and current liabilities are:

Assets used up within a financial year are current assets.

Liabilities payable within a financial year are current liabilities.

Take a look at the Current Assets and Current Liabilities of Paradise Hotel below:

The Current Ratio however suffers from a huge defect.

It can show an incorrect picture.

What do I mean?

For example, inventories are considered the least liquid of current assets.

If a hotel’s current assets are predominantly inventories, it may show a false picture of liquidity.

Is your hotel holding a lot of inventories?

Check them out.

In the above Paradise Hotel Balance Sheet, note that Current Assets total $221,000.

Current Liabilities total $214,000.

So, Current Ratio is Current Assets / Current Liabilities = $221000 / $214000 = 1.03.

Current Ratio is barely above 1.0.

We will see why this is a problem shortly.

Note that Inventories total $17,000 in Paradise Hotels current assets.

And Inventories are the least liquid of current assets.

How do we sort this issue out?

Enter the remedy for this: Acid Test Ratio.

Acid Test Ratio removes inventories from the current assets in its calculation.

And leaves the most liquid assets to be compared to Current Liabilities.

In other words, the formula is:

Current Assets Less Inventories / Current Liabilities.

Let us now see the example using the Paradise Hotel shown above.

Acid Test Ratio Example

The Current Ratio for Paradise Hotel as of 31.12.2018 is:1.03

Current Assets / Current Liabilities OR 

$221000 / $214000 = 1.03

Removing inventories of $17,000 from Paradise Hotel Current Ratio, the Acid Test Ratio is:

Current Assets Less Inventories / Current Liabilities OR

$204000 / $214000 = 0.95

Note how Current Liabilities are now higher than the most liquid current assets.

However, you would only know this if you calculated Acid Test Ratio.

Just calculating Current Ratio would have given you an incorrect picture.

Check out your hotel's current ratio and then verify it with the Acid Test Ratio.

How is Acid Test Ratio useful?

In the case of the Paradise Hotel, you discovered that Acid Test Ratio is below 1.0.

That is not a good situation to be in.

You are getting an early warning from this ratio.

Liquidity is one of the key measures of short term solvency.

In other words, the ability to pay current liabilities with current assets.

Is the hotel able to cover its short term liabilities with its short term assets?

Or, how liquid are the hotel’s current assets?

If current liabilities are not covered by current assets less inventories, the hotel will have a cash crunch.

This is because inventories are not sold yet.

So, they are not able to provide the cash necessary to pay liabilities.

This is the reason the Acid Test Ratio is so critical.

How to Read Acid Test Ratio

Current Ratio must always be verified with the Acid Test Ratio.

This is what we did with Paradise Hotel above.

In other words, calculate the Current Ratio but check with the Acid Test Ratio.

This is to ensure that inventories are not skewing the liquidity.

Acid Test Ratio below 1.0 is a warning that current assets are not very liquid.

They may not be able to pay the current liabilities.

Liquidity Ratios in Pre Opening Hotels

For hotels which are in pre opening stage, inventories tend to be higher.

This is because the hotel has not started operating.

Actual consumption of goods is not established since hotel has not opened.

Consequently, it may not have an accurate grasp of sales volume.

Moreover, the hotel will want to avoid a stock out situation initially.

Therefore, it will keep higher than needed inventory levels.

You could conclude that it is even more critical for pre opening hotels to calculate Acid Test Ratio.

Chapters in this Ultimate Guide on Hotel Financial Ratios

This Ultimate Guide is a twelve part series which will cover the following key areas:

• CHAPTER 1 of 12 - Hotel Financial Ratios - Why should you care?
• CHAPTER 2 of 12 - Liquidity Ratios Intro - Acid Test Ratio [This post]
• CHAPTER 3 of 12 -Liquidity Ratios - Accounts Receivable Turnover Ratio [Next post]
• CHAPTER 4 of 12 -Liquidity Ratios - Working Capital
• CHAPTER 5 of 12 -Solvency Ratios - Net Worth
• CHAPTER 6 of 12 -Solvency Ratios - Debt Equity Ratio
• CHAPTER 7 of 12 -Activity Ratios - Inventory Turnover Ratio
• CHAPTER 8 of 12 - Profitability Ratios Intro - Gross Operating Profit
• CHAPTER 9 of 12 - Profitability Ratios - Return on Investment Ratio
• CHAPTER 10 of 12 - Profitability Ratios - Return on Equity Ratio
• CHAPTER 11 of 12 - Asset Management Ratios Intro - Asset Turnover Ratio, RevPAR
• CHAPTER 12 of 12 - How to Identify Warning Signs in Hotel Financial Ratios

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Behind the scenes, a major piece of the Financial Skills Academy PLUS ecosystem just went live.

I’ve spent the last few weeks building, testing, and refining a brand-new digital learning environment.

Addressing Hotel Middle Managers specifically.

The goal?

To take complex hotel financial metrics and make them accessible to operation managers.

Watch short video below.

No dense spreadsheets.

No rigid accounting lectures.

Just simple, actionable visual dashboards.

I quietly opened the gates to our "5 Real-World Hotel KPI Scenarios" flash course to a few early birds yesterday, and the automation is running beautifully.

Want to sneak in before the official public announcement tomorrow?

And start mastering your hotel’s profit triggers today?

You can grab free access right now.

Click Below to jump straight into Module 1!

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Financial Literacy for Beginners - Ultimate Cookbook?

A cookbook on financial literacy!

Am I out of my mind?

Hmm…not really

Allow me to explain my thought process (however crazy it must sound to you!).

Take a look at some hotel middle manager profiles I have listed below.

Are you one of them?

If yes, you may have found a gold mine in learning!

Learning to be financially literate, I mean.

I will lay out the recipes (pun intended!) in this one of a kind cookbook.

Here is an infographic that represents the Financial Literacy for Beginners Ultimate Cookbook idea.

As you can see, cookbook is a metaphor.

I have used this metaphor considering that food and beverage is a big part of a hotel business model.

And not so out of place after all.

So, What’s the Financial Literacy for Beginners Ultimate Cookbook about, you ask.

All in good time.

Let’s get to it.

This Financial Literacy for Beginners Cookbook will cover:

Financial Literacy for Beginners Cookbook Vision

Well, my philosophy about this cookbook can be stated as follows:

Share focused, individual recipes for every aspect of hospitality finance like:

• hotel financial performance
• hotel financial analysis
• hotel financial statements
• hotel revenue management
• hotel financial decision making
• hotel asset management
• how to build financial skills, knowledge and ability
• restaurant performance

and more…

Are You One of These with < 1 Year Hotel Experience?

Front Office Manager

Food and Beverage Manager

Executive Chef

Revenue Manager

Hotel Owner

Restaurant Owner

Hotel Student

If you have a profile similar to the above and have difficulty in:

• reading hotel financial statements
• analyzing business results
• taking financial decisions

then the Financial Literacy for Beginners Ultimate Cookbook is your friend, philosopher and guide.

Why Financial Literacy?

Why am I focusing on financial literacy?

Well, every hotel middle manager is in need of regular professional development.

More specifically, financial skills based.

For that matter, who does not need it?

Post covid-19, financial literacy has become your own responsibility.

You grow skill sets that way.

Being financially literate is one such critical skill sets.

On the other hand, online learning has grown even bigger.

If you wait for companies to sponsor or conduct training, you will be left behind.

That means being committed to developing your own financial literacy.

You take ownership for becoming financially literate.

I am doing my bit to assist through the Financial Literacy for Beginners Ultimate Cookbook.

I founded Financial Skills Academy PLUS so that you could grow foundational finance skills like:

• Reading Hotel Financial Statements
• Identifying Hotel Key Performance Indicators
• Budgeting for Hotel Financial Performance and
• Managing Hotel Expenses

irrespective of your financial background.

I want you to give every accountant (never mind I am one too!) a run for their money.

I want to enable you to be more financially savvy than the finance fraternity itself.

How about that for a mission!

Want to go on this exciting journey?

OK, let’s get back to some specifics.

What’s unique about our Financial Literacy for Beginners Ultimate Cookbook, you want to know?

Unique Value Proposition for Financial Literacy

Often, learning platforms focus on knowledge only.

They drum a boatload of course information into you.

As if the world challenge currently is more information, not less!

Consider this though.

If you cannot translate financial knowledge to financial skills, is it not a waste of your time and effort?

Say you are not able to utilize your financial skills for problem solving and decision making.

Is that not meaningless for you?

Dale Carnegie once said: Knowledge isn’t power until it’s applied

Financial Literacy for Beginners Ultimate Cookbook is about building financial skills, ability in you.

One recipe at a time.

It is about empowering you.

How?

Through specific recipes that will grow financial skill sets in you.

In other words, make you financially literate.

That will build the all important basics.

Hotel Middle Managers are often found lacking in financial literacy.

I have taken great pains to ensure a few typical hurdles are removed for you.

The Financial Literacy for Beginners Ultimate Cookbook recipes are:

• Jargon free (as in non-technical).
• Example driven & Easy to understand.
• Action based Learning you can apply (to take successful financial decisions)

This is why we pride ourselves as the Complete Financial Learning Ecosystem.

And this cookbook is proof of that!

You get a glimpse of what's in store as well.

Expectations for Financial Literacy for Beginners Cookbook

What can you expect from this cookbook?

I am envisioning this cookbook to be like a Chef’s Recipe Library which you can :

• learn from, through understanding concepts
• utilize simple examples
• refer to as a manual
• look up for strategies and inspiration

If you like the cookbook idea, please share the recipes.

And spread the word to your hotel middle manager and other colleagues.

So that they benefit too.

You can Subscribe to Our Youtube Channel for Financial Literacy Video Recipes too.

My goal is reach an audience of at least 100,000!

I know, I know, I am sounding crazier than before!

However, bear with me.

And yes, do spread the word around.

Thank you in advance, I really appreciate it.

Format of Financial Literacy for Beginners Ultimate Cookbook

You will find the recipes in this cookbook laid out in the form of:

• Crisp Concept Explanations, Examples
• Visual Keynote Slides
• Byte Sized Videos & Shorts
• Colorful Infographics
• Excel file Templates
• Fictional Paradise Hotel / Taste Buds Restaurant companion financial statements

and so on.

It will be my endeavor to keep this cookbook as visual as possible.

How are the Cookbook Recipes organized?

I will keep the recipes simple and easy to digest (pun intended!).

It will broadly lay out as below (extending the metaphor of the recipe):

• Key Ingredient (concept)
• Sauces (example, how to calculate etc.)
• Taste (decision making)
• Nutrition (business results)

Chef’s Take

Every recipe in this cookbook will have a Chef’s Take.

Chef as in me.

What is my claim to fame?

I spent 26 years in the hospitality industry working alongside hotel middle managers.

Financial Literacy is a huge challenge for those managers.

I am here to overcome that challenge on their behalf.

In the Chef's Take section and relevant to that particular recipe, I will share:

• Traps to avoid
• Things to watch out for
• What you should pay attention to
• Owner expectations
• Experiences & Anecdotes in the industry

and so on

I will wear a typical stakeholder hat while providing that take so that you benefit.

Your Contribution to this Cookbook Recipes

This is not a one sided set of recipes I have decided on.

Ideally I look forward to your input on topics you would like me to create recipes on.

Your feedback on the recipes themselves will help greatly in making this cookbook dynamic.

Comment below each cookbook recipe on what you found useful.

Suggest topics for recipes which will benefit your financial literacy skills.

Complete Financial Learning Ecosystem

How can you go beyond these recipes?

What recipe or cookbook upgrades can you access to take your financial literacy to the next level?

Obviously, the cookbook will feature recipes which will give you a great taste of topics.

However, you will want to take your financial, skills and ability to a new level.

Particularly if you aspire to higher positions.

Well, you can enroll in the Financial Skills Academy PLUS (coming soon..).

Sign Up in advance below:

This will be the only complete financial learning ecosystem there is in the market..

You will get access to entire cookbooks themselves (to extend the metaphor).

Click here to learn more.

Financial Skills Academy PLUS follows the same philosophy as this cookbook.

To build financial literacy in hotel middle managers.

And transform you into a business savvy hotelier.

How about that?

Next 5 Recipes Cooked Up One by One

FLBC Recipe 1 - Restaurant Table Turnover Rate Magic

FLBC Recipe 2 - Managing Inventories for a Better Bottom Line

FLBC Recipe 3 - Yield Vs Revenue Management

FLBC Recipe 4 - Profit Flow Through Analysis

FLBC Recipe 5 - Restaurant Buffet Bundling Strategy

Your Feedback on Financial Literacy Ultimate Cookbook

Do you have any questions?

What do you think about the Financial Literacy for Beginners Ultimate Cookbook idea?

Any suggestions for improvement?

What recipes (topics) do you find difficult to understand?

Comment below and I will take a shot at it.

See you soon (very soon!!!) in the first recipe of this cookbook.

Here is a sneak peek at that first recipe:

Financial Literacy for Beginners - Ultimate Cookbook Recipes

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Did You Know that Net Worth Ratio was the Biggest Fear during covid-19 for businesses?

In other words, businesses had to find out whether they were sustainable.

Or, would they survive the covid-19 pandemic?

Let me ask you a question.

Would You Know how to quickly find out if your hotel business is sustainable?

If not, is it not something you should be concerned about.

Well, relax, I have done the homework for you.

So that you need not worry your head off about sustainability.

I will lay out a strong case on how to discover if your business is sustainable in the long run.

However, let us take a step back to understand concepts related to this mysterious net worth ratio.

Begin with Assets

What are assets?

Assets are What the Business Owns.

They are the resources of the hotel.

The primary function of an asset (business asset) is to generate revenue.

Without assets, a business cannot generate revenue.

Assets are an index of strength of a business.

This is because assets are used to generate revenue.

So, you could say that the capacity of a business to generate revenue will be based on the:

• type and
• extent of

assets owned by it.

What are Long Term Assets?

Assets can be short term or long term.

Long term assets are those whose useful life is more than a period of 12 months.

These are also commonly known as Fixed Assets.

Why should we talk about fixed assets?

I am getting to that.

Before that, take a look at the Long Term Assets of Paradise Hotel below.

Long Term Assets - Examples

See the Paradise Hotel Balance Sheet below:

Long Term Assets are only one part of the Net Worth Ratio.

We will visit the other part shortly.

However, before that, take a look at the infographic below.

Now let us learn what a Net Worth Ratio is and some related concepts.

This Blog Post will cover

What is a Solvency Ratio?

Take another look at the infographic above on Solvency Ratios.

Solvency Ratios are indicators of the long term health of a business.

They give you hints at the sustainability of a business.

You saw in earlier posts in this series about liquidity ratios.

Liquidity Ratios are indicators of the short term health of a business.

In the same way, Solvency Ratios play the role for the long term.

That most times will mean relating to assets, liabilities and owner equity.

One of the most powerful solvency ratios for a business is the Net Worth Ratio.

Let’s see what it is about.

Net Worth Ratio (or Net Worth)

We learned about long term assets earlier.

However, what is Net Worth Ratio?

Let me use a metaphor for this.

Assume you are driving an automobile.

Suddenly, the car stops running.

You check and find out your fuel tank is full.

However, the car will not start.

You take it to a nearby garage.

They tell you that the car’s engine has packed up.

It will take some time to fix it and it will cost a lot.

Your engine is the central part of your automobile.

Without it functioning well, your car cannot run.

Net Worth Ratio is similar to that.

It is the long term capability to meet your obligations.

That capability comes from fixed as well as current assets.

Your Obligations are commonly known as Liabilities.

Liabilities can be long and short term.

Take a look at the Long Term Liabilities of Paradise Hotel.

Now you realize why we needed to know fixed assets and long term liabilities before net worth ratio.

Net Worth compares long term capability with long term obligations.

Or in other words, fixed assets with long term liabilities.

It also considers current assets and current liabilities

We will understand specific types of long term liabilities shown above later in this post.

We will also see why as a hotel manager you must know what this Net Worth ratio is about.

Net Worth measures the extent of total assets to total liabilities.

Refer to the image below showing:

• What the Business Owns [Assets] and
• What the Business Owes [Liabilities

In other words, the ratio (not exactly a ratio though) of:

• Property and Equipment, Cash, Accounts Receivables, Inventories and
• Mortgage Payable, Accounts Payable, Notes Payable etc.

See Paradise Hotel Balance Sheet below for this depiction.

Higher the Net Worth Ratio, the better will be its capability to meet obligations.

In other words, higher the ratio, the better the solvency.

Hotel Owners prefer a higher ratio since this means better chances of sustainability.

It of course means balancing capability (assets) with obligations (liabilities).

Hotel Management needs to balance:

• healthy total assets situation with
• moderate total liabilities.

Net Worth Ratio Formula

Net Worth is simply the difference between Total Assets and Total Liabilities.

The formula is:

Total Assets LESS Total Liabilities

Total Assets include Fixed and Current Assets.

Total Liabilities include Long Term and Current Liabilities

Take a look at the Total Assets and Total Liabilities of Paradise Hotel below:

We have already seen what long term assets are.

Let us explain what long term liabilities shown are.

• Mortgage Payable - these are long term loan or borrowings from lenders known as debt
• Deferred Income Taxes - these are liabilities for any long term tax amount due.

In a way you could say you are measuring the extent of solvency Vs obligations.

Let us now see the example using the Paradise Hotel shown above.

Net Worth Ratio Example

The Total Assets and Total Liabilities for Paradise Hotel as of 12.31.2018 & 12.31.2019 are:

• Total Assets: 2018 - $1,065,000 2019 - $1,176,300
• Total Liabilities: 2018 - $645,000 2019 - $659,000

The Net Worth Ratio for Paradise Hotel as of 12.31.2018 is:

Total Assets LESS Total Liabilities OR

$1,065,000 Less $645,000 = $420,000

Net Worth Ratio of $420,000 amounts to 1.65 which is a healthy ratio.

How did we get 1.65?

By dividing Total Assets by Total Liabilities.

And for 12.31.2019 is:

$1,176,300 Less $659,000 = $517,300

Notice how Net Worth Ratio improves from $420,000 in 12.31.2018 to $517,300 in 12.31.2019.

Notice that this improvement is contributed by higher total assets.

The Net Worth is thus a barometer of the balance between total assets and total liabilities.

These are assets whose solvency (+ liquidity) and levels have to be managed.

The indication is that 12.31.2018 shows net worth ratio to be healthy.

Let us now see how it is useful to calculate net worth ratio.

More importantly, how you can avoid some alarming situations shown below.

Want to know more how Net Worth is Built up?

Click the Ribbon at the Top of this page for Free 7 Step Visual Guide on how Profit Builds Assets & Owner Equity.

How is Net Worth Ratio useful?

For Paradise Hotel, you found the that Net Worth Ratio on 12.31.2018 is 1.65.

This is a healthy ratio.

What does “healthy” mean?

Healthy means that say, Paradise Hotel disposed off all their total assets to pay total liabilities.

They will then still be left with $420,000.

The Ratio of 1.65 tells you that Paradise Hotel has a cushion of 65% between total assets and liabilities.

This is what “healthy” means.

It means that there is a good cushion against unforeseen obligations.

If such an obligation were to arise, Paradise Hotel will be able to pay it easily.

If you remember, we said that higher the ratio the better the solvency.

Net Worth is one of the best indicators of solvency.

Solvency is one of the key measures of long term sustainability.

In other words, the ability to pay long term liabilities with fixed assets.

Is the hotel able to cover its long term liabilities with its long term assets?

Or, how solvent are the hotel’s fixed assets?

So, they are able to provide the cash necessary to pay liabilities.

This is the reason the Net Worth Ratio is critical.

Reasons Your Hotel Net Worth May Become Alarming

What are some reasons you could avoid being in a situation of low Net Worth?

First, manage your accounts receivables well.

Accounts Receivables being uncollected sales is critical for liquidity.

While they boost liquidity, it also helps in solvency.

Second, manage your debt or borrowings, which are simply long term liabilities.

For Paradise Hotel, as of both 12.31.2018 and 12.31.2019, the hotel managed its long term liabilities well.

This is not causing any pressure on the net worth which is healthy.

Third, do not have too much of money locked up in inventories.

In the case of Paradise Hotel, Inventories in both years are quite good.

Further you must ensure that you do not fall prey to some traps stated below.

Traps You Must Avoid with the Net Worth Ratio

As we have said earlier, financial ratios are mere indicators.

It is critical that we understand how they are calculated.

Total Assets and Total Liabilities play a part in this ratio.

So, both liquidity (current assets) and solvency (fixed assets) must be taken into account.

Similarly, movement in liabilities must also be considered.

These movements have to be monitored each month and year.

You must therefore monitor the current/fixed assets and current/long term liabilities closely.

This is to ensure they do not spiral out of control.

Big Picture of the Hotel Net Worth Ratio

At the end of the day, you must step back and take a big picture overview of solvency.

Meaning, look at the solvency picture in entirety.

And not just look at current or fixed assets and current or long term liabilities individually.

The big picture will be how solvent the business is.

This means a healthy Net Worth Ratio.

That will allow you to run your hotel operation without any sustainability doubts.

Chapters in this Ultimate Guide on Hotel Financial Ratios

This Ultimate Guide is a twelve part series which will cover the following key areas:

• CHAPTER 1 of 12 - Hotel Financial Ratios - Why should you care? [Already Published]
• CHAPTER 2 of 12 -Liquidity Ratios Intro - Acid Test Ratio [Already Published]
• CHAPTER 3 of 12 -Liquidity Ratios - Accounts Receivable Turnover Ratio [Already published]
• CHAPTER 4 of 12 -Liquidity Ratios - Working Capital [Already Published]
• CHAPTER 5 of 12 -Solvency Ratios - Net Worth Ratio [This Post]
• CHAPTER 6 of 12 -Solvency Ratios - Debt Equity Ratio
• CHAPTER 7 of 12 -Activity Ratios - Inventory Turnover Ratio
• CHAPTER 8 of 12 - Profitability Ratios Intro - Gross Operating Profit
• CHAPTER 9 of 12 - Profitability Ratios - Return on Investment Ratio
• CHAPTER 10 of 12 - Profitability Ratios - Return on Equity Ratio
• CHAPTER 11 of 12 - Asset Management Ratios Intro - Asset Turnover Ratio, RevPAR
• CHAPTER 12 of 12 - How to Identify Warning Signs in Hotel Financial Ratios

Next Week

We will dive into the fifth of hotel financial ratios - Debt Equity Ratio

We will see:

• What debt is and what equity is.
• What is a Debt Equity Ratio?
• Why is Debt Equity Ratio considered so critical?
• How do you read and use debt equity ratio?

and more…

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Is your working capital enough to run your hotel operation smoothly?

How would you know?

Working Capital is a Liquidity based Ratio.

Meaning it is a ratio closely related to cash resources.

You cannot run a hotel operation without steady input of cash.

If your liquidity runs low, you cannot run the hotel efficiently.

It's like your automobile cannot run without adequate fuel in its tank.

I will lay out a case for ensuring that you do not ignore this critical hotel financial ratio.

Along the way, we will answer questions like:

• What is Working Capital?
• How to calculate working capital.
• Working Capital Management

and more.

Take a look at the infographic below on hotel liquidity ratios.

And more specifically to No 3 in hotel financial liquidity ratios.

This Chapter 4 of the Ultimate Guide on Hotel Financial Ratios will cover.

First, let us step back a bit to understand some concepts related to working capital.

Short Term Cash Requirements

For a hotel to run smoothly, it is important to have good cash flow.

Cash flow in the short term comes from earning revenue.

Earning revenue in turn requires you to have assets.

The primary function of a business asset is to generate revenue.

What are Assets?

Assets are What the Business Owns.

They are the resources of the hotel.

The primary function of an asset is to generate revenue.

Without assets, a business cannot generate revenue.

Assets are an index of strength of a business.

This is because assets are used to generate revenue.

So, you could say that the capacity of a business to generate revenue will be based on the:

• type and
• extent of

assets owned by it.

Current Assets and Working Capital

Assets can be short term or long term.

Short term assets are those whose life is less than a period of 12 months.

These are known as Current Assets.

Why should we talk about current assets?

I am getting to that.

Before that, take a look at the Current Assets of Paradise Hotel below.

Current Assets Examples

See the Paradise Hotel Balance Sheet below:

What is Working Capital?

In Part 2 of this 12 part Ultimate Guide, you learned about liquidity.

Liquidity is the ability of an asset to be converted into cash.

Let us quickly revisit the current assets in a hotel balance sheet.

Why?

Because Working Capital has all to do with current assets (and more...).

For example, Current Assets (see below) are normally these three common types:

• Cash and Bank Balances
• Accounts Receivable
• Inventories

These feature prominently in a hotel balance sheet.

For an in depth discussion, read Part 2 of this Ultimate Guide on Accounts Receivables.

Working Capital

We learned about current assets earlier.

However, what is Working Capital?

Let me use a metaphor for this.

Assume you are driving an automobile.

Suddenly, the car stops running.

You discover you have run out of fuel.

You cannot proceed further without filling gas for your vehicle.

Working Capital is similar to that.

It is the short term capability to meet current obligations.

That capability comes from current assets.

Current Obligations are commonly known as Current Liabilities.

Current Liabilities are short term obligations.

Take a look at the Current Liabilities of Paradise Hotel.

Now you realize why we needed to know current assets and liabilities before working capital.

Working Capital compares short term capability with short term obligations.

Or in other words, current assets with current liabilities.

We will understand specific types of current liabilities shown above later in this post.

Working Capital is comparing your liquidity (current assets) with obligations (current liabilities).

We will also see why as a hotel manager you must know what this ratio is about.

Working Capital measures the extent of current asset to current liabilities.

In other words, the ratio (not exactly a ratio though) of:

• Cash, Accounts Receivables, Inventories and
• Accounts Payable, Notes Payable etc.

Higher the Working Capital, the better will be its capability to meet short term obligations.

In other words, higher the ratio, the better the liquidity.

Hotel Owners prefer a higher ratio since this means lesser investment in non-productive current assets.

It of course means balancing capability with current obligations or liabilities.

Hotel Management needs to balance:

• healthy current assets situation with
• moderate current liabilities.

Working Capital Formula

Working Capital is simply the difference between Current Assets and Current Liabilities.

The formula is:

Working Capital = Current Assets LESS Current Liabilities

Take a look again at the Current Assets and Current Liabilities of Paradise Hotel (shown before).

We have already seen what types of current assets there are.

Let us explain what current liabilities shown are.

• Accounts Payable - these are invoices payable to the hotel suppliers and vendors.
• Accrued Income Taxes - these are liabilities for any tax amount due.
• Accrued Expenses - these are specific expenses which have yet to be paid off.
• Current Portion of Long Term Debt - this is the portion of long term debt due within the next 12 months.

In a way you could say you are measuring the extent of liquidity Vs obligations.

Let us now see the example with numbers using the Paradise Hotel shown above.

Example

The Current Assets and Current Liabilities for Paradise Hotel as of 12.31.2018 & 12.31.2019 are:

• Current Assets: 2018 - $221,000 2019 - $338,000
• Current Liabilities: 2019 - $214,000 2019 - $192,200

The Working Capital for Paradise Hotel as of 12.31.2018 is:

Current Assets LESS Current Liabilities OR

$221,000 Less $214,000 = $7,000

And for 12.31.2019 is:

$338,000 Less $192,200 = $145,800

Notice how 12.31.2018 Working Capital is quite low ($7,000).

On the other hand, 12.31.2019 Working Capital is very healthy ($145,800).

Notice that this healthy Working Capital is contributed by higher current assets.

This is thus a barometer of the balance between current assets and liabilities.

These are assets whose liquidity and levels have to be managed.

The indication is that 12.31.2018 shows working capital to be not very liquid.

Let us now see how it is useful to calculate working capital.

More importantly, how you can avoid some alarming situations shown below.

How is Working Capital useful?

For Paradise Hotel, you found the that Working Capital Ratio on 12.31.2018 is $7,000.

This is a low ratio.

What does “low” mean?

Low means that say, Paradise Hotel disposed off all their current assets to pay current liabilities.

They will then be left only with $7,000.

This is what “low” means.

It means that there is very little cushion against unforeseen obligations.

If such an obligation were to arise, Paradise Hotel may not be able to pay it.

If you remember, we said that higher the ratio the better the liquidity.

Working Capital is one of the best indicators of liquidity.

Liquidity is one of the key measures of short term solvency.

In other words, the ability to pay current liabilities with current assets.

Is the hotel able to cover its short term liabilities with its short term assets?

Or, how liquid are the hotel’s current assets?

And how quickly does the hotel collect its accounts receivables.

So, they are able to provide the cash necessary to pay liabilities.

This is the reason the Working Capital is critical.

Reasons Your Hotel Working Capital May Become Alarming

What are reasons you could avoid being in the situation Paradise Hotel finds itself in as of 12.31.2018?

First, manage your accounts receivables well.

Accounts Receivables being uncollected sales is critical for liquidity.

Second, manage your accounts payable, which are simply short term liabilities.

For Paradise Hotel, as of 12.31.2018 the hotel had high accounts payable and accrued expenses.

This is creating pressure on the working capital which is very low.

Third, do not have too much of money locked up in inventories.

In the case of Paradise Hotel, Inventories in both years are quite good.

Further you must ensure that you do not fall prey to some traps stated below.

Traps You Must Avoid with Working Capital

As we have said earlier, financial ratios are mere indicators.

It is critical that we understand how they are calculated.

Both Current Assets and Current Liabilities play a part in this ratio.

So, movement up or down must be taken into account.

Similarly, movement in accounts receivables and inventories must also be considered.

These movements have to be monitored each month and year.

However, it may get rectified in a later year.

You must therefore monitor the current assets and current liabilities closely.

This is to ensure they do not spiral out of control.

Inventories & Pre Opening Hotels

Another element of current assets and therefore working capital is inventories.

For hotels which are in pre opening stage, inventories tend to be higher.

This is because the hotel has not started operating.

Consequently, it may not have an accurate grasp of business volume.

Business Volume refers to:

• Occupancy for Rooms department and
• Covers Served for Food and Beverage department

Moreover, the hotel will want to avoid a stock out situation initially.

Therefore, it will keep higher than needed inventory levels.

In effect, it is even more critical for pre opening hotels to keep an eye on working capital.

Working Capital in Managed Hotels in Pre Opening Stage

Working Capital arrangements are critical for managed hotels.

They are even more vital during the pre-opening stages.

During the pre-opening stages, there is no revenue being generated.

This is because the hotel has not opened yet.

As a result, the hotel cannot generate its own cash flow.

Instead, the management must submit periodical working capital requirements to the owners.

Any error in the estimates made in the pre-opening stage will create a crisis.

Hotels do not want to find themselves in such situations.

Big Picture of Hotel Liquidity

At the end of the day, you must step back and take a big picture overview of liquidity.

Meaning, look at the liquidity picture in entirety.

And not just look at current assets or current liabilities individually.

The big picture will be how liquid the working capital is.

That will allow you to run your hotel operation without any cash resource crunch.

Chapters in this Ultimate Guide on Hotel Financial Ratios

This Ultimate Guide is a twelve part series which will cover the following key areas:

• CHAPTER 1 of 12 - Hotel Financial Ratios - Why should you care? [Already Published]
• CHAPTER 2 of 12 -Liquidity Ratios Intro - Acid Test Ratio [Already Published]
• CHAPTER 3 of 12 -Liquidity Ratios - Accounts Receivable Turnover Ratio [Already published]
• CHAPTER 4 of 12 -Liquidity Ratios - Working Capital [This Post]
• CHAPTER 5 of 12 -Solvency Ratios Intro - Net Worth
• CHAPTER 6 of 12 -Solvency Ratios - Debt Equity Ratio
• CHAPTER 7 of 12 -Activity Ratios - Inventory Turnover Ratio
• CHAPTER 8 of 12 - Profitability Ratios Intro - Gross Operating Profit
• CHAPTER 9 of 12 - Profitability Ratios - Return on Investment Ratio
• CHAPTER 10 of 12 - Profitability Ratios - Return on Equity Ratio
• CHAPTER 11 of 12 - Asset Management Ratios Intro - Asset Turnover Ratio, RevPAR
• CHAPTER 12 of 12 - How to Identify Warning Signs in Hotel Financial Ratios

Next Week

We will dive into the fourth of hotel financial ratios - Net Worth.

We will see:

• What net worth is.
• What is a Solvency Ratio?
• Why is this net worth considered so critical?
• How do you read and use net worth?

and more…

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Is your Accounts Receivable Turnover costing you dearly?

No idea what I am talking about?

Then yes, an explanation is in order.

However, before that, let us establish something important.

Accounts Receivable Turnover Ratio is a key hotel financial ratio.

It is a Liquidity based Ratio.

What are Liquidity Ratios?

See infographic below:

I call financial ratios as early warning systems.

Remember the car instrument panel dashboard metaphor from Part 1?

It is like missing a key reading on your dashboard.

Say, you do not notice that the fuel in your car is running low.

The next thing that will happen is your car will stop running.

You can consider liquidity something similar to that.

If your liquidity runs low, you cannot run the hotel efficiently.

Accounts Receivable Turnover ratio is a liquidity measure.

What are Accounts Receivables?

In Part 2 of this 12 part Ultimate Guide, you learned about liquidity.

Liquidity is the ability of an asset to be converted into cash.

Let us quickly revisit the current assets in a hotel balance sheet.

Why?

Because Accounts Receivable is a current asset.

For example, Current Assets (see below) are normally these three common types:

• Cash and Bank Balances
• Accounts Receivable
• Inventories

These feature prominently in a hotel balance sheet.

Accounts Receivables are uncollected sales.

You could describe them as sales made but money not collected yet.

So, there is a time lag between earning the revenue and collecting the money for it.

Accounts Receivables are converted into cash during a normal operating cycle.

In other words, during a financial year.

Accounts Receivable Turnover Ratio is one of the key liquidity ratios.

Now let us learn what Accounts Receivable Turnover Ratio is.

This Blog Post will cover:

Accounts Receivable Turnover Ratio

What is Accounts Receivable Turnover Ratio?

Why are Accounts Receivable listed before Inventories?

Because Accounts Receivable represent sales already made but money not collected.

On the other hand, inventories are yet to be sold and hence not as liquid.

Inventories are considered the least liquid of current assets.

Now, we broadly know the common types of current assets.

Let us understand this Ratio.

We will also see why as a hotel manager you must know what this ratio is about.

Accounts Receivable Turnover Ratio measures the speed of conversion of this current asset.

In other words:

• the ratio of what revenue a hotel earns Vs
• How much of that revenue is tied up in accounts receivable.

See infographic below:

Higher the ratio, the better will be its current and acid test ratio (Part 1 of this Ultimate Guide).

In other words, higher the ratio, the better the liquidity.

Hotel Owners prefer a higher ratio since this means lesser investment in non-productive current assets.

It of course means that too tight a credit policy will result in loss of revenue opportunities.

Hotel Management needs to balance:

• a healthy accounts receivable turnover ratio with
• maximum revenue opportunities.

Ratio Formula

Accounts Receivable Turnover Ratio is simply the ratio of Revenue to Average Accounts Receivable.

The formula is:

Total or Credit Revenue / Average Accounts Receivable

Take a look at the Current Assets and Liabilities of Paradise Hotel.

In particular, notice the Accounts Receivable for the two years 2018 and 2019.

In the above formula, two elements have to be explained:

• Revenue in the ratio can be Total or Credit.
• Credit Revenue does not take into account Cash Sales.
• It is a more accurate representation of revenue than Total Revenue.
• Average Accounts Receivable is simply the average of the opening and closing figures.
• Averaging is to ensure that a high or low opening or closing accounts receivable does not distort the ratio.

So, what is the “Turnover” in the Accounts Receivable Turnover Ratio.

By comparing credit revenue with average accounts receivable, you arrive at the movement.

Movement of revenue into accounts receivable.

In a way you could say you are measuring the extent of liquidity.

Let us now see the example using the Paradise Hotel shown above.

Ratio Example

The Accounts Receivable for Paradise Hotel as of 12.31.2018 & 12.31.2019 are:

• 2018 - $90,000
• 2019 - $140,000

Total Revenue for 2019 from Income Statement: $324,469

The Accounts Receivable Turnover Ratio for Paradise Hotel as of 31.12.2019 is:

Total Revenue / Average Accounts Receivable OR

$324469 / [($90000 + $140000)/2] = $324469 / $115000

= 2.82

This is a low Accounts Receivable Turnover Ratio.

The indication is that accounts receivables are not very liquid.

Let us now see how it is useful to calculate this ratio.

More importantly, how you can avoid some alarming situations shown below.

How is the Ratio useful?

For Paradise Hotel, you found the that Accounts Receivable Turnover Ratio is 2.82.

This is a low liquidity ratio.

If you remember, we said that higher the ratio the better the acid test ratio.

Acid Test Ratio (Part 1 of this Ultimate Guide) is the best indicator of liquidity.

Liquidity is one of the key measures of short term solvency.

In other words, the ability to pay current liabilities with current assets.

Is the hotel able to cover its short term liabilities with its short term assets?

Or, how liquid are the hotel’s current assets?

And how quickly does the hotel collect its accounts receivables.

So, they are able to provide the cash necessary to pay current liabilities.

This is the reason the Accounts Receivable Turnover Ratio is critical.

A varied calculation is make the accounts receivable a collection based ratio.

Let us see how that works.

Easier Way to Understand Ratio

A common way of translating the Ratio is using collection as days.

In other words, how many days it takes to collect the accounts receivables.

This converts the ratio into a more understandable one.

Meaning, a ratio that states the collection period in number of days.

Higher Average Collection Period will indicate inefficiency in collecting accounts receivables.

The calculation is: divide number of days in year by the Accounts Receivable Turnover Ratio.

The formula is:

365 days / Accounts Receivable Turnover Ratio.

In the case of Paradise Hotel the calculation will be:

365 / 2.82 = 129 days Average Collection Period.

This is an alarming result and reflects highly inefficient collection.

It emphasizes the early warning system we know about.

An average Collection Period of less than 30 days is considered efficient.

Meaning accounts receivable collected within 30 days of revenue earned is considered good.

On the other hand, if this collection goes into 60 day territory, it becomes a problem but not yet alarming.

If collection has entered into the 90 day period, there is real danger that the debt may not be collectible.

That means a loss to the hotel.

For Paradise Hotel example earlier, Average Collection Period is 129 days.

There is a great danger of these accounts receivable turning into bad debts & losses.

This is the reason why Accounts Receivable Turnover Ratio is so critical.

Reasons Your Hotel Average Collection Period May Become Alarming

What are some reasons you could avoid being in the situation Paradise Hotel finds itself in?

First, and hopefully the reason is this.

Accounts Receivable outstanding amounts tend to age quickly.

They can go from current (30 days) right beyond 90 days if not followed up.

So, regular follow up from your Credit department is a must.

Second, and a more serious issue is this.

Credit check may not have been conducted on the outstanding accounts.

In other words, are the companies credit worthy?

This is at the time of considering allowing the organization to be approved credit terms.

A healthy accounts receivable turnover ratio begins with prudent credit checks.

This is a reason you do not want to find yourself in for your hotel.

Absence of credit checks leads to two things:

• They begin with accounts receivables going from 30 to 90 days & more and
• Worse, they become first doubtful of collection and
• Finally turn bad which is a loss to the hotel.

Further you must ensure that you do not fall prey to some traps stated below.

Traps You Must Avoid with the Ratio

As we have said earlier, financial ratios are mere indicators.

It is critical that we understand how they are calculated.

Total Revenue and Accounts Receivables play a part in this ratio.

So, movement in revenue up or down must be taken into account.

Similarly, movement in accounts receivables must also be considered.

What this simply means is that accounts receivables may have been collected in a subsequent month.

In effect, the position as of the end of the year may not be relevant any more.

129 days outstanding accounts receivable is indeed an alarming number.

However, it may have been rectified in a later month through quick collection.

You must therefore monitor the collection period results closely across months.

This is to ensure that it does not spiral out of control.

Big Picture of Hotel Liquidity

At the end of the day, you must step back and take a big picture overview of liquidity.

Meaning, look at the liquidity picture in entirety.

And not just look at accounts receivable turnover ratio individually.

The big picture will be how liquid the total current assets are.

That will allow you to run your hotel operation without any cash resource crunch.

Chapters in this Ultimate Guide on Hotel Financial Ratios

This Ultimate Guide is a twelve part series which will cover the following key areas:

• CHAPTER 1 of 12 - Hotel Financial Ratios - Why should you care?
• CHAPTER 2 of 12 -Liquidity Ratios Intro - Acid Test Ratio
• CHAPTER 3 of 12 -Liquidity Ratios - Accounts Receivable Turnover Ratio [This Post]
• CHAPTER 4 of 12 -Liquidity Ratios - Working Capital
• CHAPTER 5 of 12 -Solvency Ratios - Net Worth
• CHAPTER 6 of 12 -Solvency Ratios - Debt Equity Ratio
• CHAPTER 7 of 12 -Activity Ratios - Inventory Turnover Ratio
• CHAPTER 8 of 12 - Profitability Ratios Intro - Gross Operating Profit
• CHAPTER 9 of 12 - Profitability Ratios - Return on Investment Ratio
• CHAPTER 10 of 12 - Profitability Ratios - Return on Equity Ratio
• CHAPTER 11 of 12 - Asset Management Ratios Intro - Asset Turnover Ratio, RevPAR
• CHAPTER 12 of 12 - How to Identify Warning Signs in Hotel Financial Ratios

Next Week - Working Capital 

We will dive into the third of hotel liquidity ratios - Working Capital.

We will see:

• What working capital is.
• Why is this liquidity ratio considered so critical?
• How do you read and use working capital?

and more…

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What if I said that you can begin immediately in leveraging balance sheet ratios to improve revenue and profit performance!

That you are leaving money on the table in this post pandemic era.

Here, 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 delivers some bad news.

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.

Remember the Last Time You Looked At Your Hotel Balance Sheet?

There are immediate and often unpleasant consequences of ignoring a Balance Sheet.

More specifically balance sheet ratios.

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 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 Balance Sheet Ratios in 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:

• 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 - 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)

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 the balance sheet so much?

I have not even come to balance sheet ratios yet.

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 items 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.

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 Post Pandemic Era where revenue is frequently strained.

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%.

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 Post Pandemic era where revenue increase is a constant 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), 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.

These are those powerful balance sheet ratios I talked about earlier.

Balance Sheet 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 Ratios is all about.

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 - a powerful balance sheet 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 of the Balance Sheet ratios.

This is one which is linked to your revenue.

Aha, that earned your attention!

Balance Sheet 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.

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 over 180 days or six months, there is danger 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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Balance Sheet Ratios - Working Capital Ratio

Remember earlier I said I would come back to the cash flow for our third and last balance sheet 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.

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 critical.

It is what the Owners approve as cash flow to run the pre-opening stages.

Say, 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 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 wouldn't you?

That wraps up our 3 part blog post series on the power of Hotel Balance Sheet Ratios.

If you missed earlier parts, click for Part 1 and Part 2.

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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Financial Literacy is your ticket to professional success!

But, are you investing in your future?

Every hotel middle manager likes to earn promotions and climb the corporate ladder.

But, most middle managers are not financially literate.

Why so?

Because they think it is not important!

Nothing could be farther from the truth.

But, did you know that being financially literate is a key requirement to success.

If you aspire to be a General Manager or higher positions, this is mandatory.

But, are you focused on this critical pre-requisite for professional recognition?

Middle management is a stage where you can still learn the ropes of financial literacy.

But, most managers choose otherwise and lose huge opportunities.

Don't be one of them.

You do not want to be trailing your peers, right?

I will guide you all the way in your journey to financial literacy.

Let's begin with Executive Housekeeper Sarah's Transformation Story.

Housekeeper Sarah's Transformation Story

Imagine Sarah, the Head of Housekeeping.

Previously, her focus was solely on cleanliness and efficiency.

However, after participating in the financial learning ecosystem, she now understands:

• how linen costs impact the bottom line,
• that efficient scheduling can reduce labor expenses, and
• how preventative maintenance can avoid costly repairs.

She starts tracking key metrics, collaborates with the finance department on budgeting.

And proactively identifies areas for cost savings without compromising service quality.

Sarah transforms from:

• managing a cost center to
• actively contributing to the hotel's profitability.

This is the power of financial empowerment at the middle management level.

Empowering Leadership with Financial Literacy

In the dynamic world of hospitality, success hinges on many factors.

It is not just impeccable service.

Or guest satisfaction.

But also on a solid understanding of financial performance. 

Middle managers in hotels are the crucial link between:

• daily operations and
• overarching financial goals

 These managers are:

• department heads,
• assistant general managers, and
• supervisors.

Yet, often, financial literacy training is misplaced.

It is either too generic or too focused on executive-level strategy.

This leaves this vital group of middle managers feeling unprepared and disempowered.

Imagine a scenario where your Food & Beverage Manager can:

• proactively analyze cost of goods sold and
• implement strategies to improve profitability,

Or your Front Office Manager:

• understands how occupancy rates directly impact revenue and
• can contribute to yield management discussions.

This isn't a pipe dream.

It's the reality a comprehensive financial learning ecosystem can create.

This post will delve into the:

• meaning,
• description, 
• benefits, and
• key elements of such a system,

demonstrating how it can be the game-changer your hotel needs.

What is a Complete Financial Learning Ecosystem?

At its core, a complete financial learning ecosystem is:

• a holistic and integrated approach
• to equipping hotel middle managers
• with the financial knowledge and skills they need to excel in their roles and
• contribute strategically to the hotel's financial success. 

It goes beyond isolated training sessions.

And encompasses a continuous learning journey.

That blends various resources, tools, and support mechanisms.

This ecosystem is tailored specifically to:

• the unique financial realities and
• operational nuances of the hotel industry.

Take a Look at the infographic below:

Benefits For Hotel Middle Managers of Such an Ecosystem

You may still ask what the benefits to this ecosystem are?

Great Question.

Let me lay down key benefits.

Improved Financial Performance

Managers understand the financial implications of their decisions better.

Thus, they are more likely to make choices that positively impact the bottom line.

Enhanced Decision-Making

Financial literacy empowers managers to make data-driven decisions.

This leads to:

• more effective resource allocation and
• operational efficiency.

Increased Employee Recognition

Managers understand financial targets and their role in achieving them.

Thus, accountability and ownership increase.

They get recognized for their new found financial literacy.

Stronger Strategic Alignment

Middle managers understand the hotel's financial objectives better.

They, thus align their departmental goals and activities with the overall strategy.

Proactive Problem Solving

Financially literate managers are better equipped to identify potential financial issues early.

As a result, they implement proactive solutions.

Still not convinced?

Learn what differentiates this learning ecosystem from the rest of the market.

What Differentiates This Approach?

Unlike generic financial training or executive-focused programs, this ecosystem is:

Hotel Specific

Content and examples are directly relevant to the hospitality industry.

This embraces the unique challenges and opportunities it presents.

Middle Manager Focused

It addresses the specific financial responsibilities and decision-making authority of this crucial group.

Ecosystem Integrated

It's not standalone but integrated into evolving business needs and strategic goals.

Learning Continuous

It's not a one-off event but an ongoing journey of learning to financial literacy.

Skills Actionable

The focus is on applying financial knowledge to real-world scenarios and developing practical skills.

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