Hotel Profit Basics Beginners Struggle With

Did you know that you cannot influence hotel profit directly?

What….you splutter in outrage!

Hold it, let me clarify.

What I meant is that you can only influence hotel profit indirectly.

More specifically, through influencing revenue and expenses.

And yet why most hotel managers miss this critical concept completely?

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 hotel profitability.

However, they forget the critical basics that are the foundation of hotel profit management.

What are those fundamentals you cannot afford to ignore?

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

It will ensure that you achieve your bottom line targets consistently.

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

Are you prepared for this post pandemic challenge?

This is Part 4 of the 6 Part Series on Hotel Profit and Loss Statement Basics Beginners Struggle with.

If you missed Parts 1, 2 and 3, click below to read that first.

This Blog Post will cover:

Hotel Profit - What the Business Retains

How efficient has your hotel business been?

Would you know how to assess that?

Thus far we have seen how broadly:

• revenue is generated in a hotel and
• what kind of expenses need to be incurred in the generation of that revenue.

In other words:

• what is the Top Line (revenue) and
• what is the cost of doing business (expenses) for a hotel.

While generating revenue is a critical first step, the ultimate purpose of a business including a hotel is something else.

Owners and stakeholders pour millions into their hotel investment so that they get back something in return.

That something in return, is often called by various names, not the least of which is Return on Investment.

So, what is this Return on Investment that is so coveted?

Well, it goes by various names and different flavors.

However, the simplest name is what is known as Profit.

Profit, in basic terms can be called as Revenue minus Expenses.

In other words, Profit is What you Retain.

Hotel Revenue, Expenses & Profit

To continue that analogy:

• Revenue is What you Earn
• Expenses are What you Incur and
• Profit is What you Retain.

What you Retain has a measure of efficiency to it.

It tells you what you finally took away.

It is what is given back to owners and stakeholders.

Why do owners and stakeholders lay store so much by profit?

They do that because you could have made a kill earning high revenue.

But say, you did not manage your expenses well in earning that.

You could end up with a profit level much lower than what the revenue suggested.

That is not acceptable to owners.

This is the reason What you retain or profit is such a big deal.

We may also observe that how much the retention could be is not consistent across departments in a hotel.

The Rooms department could turn out a departmental profit of 85%.

The Food & Beverage department on the other hand could manage only around 35%.

So, indeed it is a challenge to optimize retention or profit.

Incidentally, profit is often called Net Income or Earnings.

That brings us to those flavors of profit we talked about earlier.

Let us first understood two major flavors a profit calculation can take.

In other words:

• what are these two different types of profit calculations we can have and
• why they are important for the hotel business.

Hotel Profit - Gross Operating Profit

You are the General Manager of Paradise Hotel.

One fine morning, your Owner storms into your office and demands to know this:

How efficiently are you running your hotel operation?

Your reputation (and possibly your job!) is on the line.

What would you say?

Which hotel Key Performance Indicator (KPI) would you refer to in answering your Owner's question?

Take a look at the Paradise Hotel Profit and Loss Statement for 31st December 2019 shown below:

The index of efficiency in running a hotel operation has long been an important measure for owners and hospitality experts.

Efficiency in running a hotel operation simply means how profitably you have managed the hotel operation.

In arriving at such a measure, it is important that only expenses which are directly related to the earning of revenue during a period be considered.

Such a measure is the Gross Operating Profit and the percentage related to it.

Take a look at the Paradise Hotel PNL Statement.

It has two distinct and different parts.

The bigger rectangle in RED on top represents hotel departments which are revenue sources.

They can be called revenue centers.

Notice how in each of the revenue source departments, not only revenue is shown but also direct expenses are shown like:

• Cost of Sales,
• Payroll & Related Expenses and
• Other Direct Operating Expenses.

Notice also that Cost of Sales is only applicable to Food & Beverage and Retail departments but not to Rooms.

This denotes that revenue earned is subject to inventories (food, beverage inventories, retail goods inventories etc).

The smaller rectangle in BLUE below that represents all expenses.

Why are these expenses shown separate from the section above?

This section represents the Undistributed Operating Expenses.

These are expenses which have been incurred in earning the revenue shown in the section above.

However, these expenses cannot be directly identified to individual revenue sources.

That is why they are also called Undistributed Operating Expenses.

Gross Operating Profit

Directly below the BLUE section is the section for the Gross Operating Profit and % - the index of efficiency of the hotel operation.

Notice how the GOP % in Paradise Hotel is showing 43% for the Current Month (first column) of December 2019.

What is the interpretation of this 43%?

The interpretation is that out of every $100 earned in total revenue ($1,645,814) for the Paradise Hotel in the month of December 2019, $43 as Gross Operating Profit was retained.

In other words, the Gross Operating Profit % (GOP %) is 43%.

Is 43% a good % will probably be the Owner's and hopefully you as General Manager's next question?

That depends on a lot of things like:

• size of hotel
• number of revenue source departments etc.

However, generically, 43% can be considered a good %.

And what about expenses after the GOP?

In later blog posts, we will tackle this topic as these expenses after the GOP are different and will be explained then.

In general, they are not expenses you have much control over.

This will be made clear in later posts.

So, now as GM of the Paradise Hotel, you can tell the Owner that with a 43% GOP, you have managed the hotel operation for the month of December 2019 quite well.

The Gross Operating Profit is considered the Holy Grail of Hotel Operation Efficiency

It literally answers the question: How Efficient is Your Hotel Operation?

The Gross Operating Profit is an index of profitability for the entire hotel.

Let us now see how hotel profit is contributed by individual departments.

Hotel Profit - Rooms Department Profit

As we have seen earlier, the Rooms department is the primary profit bread winner for a hotel.

It is a Low Cost Big Margin department of the hotel business.

On the one hand, the average daily rates for hotel rooms combined with occupancy produce the highest revenue in a hotel.

This is compared to other departments in the hotel.

On the other hand, there is relatively low cost level of expenses in the Rooms department.

Look at the Paradise Hotel Rooms department statement:

Notice how the Payroll & Related Expenses are the single largest expense line item by a big margin.

After Payroll & Related Expenses, notice how Guest Supplies / Amenities and Booking Commission are the next two high expenses but way behind the payroll.

Both Guest Supplies / Amenities and Booking Commission expenses are variable expenses.

In an earlier post in this 6 part series, we saw the significance of this in a Rooms department profitability.

The combination of high revenue and low cost is a level of profit unsurpassed in the hotel industry.

Rooms department profit can range from the already astonishing 85% (See Paradise Hotel statement above) upwards.

The implication of this is: for every one dollar of revenue earned, the rooms department is able to retain 85 cents in that dollar.

That is a staggering profit margin.

No wonder, hotel owners pour in millions of dollars into guest rooms as a revenue generation source.

Let us now see another important department but with a distinctly different profitability level.

Hotel Profit - Food and Beverage Department Profit

As we have seen earlier, the Rooms department is the primary profit bread winner for a hotel.

It is a Low Cost Big Margin department of a hotel business.

In comparison, the Food and Beverage department is a High Cost Low Margin department of the hotel business.

On the one hand the average check of restaurant menus combined with covers served do not produce as high a level of revenue as the Rooms department.

On the other, there is relatively high variable costs for the department.

For example, for every food menu item prepared and sold, 35% to 40% of the menu price goes towards the cost of preparing that menu item.

This is also known as Food Cost.

A similar phenomenon happens with the Beverage Cost although the % is around 20% of the menu price of the beverage item.

Look at the Paradise Hotel Food and Beverage department statement below:

Notice how the Payroll & Related Expenses are the single largest expense line item by a big margin.

After Payroll & Related Expenses, notice how Guest Supplies / Amenities and Booking Commission are the next two high expenses but way behind the payroll.

Both Guest Supplies / Amenities and Booking Commission expenses are Variable expenses. In a later module, we will see significance of this in a Rooms department profitability.

The combination of the lower revenue and high cost is the reason the level of profit is much lower than the Rooms department.

Food and Beverage department profit can range from 30% to 40**%** (See Paradise Hotel statement above).

The implication of this is: for every one dollar of revenue earned, the food and beverage department is able to retain 30 to 40 cents in that dollar.

Let us now look at another flavor of the bottom line which is another generic index of hotel profit.

Hotel Profit - Net Operating Profit

The Net Income or Net Operating Income is in reality what is known as The Bottom Line.

In earlier sections, we saw how the Top Line, the revenue, is the place where it all begins.

We also said that if there is no Top Line, there will be no Bottom Line.

Let us see what means.

The Net Operating Profit or Net Income as it is often known in short, is the last line in a Profit and Loss Statement.

This is the primary reason why it is referred to as the Bottom Line.

The Bottom Line or Net Income (we will refer to Net Operating Profit as Net Income from hereon) is:

• What is left after deducting all the expenses incurred during a particular period
• from all the revenue that is earned during that period.

The Net Income is what goes back to the Owners.

It can be called the Disposable Income for businesses.

You can see from the Paradise Hotel PNL Statement below that:

• between the Gross Operating Profit and Net Income
• there are quite a few expense categories that are deducted.

In a later post, we will examine each such category which can now be identified as Fixed Charges, Depreciation, Interest and Income Taxes.

We have already noted that these are not expenses you have a great degree of control over as a hotel operational manager.

Hotel Profit - Recap

Let us now do a recap of what basic factors of hotel profit that managers and beginners often struggle with.

1. What the Business Retains
2. Index of Efficiency of hotel operation
3. The Bottom Line

So, there you go.

What the business retains or in other words hotel profit has different ways of being calculated.

You need to be clear what calculation you are looking for and what it stands for.

Coming Next Week….Part 5 of 6 - Variances

How do you look at profit for your hotel?

Do you consider the three basic factors before looking at profit?

In Part 5 of this six part series on hotel profit and loss statement basics, we will look at yet another basic element - variances.

Sign Up for More Tips, Strategies and Secrets

Sign up to the Financial Skills Building Newsletter for more tips, strategies and secrets straight to your inbox.