Hotel Expenses Basics Beginners Struggle With

Have you ever directly related hotel expenses to profitability?

More specifically using hotel expenses to boost profit.

And yet why most hotel managers miss these critical elements of expenses as a Key Performance Indicator [KPI]?

In the process regretfully, they are left wondering why they did not achieve their bottom line targets.

Are you a victim of this syndrome?

Often hotel managers are looking for some lofty goals of expenses management.

However, they forget the basics that are the foundation to effectively manage expenses.

I will lay out the basics of expenses management which no hotel manager can afford to ignore.

It will ensure that you achieve your profit targets consistently.

In this post pandemic era, expense management is equivalent to survival of the business itself.

Are you prepared for this post pandemic challenge?

This is Part 3 of the 6 Part Series on Hotel Profit and Loss Statement Basics Beginners Struggle with.

If you missed Parts 1 and 2, click below to read that first.

This Blog Post will cover

The Revenue - Expenses Relationship You Missed

The Revenue - Expenses relationship brings out a key ingredient in earning that revenue - hotel expenses.

Revenue does not happen by itself.

It has to be invoked.

That is achieved by incurring expenses.

The Revenue - Expenses relationship may be broadly of two categories:

• direct or indirect one or
• proportionate or disproportionate one.

A direct expense relationship with revenue is an expense that must be incurred to earn that revenue.

For example, in order to earn revenue from a guest room, expenses have to be incurred on that guest room.

Expenses like a key card, amenities placed in the room, linen supplies and so on.

Another example of direct expense is the direct cost of preparing a menu item which is served in the restaurant.

If that preparation cost is not incurred the menu item cannot be served.

Thus there is no revenue earned.

We can go as far to say that if these expenses are not incurred, that room / menu item cannot be sold and revenue earned.

An indirect expense is something that must be incurred.

However, it cannot be directly related to a particular chunk of revenue like the guest room in our example.

For example, Shuttle Bus expenses are incurred to bring a hotel guest from the transportation hub (airport, train or bus station etc.) to the hotel (and back).

That expense is necessary.

However,  it cannot be attributed directly to any specific part of the room revenue earned as many guests would be using that shuttle bus.

Proportionate expenses are expenses incurred which have a certain proportion to the revenue earned.

For example, Food Cost of preparation of a menu item has a certain proportion to the sale price of the menu item.

It is true though that the proportion may be moving within a certain range.

Food cost may be 38% of the sale price of one menu item while it may 40% for another menu item

Disproportionate expenses are expenses incurred which do not have a certain proportion to the revenue earned.

They are often incurred as a routine and do not show any proportion to the revenue incurred.

In the Shuttle Bus expenses example, the expenses are a routine running of the bus.

Thus they have no proportional relationship to the room revenue earned.

Hotel Expenses - The Cost of Doing Business

In earlier posts in this series, we discussed how revenue may be earned or generated by a hotel.

However, we will now see how the cost of doing business is what actually produces the revenue.

In other words, incurring expenses is almost a given toward earning revenue.

It is important to understand however that revenue is not earned automatically as soon as expenses are incurred.

Revenue and Expenses share a great relationship.

They influence each other a lot.

The simplest definition of expenses would be:

It is cost that is incurred both toward earning revenue and keeping the business going.

This is why expenses are called as the cost of doing business.

Every expense incurred does not result in revenue.

However, every expense incurred is toward running the business.

This is so that earning revenue is optimized, as in, the highest level possible.

Expenses may be placed in 3 broad categories.

It is important to note that the same expenses are just being given a criterion for their categorization. 

Let me explain.

Hotel Expenses - Direct and Indirect

The first categorization is based on the relationship of the expenses to revenue earned.

If the expenses are directly linked to the generation of revenue, they can be considered Direct.

For example, if room revenue is earned from a guest room, there are expenses incurred in getting that room ready for occupation by the guest.

These could be amenities placed in the guest room etc.

Indirect expenses are those that are incurred for generation of revenue.

However, indirect expenses cannot be identified directly to the revenue.

These can be considered as expenses incurred generally in running a department which is related to the revenue being earned.

For example, say, hotel expenses are incurred in running a Shuttle bus for guests to be picked up from the airport.

These cannot be identified directly to revenue earned.

However, they form part of the Rooms department expenses.

These would be Indirect expenses of the Rooms department.

Hotel Expenses - Fixed and Variable

Another category is that of Fixed and Variable Expenses.

Fixed Expenses are those which do not change with change in business volume.

Variable Expenses on the other hand are those which do change with change in business volume. 

Business volume could be:

• occupancy in Rooms department and 
• covers served in Food & Beverage department.

Variable Expenses often change proportionately with change in business volume or even revenue but not always.

Hotel Expenses - Total and Unit Cost

The last category is about whether expenses are considered:

• in accumulation or as Total Costs or
• when they are calculated per unit of business volume or Unit Costs.

For example, if the costs of consumption of cleaning supplies in the Rooms department for the month of December 2019 total up to $3,723, these will be considered Total Costs.

However, say, the above Cleaning Supplies expense total is divided by the rooms occupied for that month.

That will result in a Unit Cost.

This means expenses incurred on Cleaning Supplies for every room occupied in that same month.

It is important to note that Unit Costs are normally calculated only for Variable Expenses.

Hotel Payroll Expenses - Single Highest Expense in the Profit and Loss Statement

Employee Expenses

Look at the six month extract of expenses of the Rooms department of the Paradise Hotel.

Employees in a hotel may be on a permanent hire basis or temporary.

Notice in the Statement above the first two expense line items of Payroll & Related Expenses of the Paradise Hoel.

They are Salaried and Hourly.

The Salaries are the permanent employees while the hourly are the temporary ones.

The single most important difference between permanent (Salaried) and temporary (Hourly) employees is that the latter often do not enjoy all the benefits that permanent employees enjoy.

This means that the total Payroll & Related expenses for a permanent employee will be much higher than that of a temporary one.

Payroll & Related Expenses are arrived at after taking into account and adding up all the employee numbers and multiplying them with the salary or wage rate applicable to each of those employees.

In other words, Payroll & Related Expenses is the product of manning (employee numbers) and salary / wage rates.

Manning

Manning is a word or term used to denote employee numbers.

So, when we say the permanent manning of the Paradise Hotel is 115, we are saying that Paradise Hotel has 115 permanent employees.

Expenses incurred on permanent manning are often considered as Fixed Expenses.

This is because the permanent manning is available whether a hotel does 30% occupancy or 90% occupancy.

If you remember, we said that Fixed expenses are those which do not change with changes in business volume or occupancy in the Rooms department.

In North America (USA and Canada) as in many other countries, there is no concept of permanent manning.

All employees are on a contractual basis which tends to be limited to a couple of years (renewable often).

As such, Payroll & Related Expenses can be considered a Variable (actually Semi Variable) expense.

This however may not be strictly true because employees cannot be hired and fired according to occupancy.

Salary / Wage Rates

Salary / Wage Rates are the other component of Payroll & Related Expenses (the first one is the manning or employee numbers).

Salary / Wage Rates are different depending upon the level at which an employee is placed in the organizational hierarchy.

The higher the level of the organizational hierarchy an employee is placed, the higher the wage rates.

At most times, based on their performance evaluation, every year, an employee is entitled to a salary / wage increment that the organization announces. 

Bonuses are also paid out based on the performance of the hotel and profit it earns during a particular year.

From the Paradise Hotel Rooms department statement, you will notice that there are two more items of expenses in Payroll & Related Expenses - Payroll Taxes and Benefits.

Payroll Taxes are dependent upon the law of the land.
It is a tax on the salary / wage component based on a certain percentage.

Many countries do not have Payroll Taxes while many others do.

Benefits are expenses incurred in providing services for employees.

For example, medical insurance, retirement contribution, employee cafeteria, transportation and so on are expenses that the hotel pays on behalf of each employee.

As said earlier, benefits are mostly applicable to salaried employees.

Federal mandates may require every hotel to pay certain expenses on behalf of employees mandatorily like for example medical insurance.

Again this will depend upon the law of the land.

Canada has universal health insurance provided free of cost to all citizens while United States of America does not have this and citizens have to pay their own insurance.

Of course, for those who are employed, the companies take care of that.

Hotel Expenses - Rooms Department

The Low Cost Big Margin department

As we has seen thus far, the Rooms department is the primary revenue contributor to a hotel performance.

It may interest you to know that it is also the department with:

• low costs (say, compared to the Food & Beverage department) and 
• big profit margins.

Rooms department appears to be a low cost department principally because expenses are a smaller part of room revenue.

Generically, a Rooms department expense tends to be in the 15% to 20% range resulting in a 80% to 85% profit margin.

This is mainly because the Rooms department does not have as high Direct expenses as a Food & Beverage department has.

The best example would be whenever a menu item is served in the restaurant.

It immediately incurs a Food Cost of at least 35% and much more if it includes expensive ingredients.

On the other hand, the Rooms department does not have these kind of high Direct expenses.

Look at the Rooms department expenses of Paradise Hotel shown above.

Notice how the rooms department expenses total up to 15% of Room Revenue yielding a Departmental Profit % of 85% for the Current Month.

The operating expenses cover both fixed and variable types in the Rooms department.

Hotel Expenses - Food and Beverage Department

The High Cost Low Margin department

The Rooms department is the Low Cost Big Margin department of the hotel.

Comparatively, the Food & Beverage department is the High Cost Low Margin department.

Why is this?

As we said briefly earlier, the Food & Beverage department has much higher Direct expenses compared to the Rooms department.

For example, when a menu item is served as a dish in the restaurant within the hotel, simultaneously, a direct expense called the Food Cost is incurred.

This Food Cost is not only a Direct expense but also a Variable Expense.

The Beverage Cost is another Direct Variable Expense representing beverage that is served along with the food menu item.

Look at the Food & Beverage statement for Taste Buds Restaurant in Paradise Hotel below:

Hotel Expenses - Why Expenses Triggers Are Critical

The Revenue Enablers

In an earlier section, we learned that revenue does not happen on its own.

Expenses need to be incurred most times before revenue can be achieved.

You saw types of Revenue Triggers earlier.

it might surprise you to learn that expense triggers broadly also take a similar approach.

Let me explain.

The following can broadly be considered expense triggers for the Rooms department:

• Business Volume (Occupancy)
• Price (Cost)
• Attribute

If you remember, earlier you saw how expenses can be broadly direct or indirect or proportionate or disproportionate and even fixed or variable.

Almost all of these categories are because of the business volume revenue trigger - either occupancy or covers served.

For example, take the case of Guest Supplies in the Rooms department.

For every guest room sold resulting in room revenue, a proportion of that revenue is incurred as direct rooms expenses.

This Guest Supplies room expenses have two parts to them - the business volume and price parts.

Let us take business volume first which is occupancy.

Look at the Paradise Hotel Rooms Statistics statement below:

Based on say, 90% occupancy in April 2019, Total Paid Occupied Rooms are 4,200 and Guest Supplies expenses are $12,609.

Room Revenue in April 2019 was $1,050,000.

If you divide the Guest Supplies expenses of $12,609 by the Total Paid Occupied Rooms of 4,200, you will get $3.01 per paid room occupied.

The higher the paid rooms occupied, the higher the Guest Supplies expenses which can be considered as Direct / Proportionate expenses.

So, as you can see, the business volume is an expense trigger as much as it is a revenue trigger.

The only difference is that it may or may not be proportionate.

Price acts as an expense trigger when you analyze the dollar value in a hotel PNL for a period.

Price as expenses trigger often is less visible than business volume.

For example, in the Paradise Hotel Rooms Statistics statement Guest Supplies expenses, we saw that the expenses for April 2019 were $12,609.

This figure represents the cost of purchasing (and subsequently using in the operation) Guest Supplies which may consist of amenities placed in the guest rooms.

Say, the supplier of the amenities raises the price of those items.

Then, Guest Supplies expenses will become higher even without any change in the business volume.

However, this price increase will not be apparent unless on analysis it is found that the occupancy did not go up but the Guest Supplies expenses did.

That can then be only due to this price increase of those items.

The third expenses trigger is what is known as an attribute.

Attributes are certain qualities of an expense item which influences it.

For example, in the Guest Supplies expenses of Paradise Hotel we just saw, an attribute called inventories is also triggering those expenses.

Guest Supplies are normally variable expenses for which the hotel holds inventories.

This means that the hotel purchases these items on a regular basis.

It then stores them for issuance to the operation depending upon business volume (occupancy etc.).

Only expenses which are variable and for which a hotel holds inventories have this attribute as expenses trigger.

When the hotel makes purchases of those types of items, they are regularly ordered and often in bulk.

Because of these two factors, the hotel may negotiate a better price for those items.

In this case, the price of the item is an expense trigger on the one hand and on the other.

The inventories as an attribute are also considered an expense trigger.

Similar to the example above in the Rooms department, the following can broadly be considered expense triggers for the Food & Beverage department:

• Business Volume (Covers Served)
• Price (Cost)
• Attribute

These operate in much the same way as the Rooms department.

Covers served take the place of occupancy in the food & beverage department.

So, there you go, basics of hotel expenses which no manager can afford to ignore or not understand.

How do you treat expenses in your hotel?

Let me know below in the comments.

In the next week, we will look at Part 4 of this 6 part series on Hotel Basics Beginners Struggle with. 

That Part 4 will about Profitability basics.

So, stay tuned.

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