Hotel Budgeting Basics Beginners Struggle With – The Why

Have you ever considered hotel budgeting as the guardrails of the profit and loss statement?

Guardrails that protect and provide a valuable yardstick to measure against.

Managers tend to treat the hotel budgeting process as just a necessary evil.

However, by doing so they miss out on critical indicators which help improve performance.

Moreover, in the post covid-19 environment, being on top of hotel budgeting may mean survival.

How so, you ask rather skeptically.

Hold on, I am getting to that.

However, let me ask you this question.

Are you also treating budgeting as something to put up with?

Read on for some illuminating findings.

I will lay out some arguments which will establish the importance of hotel budgeting.

Arguments which will seal the benefits of the process.

However, it is absolutely essential that some basics are first adhered to.

Basics that beginners often ignore at their own peril.

This will cover hotel budgeting example, format and more.

Let us see which are those basics.

This Chapter 1 of the Ultimate Guide on Hotel Budgeting and Forecasting will cover

Hotel Budgeting - Seeing But Not Noticing

When it comes to the hotel profit and loss statement, often you may see but not notice things.

What? you look totally confused.

What do I mean by that statement?

Hang on, I am getting to that right now.

You may think that the statement I made is a bit dramatic and exaggerated.

But I will shortly convince you that it is not only true but needs to be changed.

We must not only see but also notice things.

Here is why that is so important.

Look at the screenshot above of the Paradise Hotel Statistics for six months from January to June 2019.

I want you to focus only on the parts which are outlined in RED.

Notice that, above the months of the year is a row which shows a label for each month.

The labels read Standard, Lean and Peak.

These labels are what I call the Seasonality Labels.

Notice also that the columns for each of the months are color coded.

This is for easy identification of a standard, lean or peak month.

Unfortunately, a traditional hotel P&L does not show these labels.

However, all is not lost.

Look at the Paid Occupancy % row in the table which is also outlined in RED.

And the arrows pointing to four different months.

Notice that the Lean month of February 2019 has the lowest occupancy % of 60%.

This is color coded in blue.

Two yellow color coded months corresponding to Peak months are April and May 2019.

Note that May has the highest occupancy % of 91%.

Where am I going with this, you wonder?

Well, I am about to reveal what you often see but do not notice.

How Seasonality affects Hotel Budgeting and Forecasting

And that is the seasonality of the hospitality industry.

Why is knowing this seasonality such a big deal?

First, notice that the difference in the occupancy % of February (60%) and May 2019 (91%) is 30 percentage points.

It can also be said that the May 2019 occupancy is 50% higher than the February month.

This simply means that the revenue in May 2019 will be significantly higher than the month of February.

Second, if you are currently in the month of February 2019, your next three months will have occupancies above 80% and highest at 91%.

This is powerful information for you to take action.

And ensure that you meet your revenue budget and forecasts.

Aha, there we have the connection between seasonality and hotel budgeting.

On the other hand, if you are currently in the month of May 2019, next month your occupancy is going to drop by 30 percentage points.

You need to be prepared for this.

Prepared as in have strategies ready to deal with it.

You will need strategies to push your occupancies up at least by 10% points.

Otherwise your revenue will suffer.

Third, the above is only about the revenue.

By understanding standard, lean and peak months you can manage your expenses way better.

In particular, you should be adopting strategies to optimize your expenses in the lean months.

All this through effective budgeting.

Now do you see how knowing seasonality information is so powerful.

And so essential to budgeting and estimation.

We have only looked at occupancy %.

But you can apply that to:

• Average daily rate,
• RevPAR,
• Total Revenue,
• Total Expenses and
• Net Income (Profit) or
• any other KPI you think is important.

Hotel Budgeting - the guardrails for Financial Statements

I consider budgeting / forecasting as the guardrails for financial statements.

What does that mean?

A budget is primarily an annual exercise which then gets translated to monthly forecasts.

But a caveat here.

Budgets and Forecasts are like guard rails that protect.

But both deal with estimates and are based on assumptions.

Estimates are not actuals.

Actuals are based on facts and transactions.

Estimates however are more like projections.

That itself should give room for exercising care.

Here are some key factors that will make your budgeting effective.

Heart of Budgeting - Assumptions

Budgeting is an iterative process.

It evolves over time.

Since they are estimates, there is a major degree of assuming situations that goes on.

Assumptions are at the heart of good budgeting.

Assumptions have to be realistic as a minimum.

Just because they are estimates does not mean that they have no basis.

However, 100% accuracy is rarely looked for.

After all, as said before, they are estimates.

However, it is important as a process that:

• actuals are measured against the budgets and in particular
• the assumptions that were used during budgeting

This allows you to measure how realistic your budget assumptions are.

Peter Drucker once said: "You cannot manage what you do not measure."

As far as possible, budget assumptions must be close to the source of the revenue or expense item.

Revenue assumptions tend to be more structured than expenses broadly.

Example:

Room revenue assumptions have multiple contributing factors like:

• occupancy,
• average daily rate and
• market segments

which can be utilized to estimate revenue.

Expense assumptions also have to be close to the source of the expense item.

Expenses are often categorized as:

• Variable (based on business volume and
• Fixed (not based on business volume)

Variable expenses have a powerful assumption basis which is using business volume which will be:

• occupancy in Rooms department and
• covers served in Food & beverage department

Assumptions for fixed expenses follow:

• any contractual agreements signed or
• any other indication that can be relied upon to estimate the amount.

In all of this, there is a most important ally of accurate budgeting and forecasting.

And that is a hands on understanding of departmental statements.

In other words, a hotel manager's understanding of P&L is critical.

The more they understand, the better they will get at estimating revenue and expenses.

Remember, the more accurate your budgets / forecasts are, the closer they will be to your actuals.

This will allow you to get a heads up number which will be confirmed later on when the P&L is released.

Period in Hotel Budgeting

Look at the P&L of Paradise Hotel shown below.

In this P&L, actual revenue, expenses and profit are shown for the period ended 31st December 2019.

One of the first things to be clear about in a hotel P&L is the answer to this question:

Which part of the year are you in?

This may seem like an obvious thing.

But the implications are beyond what we generally accept, so bear with me.

Why is it important to know which part of the year we are in?

After all, we are in the hotel operation day in and day out.

We know that already.

In reality, you may not have realized a few things.

Knowing that information may have empowered you with useful knowledge.

First, which part of the year you are currently in may be essential.

To how you can influence the performance of the hotel going forward.

Let me explain.

Say, you are analyzing and discussing the performance of the month of February in a year.

Would it make sense to you if I said that is totally different from being in the month of November in a year?

I don't just mean that the month is different.

I mean something much more powerful linked to a month.

In the month of February, essentially you are *looking at only 1/6th of the year (16%*).

Meaning, you are in the early part of the year.

This means you have 10 out of 12 months of the year to correct and set right your variances.

You could be behind your budget and forecast in February.

But it may not matter since you can make up in the balance 10 months of the year.

This is a powerful element which is often forgotten by hotel managements.

It is even more critical in the process of budgeting.

The hotel industry is a seasonal business.

Say you have a deficit in revenue and profit in a particular month.

This can be easily made up by the number of months left in the year.

November is exactly the opposite.

It is almost the end of the year.

There is very little you can do to set right negative variances in revenue and profit.

This is because you have only one more month to go for the year to be over.

The next time you are analyzing your hotel profit and loss statement, pay attention to this critical element.

Go back to the Paradise Hotel P&L above.

Here, a comparison to budget and last year are available.

There are two important elements to those numbers as follows:

• Current Month revenue, expenses and profit and
• Year To Date revenue, expenses and profit i.e., for the actual number of months completed in the current year

Why Current Month & Year To Date?

Why is it important to separate:

• current month, year to date figures for
• revenue, expenses and profit?

Current month results only reflect the performance of the hotel for the particular month.

This can be analyzed in isolation.

We will revisit this shortly.

The Year To Date Mirage

The Year To Date number in a hotel profit and loss statement is a sort of mirage.

Things are not exactly what they appear to be!

What do I mean by that?

For starters, the same question we asked for the current month applies to year to date too.

Which part of the year are you in?

Are you at the beginning of the year, in the middle or at the end of the year?

The same comment as current month applies here too.

If you are at the beginning of the year:

• you have an opportunity to fix negative variances
• as you have a majority of the year still left.

But that is not the mirage!

The mirage happens because of the way the year to date numbers are derived.

Let me explain.

Let us say you are looking at the P&L for the month of February 2020.

In this case, your year to date will be for the two months of January and February 2020.

So, the calculation is:

• you take the year to date at the end of January 2020 and
• add the current month of February 2020 to it
• to get the year to date of February 2020.

Here is the mirage!

You actually CANNOT do anything to the year to date number.

You ONLY CAN do something to each current month results.

Let me say that again in a different way.

The Year To Date number is ONLY adding individual Current Month numbers.

So, all your action on variances must take place in individual months.

This is why Current Month is the most powerful period you should be looking at.

In the next section on seasonality, I will illustrate the power of focusing on the current month.

This I will do by adding a dimension we all know is there but take it granted.

Worse, we do not factor that into our decisions.

Hang on, we will discuss that next.

The Apples and Oranges in Hotel Budgets

We have looked at the basics of current month and year to date.

Let us turn our attention to something more critical.

And more importantly, hidden.

What I call the apples and Oranges in hotel budgets.

You are giving me that weird look.

Hold on, I will clarify.

Most hotel managers and beginners to the process of budgeting miss this part.

Figures in hotel profit and loss statements are not all the same.

And yet we treat them as same.

Huge mistake!

How so you want to know?

Coming right up!

When you compare actual results with budgets, you must consider these basics:

• Actual numbers are fact and transaction driven
• Budgets are simply estimates

Now, it is important that you recognize this basic difference in numbers.

So, when you perform variance analysis, you must check to see if:

• the budget is over or understated or
• just about right

If the budget is overstated, the variance may be a negative one.

We must not get rattled by that.

On the other hand, if the budget is understated, the variance may be a positive one.

We must also not be thrilled at the positive variance.

What is the moral of this story?

Well, the moral is that we must read results keeping in mind and over or understatement in budgets.

Otherwise, we will jump to incorrect conclusions.

Worse, we might take decisions based on the wrong premise.

Both can be disastrous!

Let us now recap the 3 basics of hotel budgeting that beginners struggle with.

Hotel Budgeting - Recap

Chapter 2...

In Chapter 2 of this Ultimate Guide on Hotel Budgeting and Forecasting we will examine essentials in how revenue is budgeted for in a hotel.

Other Chapters of Ultimate Guide on Hotel Budgeting and Forecasting

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