Hotel Financial Performance Analysis - The Ultimate Jargon Free Guide
Hotel Financial Performance Analysis minus the hype - are you ready for this?
Have you ever been stumped, not knowing how to make sense of your hotel financial performance?
Did you ever wish for a non-technical guide to measuring hotel financial performance?
Over a quarter of a century, I have sat in too many hotel financial performance meetings.
Meetings that were lost in a blizzard of information and went nowhere.
In this Hotel Financial Performance Analysis - The Ultimate Jargon Free Guide:
- We will traverse the entire journey of analysis using the fictional Paradise Hotel as a Case Study Example of performance analysis.
- Use simple, non-technical narratives.
- This is so that even those with a non financial background can easily understand powerful financial metrics for the hospitality industry.
The Guide will also explain key concepts / terms used at the end of the blog post.
We will cover the following areas:
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What Will this Hotel Financial Performance Analysis Post Do For You?
This blog post gives you two views of your hotel financial performance:
- dimension view and
- dashboard view
that the traditional profit and loss statement does not give you.
What do these dimension and dashboard views achieve for your hotel?
- First, they make your hotel profit and loss statement dynamic and forward looking as opposed to static and after the event.
- Second, they facilitate decision making which is key to positive business results as well as arresting negative results
- Third, they place you in charge of the situation and able to control your business more effectively
- Fourth, they allow you to use Key Performance Indicator (KPI) triggers in financial statements
- Finally, they enhance bottom line on an ongoing basis which is what businesses aspire to do
They will change the way you run your hotel.
Through simple techniques that you can apply to deliver superior business results.
In other words, superior performance.
After going through this guide, you will be able to take the following action steps toward that performance:
- Determine Relationships between
- revenue,
- expenses and
- profit in your Profit and Loss Statement
- Identify Key Performance Indicator (KPI) Triggers based on relationships
- Determine Cause Effect in relationships and triggers of KPIs
- Target Cause in Financial Decision Making
- Measure Action taken and Business Results achieved
3 Pillars - 5 Step Actions for Hotel Financial Performance Analysis
Hotel Financial Performance Analysis Background
Welcome to Hotel Financial Performance Analysis - The Ultimate Jargon Free Guide
How to perform a clinical Hotel Financial Performance Analysis minus the hype.
And in the process, squeeze out significantly more hotel profit!
Business ventures need to measure themselves in financial performance as much as any other worthwhile undertaking.
The age old, traditional method of measurement of business performance is the production of the monthly Income Statement.
Income Statement is also more commonly known as Profit and Loss Statement or the shorter P&L.
However, the monthly Profit and Loss Statement has inherent drawbacks.
These are not immediately apparent from reading it sometimes even for accountants.
Despite this, all businesses place reliance upon it for financial performance analysis and measurement.
A Profit and Loss Statement is:
- a historical record of commercial transactions
- classified under revenue and expense categories.
However, they are past transactions.
They are after the event.
Whatever has happened has happened and cannot be undone.
You could say metaphorically that it is like performing an autopsy.
Hotel business ventures (like others) are known as going concerns.
Meaning, that they will continue existing indefinitely.
They produce results and survive on an ongoing basis.
Thus they are forward looking in order to generate more revenue and optimize expenses.
The net result is a positive one which is the goal of any business venture.
Measuring Hotel Financial Performance amidst Seasonality
The foremost, unique feature of the hotel industry is that it is primarily a seasonal business.
This facilitates different methods of measuring hotel financial performance.
Each month of a 12 month cycle could see different business volumes at which the hotel will operate.
Each month of a 12 month cycle could see different business volumes at which the hotel will operate.
This has a great impact on revenue and overall hotel financial performance.
Business Volume refers to occupancy for the hotel rooms business.
Inevitable parts of a business cycle and the seasonality factor are:
- revenue going down or being stagnant,
- losing or gaining market share etc. and so on.
During these times, the hotel has to ensure that it is optimizing each dollar of revenue earned and expenses incurred.
This is toward achieving the highest profit.
In particular, are times of decreasing or even stagnating revenue.
Prudent management of expenses assumes huge significance.
In this goal, the Profit and Loss Statement is found wanting since by nature it happens to be historical.
You can only find out the results after the event.
Hotel Financial Performance Analysis & Degree of Control
One of the central elements of optimizing hotel financial performance is degree of control.
How much control can the business exercise over its revenue and expenses.
This may be in times of decreasing or increasing revenue situations.
These situations particularly apply to expenses which tend to be internal.
Revenue is external in a broad sense from the perspective of degree of control.
Degree of control simply means how much of room you have to take corrective action.
Degree of control simply means how much of room you have to take corrective action.
This is to ensure you can avoid future mistakes in the objective of revenue and expense optimization.
Hotel Profit and Loss Statements fall woefully short in this area.
This is because they are historical in nature.
They are not behavioral.
What does "behavioral" mean?
Hotels need a much better and forward looking method of analyzing revenue and expenses.
This is so that corrective action is taken to protect future mistakes or losses.
Hotel Financial Performance analysis mechanisms must be:
- Able to throw light on how revenue and expenses behave on the one hand
- On the other, they must be able to guide how to influence them through decisions and action.
Hotel Financial Performance Analysis & Profit Flow Through
Enter a powerful, dynamic hotel performance metric or KPI (Key Performance Indicators).
Profit Flow Through Analysis.
It is sometimes also called Contribution Margin Analysis or Break Even Analysis.
This Ultimate Guide will prove that with the use of this analysis, the humble Hotel Profit and Loss Statement can be turned multi-dimensional.
Multi-dimensional means:
- a hotel profit and loss statement can used to track many hotel financial performance indicators
In its original, traditional state, at best, it is uni-dimensional.
This Ultimate Guide will give you a unique 3 Dimensional View of the Hotel Profit and Loss Statement.
The 3 Dimensional view will throw up the element of "behavior."
Meaning, behavior of an expense or revenue item.
That allows you to take forward planning initiatives to be pressed into action.
Along the way, hotel financial performance analysis will reference some Key Performance Indicators like:
- Contribution Margin,
- Break Even Analysis etc.,
Profit Flow Through Analysis magically transforms a historical Hotel Profit and Loss Statement.
Into a dynamic, forward looking, living statement.
Such a statement can be used as a tool for:
- hotel financial performance measurement,
- improvement and
- course correction.
Before that, let us see what are the pain points of a traditional hotel Profit and Loss Statement.
Hotel Financial Performance Analysis - The Pain
What the Paradise Hotel Profit and Loss Statement Does Not Show You!
The Profit and Loss Statement below shows financial performance of Paradise Hotel, our Case Study Example.
Paradise Hotel Profit and Loss Statement
It is for the year ended 31st December 2019 compared to Last Year and Budget respectively.
Comparisons with previous period and with budget are common methods of analyzing and measuring hotel financial performance.
However, the statement lacks some key traits for facilitating effective financial performance analysis.
- First, it does not distinguish between financial performance of Current Month and Year-To-Date.
- Second, it does not show relationships between revenues, expenses beyond respective variances
- Third, the Statement does not show behavior of expenses vis-a-vis revenue.
The pain from these huge shortcomings is almost paralyzing.
Meaningful financial decisions cannot be taken based on what is existing in these statements.
Decision making requires a point of reference which is indicative of situations in the future.
Decision making requires a point of reference which is indicative of situations in the future.
The Hotel Profit and Loss Statement unfortunately cannot deliver here as it is historical.
Let us examine why these traits are so key to evaluating financial performance analysis.
Why are they critical to actionable decision making to deliver better profit consistently?
Hotel Financial Performance Analysis - The Problem
Historical nature of Hotel Profit and Loss Statement
The concept of a Hotel Profit and Loss Statement is to show:
- actual accumulated revenue and
- expenses
for the current period.
This is compared with the budget of that period and resulting variance.
If there is a forecasting process in place, you compare with the forecast as well.
It normally also makes a comparison with the actuals of the previous period and shows the variance.
The variance is expressed both in terms of dollar as well as percentage.
A Profit and Loss Statement thus normally:
- shows variances on a stand alone basis, ie., variances of revenues and expenses are shown separately
- the variance is between actual and budget of the current period
but no effort is made to show a relationship between movement in revenue and of expenses.
Hotel Financial Performance Analysis - The Normal View
A traditional Hotel Profit and Loss Statement by virtue of being historical has only two dimensions to it:
- revenue dimension and
- expense dimension
You could say that this is the normal view of the Hotel Profit and Loss Statement.
But this normal view suffers from serious shortcomings.
- Revenue and expenses are recorded historically - these are transactions over and done with.
- They are not dynamic and forward looking.
- Only record of revenue and expenses are individual variances compared to last year or budget.
- They do not show how one impacts the other.
- There are no connections shown between revenue and expenses.
- That would, in a dynamic way, provide a cause-effect relationship.
- Categorizing expense or revenue in a generic way does not allow cause-effect dynamism
- Often the revenue and expenses
do not isolate current month from year-to-date performances
- These are critical to understanding the way business cycles impact results.
- I am talking about high, low periods of business behaving differently even in the same year
Enter the third dimension of a radically transformed Hotel Profit and Loss Statement!
Want to Read a Profit and Loss Statement Easily?
Watch the Video Preview below!
Hotel Financial Performance Analysis - 3 Dimensional View
What is the 3rd Dimension of a Hotel Profit and Loss Statement?
Is this some kind of trick or a gimmick?
Do you have to wear 3D glasses to get that view?
No, the 3rd dimension of a Hotel Profit and Loss Statement is neither a trick, nor a gimmick.
And no, you do not need to wear 3D glasses!
It is a working, dynamic principle.
This principle elevates it to a powerful financial performance analysis tool in the kit of a hotel manager.
It supercharges hotel financial performance analysis.
Stop right here and do this now!
Give the nature of a traditional Hotel Profit and Loss Statement good thought.
Did you do that?
You will definitely have come to the conclusion that it tends to be grossly static.
Static, in the sense of dynamism.
There is no dynamism to it.
What does that mean?
I am talking about the kind of dynamism that is required to:
- battle changing trends,
- preferences and
- habits of the customers.
Not to mention the fluctuating nature of the business world itself.
In this backdrop of changing events and circumstances, what is of paramount importance?
The requirement is a tool which allows you to respond to the changing circumstances.
To do this, you should be able to understand the behavior of revenue and expenses in the Hotel Profit and Loss Statement.
Hotel Financial Performance Analysis and The Behavior Dimension
Behavior of revenue and expenses is the third dimension of a Hotel Profit and Loss Statement.
In its traditional form, alas, it sadly lacks it.
Behavior is the dimension which will allow you to gain control over revenue and expenses.
With this control, you are able to respond and in many instances even anticipate the changing forces of the hospitality industry.
See the visual on the behavior dimension.
Hotel Financial Performance Analysis - The Ultimate Jargon Free Guide
Behavior will put you in charge.
You will be calling the shots.
That means responding actively and dynamically to situations rather than just reacting to them.
In short, the behavior dimension provides the much needed depth to the normal/historical view of revenue and expenses.
Case Study Example of “Behavior” & the 3D View
Let us take a Case Study Example from Paradise Hotel to illustrate the behavior dimension of a Profit and Loss Statement.
Below are the Rooms and Food and Beverage Department - Taste Buds Restaurant and Catering Profit and Loss Statements of Paradise Hotel.
Paradise Hotel Rooms Department Statement
Taste Buds Restaurant Statement
Catering Department Statement
Take a look at the departmental Profit and Loss Statements of Paradise Hotel.
You will notice that we have now gone a notch deeper into the financial statements.
We can now see the individual revenue and expense line items.
Each individual revenue and expense line item indicates the nature of revenue and expenses.
It helps us understand what categories of revenue and expenses:
- contributed to earning revenue and
- producing overall results.
Contribution also shows comparison with the previous year.
This is in the form of variances both in dollar terms and well as in percentages.
We have a good picture of what happened during the current period of financial performance.
However, here is also the classic dilemma.
Shortcomings of Historical Record of Financial Performance
We do not know the following important factors from this historical record of financial performance:
- How good is this financial performance in terms of potential to achieve more?
- Why are certain expenses the same as or similar to last year while others are increasing or decreasing?
- What are wastage and redundancies that can be avoided?
- Can we set targets for future years based on just historical financial performance?
- What degree of control can be exercised on the revenue and expenses through decision making for the future?
- Is there any relationship between revenue achieved and expenses incurred?
- If there is relationship, how can we leverage that for future improvements?
- Are we able to understand cause-effect relationship in revenue and expenses from this historical record?
- How can we create more accurate budgets and forecasts for the future?
- This is so as to get a better handle on financial performance from this historical record?
As you can see, there are major questions left unanswered by the historical, normal view of the traditional Hotel Profit and Loss Statement.
Hotel Financial Performance Analysis - The Results
This is where the behavior factor comes in.
Behavior provides the vital 3 Dimensional View of the Hotel Profit and Loss Statement.
Take a look at the statement below.
This is the same Rooms Department Profit & Loss Statement shown earlier.
However, now it has the behavior factor assigned to it.
Paradise Hotel Rooms Department Profit and Loss Statement
What is the behavior factor and how does it work?
The behavior factor is the additional categorization of expenses according to their behavior - whether Fixed or Variable.
See the column to the right of the Rooms department Expense lines.
A character "F" represents Fixed and "V" represents Variable Expenses.
These are explained shortly in detail.
How does this help us?
All expenses can be categorized according to the way they behave or move during a business performance period.
This means analyzing how they move in relationship with the following key elements or movement in:
- revenue
- business volume
In short, what we are saying is that we would like to analyze and understand
- how movement in expenses is impacted by
- movement in revenue or movement in business volume.
This is a dynamic and forward looking method of analyzing business results.
Clearly, this is superior to the historical and static way of the traditional Hotel Profit and Loss Statement.
Hotel Financial Performance Analysis and Cause Effect Relationships
In this dynamic analysis, we are now looking at the revenue-expense connection in terms of a cause-effect relationship.
Or in other words, we are going to study what are the causes that affect the movement of expenses.
Pre-dominantly we will look at expenses but in some instances revenue too gets affected in a business performance period.
Now we are able to understand what is causing the movement and even in what proportion.
It is then a much simpler task to begin focusing on and influencing the underlying causes.
Effectively (pun intended), having a great degree of control over the effect.
What are the causes that we are looking at?
The Cause in Hotel Financial Performance Analysis
In studying the cause elements which affect the movement in expenses, we look at two aspects:
- Movement in revenue - expenses which are directly related to movement in revenue (in dollar terms) will be impacted by their increase or decrease.
- For example: In Sales & Marketing Statement, one expense line item is Marketing Fees.
- Marketing Fees are agreed upon (say, through Hotel Management Agreement) and stated as a % of revenue.
- This means whenever revenue in dollar terms increases or decreases, a proportionate increase or decrease (based on actual percentage) will take place in expenses in dollar terms.
- Revenue in dollar terms is the cause and the marketing fees in dollar terms the effect.
- This is an example of a Variable expense which moves directly in proportion to the revenues on which it is based
- Movement in business volume - expenses which move in direct proportion to movement of revenue in dollar terms are an exception rather than the rule.
- More often, expenses move because of movement in business volume.
- What we do mean by business volume?
- Business volume refers to Occupancy levels in the hotel for the Rooms revenue streams and to Covers Served levels for the Food and Beverage revenue streams.
- These require further explanation.
In the Paradise Hotel Rooms Department Profit and Loss Statement you saw earlier, Total Room Revenue is contributed by two factors - see Market Segments Statistics table below for Jan-Jun (6 months):
- Total Paid Occupied Rooms (measured in terms of Occupied room nights) and
- Average Daily Rate on Paid Occupancy
Rooms Dept Market Segments Statistics Jan-Jun
- These can be called Business Volume and Price factors which contribute to Total Room Revenue.
- In the study of movement in business volume above, the room occupancy is that business volume.
- It represents the number of nights that the guests of Paradise Hotel stayed in the hotel in the business performance period.
- Note the Paid Occupancy % for each month over the six months - the occupancy % varies from 60% all the way to 91%
- This variation in occupancy or business volume is due to the seasonal nature of the hotel business we talked about earlier
- Note the color coded month columns at the top of the table representing Standard, Lean and Peak months
- Taking this further, any movement in the occupancy of Paradise Hotel will impact certain expenses which are proportionate (or otherwise) related to such occupancy.
- For example: Guest Supplies/Amenities is one of the expense line items in the Rooms Department Profit and Loss Statement - see Jan-Jun months extract below
- These expenses relate to supplies placed in guest rooms like bathroom amenities, etc.,
- Cost of these supplies will increase when occupancy increases (more guests in rooms) and decrease when occupancy falls.
Rooms Dept Expenses Jan-JunJan-Jun
The Power of the Cause-Effect Relationship Study
We can see the power behind analyzing cause factors as we can see now what is influencing expenses.
- This allows us to estimate expenses accurately (more effective budgeting and forecasting).
- It also gives us better control over their behavior.
- We can detect wastage or disproportionate movement in expenses as we know the cause.
Occupancies fluctuate from month to month as shown in the 6 month Statistics table above.
These are mainly affected by the business cycle and Standard, Peak and Lean months.
Using our 3 Dimensional view provides us invaluable information on this factor influencing the movement of expenses.
This further allows us to take corrective action.
Finally, this action dynamically optimizes the bottom line performance over time.
[5 Step Action Plan below of 3 Pillars of Hotel Profit & Loss Statement Analysis for this magic to happen].
3 Pillars - 5 Step Action Plan
How are Hotel Financial Performance Results actually achieved?
Dramatic results can thus be achieved over time through the study of the cause-effect relationship between revenue and expenses.
This is done by re-casting the Hotel Profit and Loss Statement to reflect the behavior factor as described in earlier paragraphs of this blog post.
Notice the RIGHT MOST COLUMN of the Operating Expenses section in Rooms Department Statement seen earlier - each expense line has an alphabet assigned to it
F stands for Fixed Expenses which do not change with occupancy levels
V stands for Variable Expenses which change (proportionately or otherwise) with occupancy levels
I must clarify here that in reality there is a third type called Semi-Variable Expenses.
However, we have ignored that in the interests of simplicity and to emphasize how Fixed and Variable expenses move.
We have until this point understood how the behavior factor can provide a 3D View of the traditional Hotel Profit and Loss Statement.
This now brings us to the phenomenon known as Profit Flow Through.
By being in better control over our revenue and expenses, we are able to influence that key measure of hotel financial performance - profit.
The Profit Flow Through analysis shows how to do that effectively.
Profit Flow Through Analysis Concept
In earlier paragraphs of this blog post, we studied the cause-effect relationship between movement in revenues and expenses.
This provided us a third dimension and a powerful method to influence the profit.
How can we benefit from this fresh insight?
The Profit Flow Through Analysis concept produces the results of the 3 Dimensional view of the Hotel Profit and Loss Statements that we talked about so much earlier.
It harnesses the cause-effect relationship to produce its magic.
The Concept explained
Profit Flow Through Analysis concept can be stated as follows:
Profit Flow Through Analysis measures the extent to which any incremental change in revenue results in incremental change in profit.
This analysis measures:
- the extent to which any incremental change in revenue
- results in incremental change in profit.
Or, in other words:
- for every extra dollar earned in revenue,
- how much of that extra dollar revenue is reflected in extra profit.
Knowing what are the causes that influence the movement in revenue and expenses is going to be priceless if we are to optimize Profit Flow Through.
In a way, we have done our homework on this.
Hotel Financial Performance Analysis Using Current Month and Year To Date
Actual revenue, expenses and profit are commonly shown in a Hotel Profit and Loss Statement.
This is either by comparison to budget or last year or both.
There are two important elements to those actuals as follows:
- Current Month revenue, expenses and profit and
- Year To Date Actual revenue, expenses and profit i.e., for the actual number of months completed in the current year
Current Month & Year To Date:
Why should we separate current month, year to date figures for actual revenue, expenses & profit?
Current month results:
- only reflect the performance of the hotel for the particular month and
- thus can be analyzed in isolation.
A current month could be a Peak, Lean or Standard revenue month (see Jan-Jun color coded columns in earlier table).
We need to analyze its peculiarities or behavior within a business cycle.
Example.
A Peak revenue current month will be able to absorb more of the fixed expenses.
This is the cornerstone of the Profit Flow Through analysis thereby resulting in better profit.
See Table below
Rooms Dept Market Segments Statistics Jan-Jun
In the Table, the two yellow color coded months (April & May 2019) are Peak Months with 90% and 91% Occupancy.
These are also the months with the highest Departmental Income (Profit) - refer to the Rooms Department Statement;
In fact, May month with 91% Occupancy has the highest Rooms Profit $904,136 (85%)
On the other hand, the two blue color coded months (February & June 2019) are the Lean Months with 60% and 61% Occupancy.
These are also the months with the lowest Departmental Income (Profit);
In fact, February month with 60% Occupancy has the lowest Rooms Profit $526,702 (79%)
The above two examples emphasize a powerful phenomenon of the hotel operation.
That occupancy levels (cause) of a hotel in a month often influence revenue and profit (effect) in a significant way.
Moreover, the results of a current month can either raise or bring down the variance year to date compared to budget or last year.
This has great significance depending upon whether we are in the beginning, middle or end of the year.
Significance of Year To Date in Hotel Financial Performance Analysis - Example
Year To Date figures for revenue, expenses and profits play a key role in the entire hotel financial performance management system.
Say, Paradise Hotel is in the first quarter of a calendar year and reporting results for end of first quarter.
Its business results as of 31st March 2019 will be reported as below (see Rooms Department Statement):
- Current Month revenue, expenses and profit for March 2019 compared to budget, last year and forecast and
- Year To Date revenue, expenses and profit as of 31 March 2019, i.e., at the end of three months of the year 2019
Paradise Hotel Rooms Dept Statement 31st March 2019
Some key elements of the hotel financial performance management are at play here:
- First, revenue, expenses and profit as of 31 March 2019 are compared with the budget first to determine whether Paradise Hotel is ahead or behind (for current month it is ahead of budget on revenue and profit).
- This is the preliminary step in any hotel financial performance management system and is known as the Big Picture Overview.
- Second, depending upon whether revenue, expense and profit are ahead or behind, we will determine the variance factor.
- The variance factor measures what is the extent to which they are ahead or behind.
- This is critical in order to determine course of action to be taken for the rest of the year.
- Third, we will ascertain whether the performance of the current month actually added to or reduced from the year to date revenues, expenses and profits.
- Finally, we will compare that to the Year To Date results as of the previous month.
Hotel Financial Performance Analysis - Formula
In other words, you could say that the formula is:
PREVIOUS MONTH YEAR-TO-DATE VARIANCE OF Revenue, Expenses, Profit - ACTUAL Vs BUDGET “A”
PLUS or MINUS
CURRENT MONTH VARIANCE OF Revenue, Expenses, Profit - ACTUALS Vs BUDGET “B”
EQUAL
CURRENT MONTH YEAR TO DATE VARIANCE OF Revenue, Expenses, Profit - ACTUALS Vs BUDGET “C”
Assume that “A” is a positive figure.
Whether “C” will be a higher positive figure than “A” will depend on whether “B” is a positive figure.
Let me repeat what was said earlier:
- If current month financial performance resulted in a positive variance of actuals vs the budget,
- it will add to positive variance of actuals vs budget of previous months year to date performance.
Having done the above arithmetic, we have laid the foundation for our investigation.
Of what the financial performance of the current month meant.
Now we can decide what corrective action needs to be taken for the rest of the year.
Thus, it can be seen:
- analyzing the financial performance of Paradise Hotel separately
- for the month and then for the year to date (See Table) is critical.
This is to isolate reasons negative or positive variance resulted compared to the previous month.
Revenue Expense Relationships in Hotel Financial Performance Analysis
Earlier we saw that a current month financial performance should be analyzed in isolation.
This will give us an indication of what corrective action needs to be taken for the rest of the year.
So as to impact year to date results positively.
It is now time to determine how to go about course correcting.
- First, we should understand the umbilical cord relationship between revenue and expenses.
- We will then use that understanding to leverage its power.
The single most critical analysis in the revenue expense relationship is the profit flow through analysis.
How Profit Flow Through Works
The entire concept of Profit Flow Through Analysis is based on:
- creating relationships between
- increase in expenses and revenue.
So, what is the Profit Flow Through Analysis?
How is this analysis powerful to a business venture?
The Profit Flow Through Analysis compares the difference between revenue and profit over two periods.
- The analysis could to a lesser extent compare between budget and actuals or forecast and actuals.
- It takes the difference between the profit over the same two periods and arrives at an index or Key Performance Indicator (KPI).
- This KPI shows how much increase in revenue was carried over to profit.
In short, profit flow through measures:
- for every dollar increase in revenue for this period over the last period
- how much of that dollar increase flowed to the profit of this period.
Profit Flow Through Example
We take the figures shown in the Table (comparison between Current Year and Last Year) for Paradise Hotel for the Food and Beverage Department Taste Buds Restaurant for the year ending 2019.
Taste Buds Restaurant Statement 31.12.2019
Total Departmental Income (Profit) is $124,002 compared to $104,853 in year ending 2018.
Food and Beverage Revenue is $357,848 compared to $324,619 in year ending 2018.
Profit Flow Through in this example would be calculated by:
- dividing the difference between $124,002 and
- $104,853 in Departmental Income (Profit) first.
Then we take the difference between $357,848 and $324,619 in revenue.
Finally, we express the above two differences as a ratio percentage.
Profit Flow Through Formula
Difference in Profit (Current Vs Last Period) / Difference in Revenue (Current Vs Last Period) X 100
In this example, it would be 19,149 divided by 33,229 which in terms of percentage equals to 58%
Profit Flow Through % here is thus: 58%
This can be stated as follows:
- Out of the increase of $33,229 in revenues for year ending 2019 over year ending 2018, only 19,149 flowed to the profit for year ending 2019.
- It may be noticed that the increase in revenue for year ending 2019 over 2018 is 10.2% ($357,848 - $324,619/324,619).
- The increase in Total Operating Expenses for year ending 2019 over 2018 is 10.3% ($57,816-52,458/52,458).
This means that increase in expenses as a percentage was marginally higher than increase in revenue.
The percentage increase in revenue year on year is marginally lower than the percentage increase in expenses.
Despite this, overall result of the analysis is a positive variance.
In dollars, Departmental Income increased by $19,149 in 2019 compared to year 2018) year on year.
Or, the Profit Flow Through is said to be positive.
Let us take a big picture overview.
In this example of Paradise Hotel, it can be said that:
- By understanding the relationships between movement in revenue and expense and
- their effect on profit, important decisions can be taken.
However, it is important to clarify that this is the first step - identifying what the flow through is.
[See 3 Pillars of Hotel Performance Analysis 5 Step Action Plan Infographic below]
3 Pillars of Hotel Financial Performance Analysis
- Follow up steps need to be taken first in going into which expenses went up or down and why.
- A similar exercise to be done for which revenue sources went up or down and why.
- At the end of the exercise, you will get a good fix on how your fixed and variable expenses are moving in relation to business volume and revenue as we saw earlier.
- Finally, it is critical to note that profit flow through percentages are different for different hotel departments.
For Rooms department, they can be as high as between 80% and 90%.
As we saw earlier though, in the Food and Beverage department it can be between 50% and 70%.
This is because Food and Beverage department has higher variable costs than the Rooms Department.
Another behavior that can be utilized for taking decisions and achieving a higher profit margin.
In summary, the normal view of the Profit and Loss Statement is the historical view.
It is simply a chronological accumulation of commercial transactions.
Moreover, it is static and historical.
The forward looking, dynamic view is the 3D view of behavior.
Hotel Financial Performance Analysis - Key Concepts & Terms Used
The key to understanding the concept and analysis of profit flow through is:
- understanding of how revenue and expenses are related
- and in what proportion.
The following concepts will help us:
- understand the profit flow through analysis and
- its powerful contribution to effective, results oriented decision making:
- Business Volume
- Business volume is the activity level a business operates at. Also known as the Output level.
- For example, in the case of Paradise Hotel, business volume or output level would refer to the Occupancy levels that it runs in its operation.
- Occupancy % is a vital statistic that is computed in a hotel operation to denote the average occupancy levels it runs.
- It is comparable to the Capacity Utilization factor in a manufacturing organization.
- Behavior of Expenses
- The behavior factor is the additional categorization of expenses according to their behavior - whether Fixed or Variable.
- How does this help us?
- All expenses can be categorized according to the way they behave or move during a business performance period.
- This means analyzing how they move in relationship with the following key elements:
- Movement in revenue
- Movement in business volume
- In short, we would like to analyze and understand how movement in expenses is impacted by movement in revenue or movement in business volume.
- Price and Quantity Factors
- In the Paradise Hotel Rooms Department Profit and Loss Statement, the Total Room Revenue is contributed by two factors - see Statistics table for Jan-Jun (6 months) :
- Total Paid Occupied Rooms (measured in terms of Occupied room nights) and
- Average Daily Rate on Paid Occupancy.
- In the Paradise Hotel Rooms Department Profit and Loss Statement, the Total Room Revenue is contributed by two factors - see Statistics table for Jan-Jun (6 months) :
- In the course of planning the performance of Paradise Hotel for a year ahead, the budgeting process would target a certain occupancy % and number of guest covers.
This would be a starting point for building revenue targets for rooms and food and beverage operations.
Based on this, the hotel can set RevPAR, Market Share, Gross Operating Profit, Net Income and other KPI targets to measure its performance.
It can then monitor hotel financial performance against the budget and forecast for these metrics.
The variance analysis would throw up areas to correct and improve.
Hotel Financial Performance Analysis - Action Steps For You
[See 3 Pillars of Hotel Financial Performance Analysis 5 Step Action Plan Infographic ]
ACTION STEPS FOR YOU
- Determine Relationships between revenue, expenses and profit in your Profit and Loss Statement
- Identify Trigger Key Performance Indicators (KPIs) based on relationships
- Determine Cause Effect in relationships and triggers of KPIs
- Target Cause in Financial Decision Making
- Measure Action taken and Business Results achieved
A Questionnaire on Flow Through for You
- What are the types of financial statements that you generate on a monthly basis? List these.
- Which accounting software or system or application are you using currently? Is it a customized one or off the shelf?
- Are financial statements directly exported from accounting software or extracted, produced on Excel?
- Do you currently have any reports showing Incremental Profit Flow Through?
- If yes, does the Incremental Profit Flow Through track only actuals or forecasts and budgets numbers are also included?
- Does your Chart of Accounts show revenue and expenses according to the different departments?
- Is Profit and Loss Statement showing behavior of expenses, Fixed, Variable or Semi Variable?
- Will your Chart of Accounts break down expenses into Fixed or Variable?
Phew! that was a long one!
Hopefully, I shared with you some powerful strategies for hotel financial performance analysis.
The crux is to take the Profit and Loss Statement and turn it into a financial decision making powerhouse.
A tool to guide you in sound financial decision making that will produce consistent business results.
That is what your hotel owners will also be expecting in hotel financial performance.
Your Takeaways
What were the takeaways for you from the blog post? And from the video?
Are you leveraging the 3 Dimensional view in your hotel performance analysis?
What topics would you like to see as future blog posts?
Tell us in the comments section below.
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