What is the Hotel Profit and Loss Statement not telling you?

The Iceberg Theory

Imagine that you are:

• navigating a humongous ship (rather like The Titanic!), and 
• in the distance you sight an iceberg.

What do you see?

A huge chunk of ice above the surface of water.

What you can’t see though is: 

• that underneath that visible iceberg 
• is another gigantic bigger chunk of ice hidden from your view 
• which holds it together.

Ernest Hemingway’s Iceberg theory says: 

• we only deal with that which we perceive with the naked eye. 
• The rest goes unnoticed, which can be compared to an iceberg. 
• There is a conscious part of the information, 
• but there is also another unconscious part underneath.

Your Hotel Profit and Loss Statement can be metaphorically compared to the iceberg.

What is seen is a small part compared to what lies beneath the surface.

Let us see how that works out and Why You Should Care.

The Performance Statement

Profit and Loss Statement is one of the critical Profit and Loss Reports that management uses month after month.

It is a report that lays out the business results of the past month.

Most articles you read on a Profit and Loss Statement will tell you that: 

• it is a statement of revenue, 
• expenses and 
• profit or net income.

Sometimes it is just revenue and expenses.

It is like the iceberg we talked about earlier.

Everybody talks about the revenue (above the surface).

However, rarely anybody talks about the asset which is generating that revenue. 

That is buried underwater per our metaphor and does not remain visible.

That first unseen iceberg chunk is Capacity.

Capacity is a owner’s favorite topic.

Not surprising though. 

A hotel owner has sunk in sizable amount of money into the hotel investment.

Capacity

Capacity is what drives revenues.

You could say that it is the highest capability of producing revenue with the asset.

In a hotel Profit and Loss Statement:

• capacity is Rooms Available for Rooms department and 
• Covers Served for the Food and Beverage department.

Without capacity, revenue cannot be generated.

It is astonishing how little importance this is given to in a hotel Profit and Loss Report.

Revenue is drilled down into in great detail:

• according to market segments but
• capacity is barely shown in a single row. 

See Paradise Hotel Rooms Department Statement screenshots below for the first six months of 2020.

Template

Most Profit and Loss Statements have one line showing Rooms Available.

In later blog posts, you will dive deep (pun intended) to: 

• unearth the hidden iceberg chunks, 
• the most important of which is Capacity. 

You will examine why capacity is a owner favorite.

Revenue is the next iceberg chunk.

But this one is seen above water mostly.

In later blog posts, I will explain why I say mostly.

The foremost feature of the hotel industry is that it is primarily a seasonal business. 

This has tremendous impact on its:

• revenue generation and
• management strategies

Each month of a 12 month cycle could see different business volumes at which the hotel will operate.

Business Volume is about:

• occupancy for the hotel rooms business, 
• covers served for the food and beverage and
• market segments for the Catering department.

Expenses are the next visible iceberg chunk. 

But there are some underwater elements. 

In later blog posts, I will go into depth about the expense chunks we normally do not see.

Profit or Net Income is an unusual animal.

It appears to be visible. 

But there are a lot of chunks below the surface.

This is primarily because profit is a derivative.

Meaning, it is the result of deducting expenses from revenue. 

Without revenue or expenses, there would be no profit (or loss for that matter). 

I will discuss them in detail in later blog posts.

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Analysis

Analysis is unfortunately the submerged chunk of the iceberg. 

Because it is unseen to the naked eye, so to say. 

It is not apparent.

It needs to be fleshed out.

It is a grossly misinterpreted phenomenon. 

There are as many versions and interpretations of analysis as users.

A lot of them are also grossly incorrect.

Analysis is considered an enigma. 

Nobody understands it goes the refrain.

But this is not true.

Two basic principles underpin financial analysis (in fact non-financial analysis also for that matter!): 

• cause effect and
• context

Assume you do not have a financial background.

You will easily master financial analysis if you just remember this first basic principle - cause effect.

Cause Effect is all about: 

• what is causing something and
• what is being affected by something. 

This is central to a key part of financial analysis - variance analysis.

Cause Effect has another ingredient which is critical for financial analysis. 

That ingredient is Triggers.

Triggers often can be the cause behind a particular phenomenon. 

Triggers will be discussed in a later blog post in detail.

Variances should only be analyzed using cause effect. 

If not, you will end up with deceptive results.

Worse, you will take incorrect decisions based on that.

If you understand what is causing a particular number, say,

• a Key Performance Indicator (KPI), and
• what KPI is affected in a Hotel Profit and Loss Statement,

I can safely tell you that you have won 50% of the analysis challenge.

For example:

• if your RevPAR KPI is showing a decrease in a month (or whatever period you are considering) 
• compared to a previous period or year, 
• you need to know what is causing it - is it occupancy or average rate or both?

Visible iceberg chunks in a hotel Profit and Loss Statement are not:

• what they appear to be and 
• what is hidden under the surface!

WATCH the video on How to Read a P&L. It is a Big Picture Overview of the Cause Effect Principle.

Context is the other basic chunk. 

Everything is relative to everything else in a Profit and Loss Statement. 

This means you need to harness context before you can perform effective analysis

For example: a good part of analysis is about comparisons with previous periods and years. 

However, you should be clear what period you are considering. 

Current Month operates differently from Year-To-Date.

Even which part of the year, first quarter Vs say, last quarter is important in Year-To-Date figures. 

This is context. 

In a later blog post, we will examine how these hidden contextual chunks define analysis.

Tools

Continuing the iceberg metaphor for the hotel Profit and Loss Statement, many tools are visible and above the surface. 

At the same time, some tools are hidden.

Two of the most visible iceberg chunk activities in a hotel Profit and Loss Statement are: 

• Budgeting and 
• Forecasting

The two are closely related. 

However, it is quite amazing how much confusion exists in understanding differences between the two.

Budgeting is broadly an annual exercise.

This exercise lays out the compass or direction that hotel performance is expected to tend toward.

Once a budget is submitted and approved by the owners, it takes a back seat as the year progresses. 

It is then replaced by a Forecast.

A forecast is nothing but an annual budget adjusted monthly for actual results.

For example: say, 

• a forecast for the month of October 2020 is being made, 
• it will be created based on the budget for that month 
• adjusted for actual performance in the first nine months (until September) of the year and 
• the estimate for October 2020.

Understanding your hotel Profit and Loss Statement thoroughly is a pre-requisite for effective forecasting. 

In a later blog post, we will go through a real life forecasting situation.

A well conceived system of forecasting throughout the year will ultimately result in better budgeting in later years. 

This will in turn, produce more accurate and consistent results.

One huge hidden chunk in the Profit and Loss Statement iceberg is Break Even Analysis.

It broadly answers the question: is a hotel making money?

All ingredients of the Break Even Analysis are mostly above water.

It is the recipe which brings them together which is under water.

A break even calculation is a tool for survival for a hotel or any business for that matter.

In the seasonal nature of business that a hotel operates in, break even is a life saver. 

During low periods of occupancy it is critical to know if a hotel will break even.

In a later blog post, a real life break even situation will be illustrated.

Decision Making

Let us go back to the Profit and Loss Statement iceberg metaphor.

What use is information if it cannot be utilized to take decisions?

Understanding both visible and hidden (greater!) chunks facilitate decision making.

In the world of financial decision making hundreds of thousands of dollars could be at stake.

Taking sound decisions is paramount for growth and survival too.

The operation is the hub of decision making in a hotel. 

Everything that is planned should relate back to that operation.

Unfortunately, here is the biggest drawback of a Profit and Loss Statement. 

Sticking to our metaphor, indeed, the greater chunk of a hotel Profit and Loss Statement is underwater.

This stems from the Profit and Loss Statement being a historical one. 

It is merely a record of past transactions.

We do not know the following important factors from this historical record of performance:

• How good is this 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?
• How can we set targets for future years based on this historical performance?
• What degree of control can be exercised on these revenue and expenses through decision making for the future?
• Is there any relationship between the revenue achieved and expenses incurred and
• if so 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
• in order to get a better handle on our performances from this historical record?

There are thus major questions which are largely left unanswered by the historical nature of the traditional Hotel Profit and Loss Statement.

Meaningful 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.

The Profit and Loss Statement unfortunately cannot deliver here.

Or can it?

In a later blog post, we will discuss with examples:

• how the huge hidden chunk of the Profit and Loss Statement iceberg 
• can be utilized to gather some information and 
• make powerful decisions in the hotel operation. 

In the normal state of a hotel Profit and Loss Statement, it is broadly not possible.

Financial Performance

The story does not end with taking decisions.

in fact, it starts a new cycle of performance measurement and course correction.

How do you know if your decision was good or bad?

And how can you adjust that for future decisions?

Hundreds of thousands of dollars are at stake with financial decisions. 

In this context, knowing how you did with your decisions is critical.

In the hotel business, performance measurement takes the form of KPIs - Key Performance Indicators.

It is important to first note the word “indicators.” 

It is even more critical to ensure that:

• you do not jump to decisions 
• merely on the basis of what a KPI is showing without verifying it.

Verification is beneath the surface and cannot be seen, to use our iceberg metaphor.

Tread carefully.

Most often, verification means clearly distinguishing cause from effect.

Confusion between the two may lead to a catastrophic decision and possible losses.

Having verified the KPI, where relevant, course correction needs to be made. 

This means adjusting future decisions and strategies for the verified KPI.

For example:

• if restaurant covers served are decreasing fast,
• it is important to understand what is the cause -
  • a high price,
  • bad quality,
  • poor service or
  • a mix of all
• before future decisions can be taken.

It is an iterative process requiring regular tweaking.

Financial Results are also the basis for assessment of managerial performance.

Thus, a lot is at stake.

In a later blog post, we will examine specific KPIs with real life examples.

Iceberg Secrets

As you saw in this blog post, the hotel Profit and Loss Statement is much like an iceberg in the ocean.

It shows some chunks above the surface but hides the bigger part under water.

It is important to dive deep and:

• unearth the greater chunk during analysis and 
• definitely before decision making.

The iceberg secrets of the hotel Profit and Loss Statement are a host of:

• concepts,
• principles and
• KPIs.

These will create a more holistic understanding of the Statement through better analysis. 

This will elevate the quality and level of decision making. 

That should produce consistent successful business results.

In a later blog post, the iceberg secrets will be discussed with real life hotel examples.

This will make for powerful decision making and predictable business results.

This blog post is:

• an overview of what the Profit and Loss Statement is capable of 
• as well as what it does not show in its traditional incarnation.

In later blog posts, I will dive deep into how this financial statement can be turned into a powerful financial decision making tool.

At the end of the day, producing consistent business results will be the greatest test.

Does the hotel Profit and Loss Report pass this litmus test?

Stay tuned for future blog posts for the verdict on this.

Strategies you can apply right now

STEP 1

Go back to your hotel or restaurant Profit and Loss Statement. 

STEP 2 

Apply Cause Effect Principle to revenue and expenses and KPIs.

Which KPI is causing a fall or rise? Which is the effect?

STEP 3

Find out more about the capacity of your hotel rooms and restaurants.

STEP 4

What kind of information is available on these assets which generate your revenue.

STEP 5

Consider how you are using the Profit and Loss Statement for your financial decision making.

What is your strategy going forward?

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Your Takeaways

What were the takeaways for you from the blog post? And from the video?

Are you leveraging the Cause Effect principle in your hotel Profit and Loss Statement?

What topics would you like to see as future blog posts?

Tell us in the comments section below.

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