Inventories - Are You a Victim of this Profit Drainer in Your Hotel Financial Statements?

Have you ever given thought to inventories hurting your hotel bottom line in a way not immediately visible?

They come from a financial statement you may not be looking at often!

I am talking about inventories that sit in the Balance sheet but have serious impact on your hotel Profit and Loss Statement!

I will lay out a case with examples of how you can keep tabs on this hidden enemy.

So that your bottom line does not take a bad hit!

Let’s get to it.

This Blog Post will cover:

This is Part 3 of the 5 Part blog post series on warning signs from hotel financial statements.

If you missed the earlier two posts, click below:

Inventories - the blood flow of business

How does the hotel operation run like clockwork every day serving guests?

If you stop to think about it, you will be surprised by an element that that is not immediately apparent.

You are giving me that questioning look.

Hold it, I will explain myself.

EXAMPLE

Consider your hotel guest room as an example.

Say, you are running 90% occupancy average for a month.

Day after day, your guest room is seemingly automatically stocked with room amenities and supplies.

How does that magic happen?

Yes, I know and you do too that Housekeeping department takes care of that.

But it may surprise you to know that there is a machinery operating even before Housekeeping gets into the picture.

What is that magic mechanism that causes automatic appearance of amenities in hotel guest rooms day after day?

The same example could be applied to the hotel restaurant or spa or health club and so on.

Well, that magic mechanism goes by a rather boring sounding name.

Inventories!

Inventories are stocks of goods and consumables regularly maintained by the hotel.

Inventories are the mechanism that cause that automatic appearance we saw earlier.

Inventories are the blood flow of business.

Imagine a situation if the hotel runs out of shampoos or body washes needed in hotel guest rooms.

It will be a disaster of epic proportions.

To ensure that a hotel does not run out of essential supplies consistently is a task not for the faint of heart.

It requires an intuitive understanding of hotel operation requirements first.

Next it requires coordination between Purchasing and Operational departments.

That is why I said it is a magic mechanism.

However, just like any magic mechanism, if not handled carefully, it can cause major disasters.

And Losses.

How you ask?

Coming right up!

Why are Inventories Profit Drainers?

The magic mechanism that we talked about earlier can fail at times.

If it fails drastically, hotel operation could well grind to a halt.

For, when you are unable to serve the guest needs, that guest is going to be unhappy.

And probably not come back.

That will hurt your hotel business.

But how will it hurt is your question?

Hang on I am getting there.

There are numerous ways hotel inventories could be profit drainers.

But first, what is a profit drainer?

A profit drainer is something that causes the hotel profit to slowly decline.

Let us now examine how inventories could drain hotel profit.

Remember our earlier example.

Where we said that if guest room amenities are not automatically made available to guests they will not return.

Well, that is one side of the equation.

Consider the other side.

What if the hotel is actually over stocking inventories?

You are looking at me strangely.

Let me explain.

Overstocking inventories is one of the most common traps hotel fall into.

it simply means that you are holding more inventories that you need for your operation.

it may not seem to be serious, but believe me it is a trap which you do not want to fall into.

So, on the one hand, you may run out of inventories and on the other hand you may be over stocking them.

How will you know if you are holding the right quantum of inventories?

Is there a way, you ask?

I am glad you asked the question.

There is indeed.

Inventory Turnover Ratio to the Rescue

By this time inventories should be familiar to you.

You plan to buy them, buy them, store them and then issue to the hotel operation.

How would you know if your inventory management is efficient?

Your hotel may be circulating a schedule which is part of monthly financial statements.

And it could include schedule on inventories as part of the monthly profit and loss statement.

Let us first see what this inventory turnover ratio is all about.

The Inventory Turnover Ratio literally tells you how many times your inventories turned over.

That means, how many times sold or consumed in the hotel operation.

It is the productivity measure for inventory management.

Here is the formula for the Inventory Turnover Ratio

FORMULA

Cost of Goods Sold / Average Inventory

Average Inventory is simply Opening Inventory + Closing Inventory divided by 2

So, the Inventory Turnover Ratio tells you how many times the hotel sales or consumption you are holding inventories for.

Ideally, you want a high inventory turnover ratio.

That means that your inventories are moving or being used up quickly.

It will depend upon the volume of occupancy the hotel is doing and patronage of the restaurants

Believe me, you do not want a low inventory turnover ratio.

A Low Inventory Turnover Ratio simply means that you are not selling or consuming fast enough.

That can lead to dire consequences.

In Part 4 of this 5 Part blog post series, you will see ways in which your hotel inventories could do serious damage to your profit through expenses.

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One other thing that inventories impact greatly is cash flow.

It you are overstocking, it means you have paid for goods that are not selling or being consumed.

That locks up precious cash flow.

The scary thing is you will not know it too if you are looking only at the Profit and Loss Statement!

A high price to pay indeed!

Inventories - Holding What You Sell

One of the concepts we discussed in the previous section is about how quickly inventories move.

Move, as in either sell or get consumed.

Why is this such a big deal?

It is a big deal because you should be analyzing your inventories closely on a monthly basis.

Your Inventory Turnover Ratio will only tell you whether you have a high or low or just about right ratio.

You need to get into your Inventory Management system and analyze categories of inventories.

A broad category could be Food and Beverage.

But within food you could have meat, poultry, vegetables, seafood and so on.

For each category of goods you should check your inventory turnover ratio.

Why?

Because, it will tell you how well the related menu item (in the case of the restaurant) is selling.

For example, say, your hotel restaurant is doing excellently selling seafood menu items.

it is important that you continue to keep a high inventory turnover ratio for seafood items.

This will result in higher sales, revenue and ultimately profit.

This is the concept of Holding What You Sell.

Analysis of inventories will show you whether you are carrying inventories closely related to what you are selling in the operation.

Many hotels fall a victim to the Selling What You Hold principle.

They are trying to increase sales of items they have in their inventories.

However, this is basically a flawed strategy bound for disaster.

Your sales are the indication of what your customer is demanding.

Thus, your inventories should also relate to those menu items your customers are consuming.

The Hidden Cost of Inventories Wasted

In the hotel operation and more particularly the restaurant operation there is one deadly hidden enemy.

This enemy causes major damage to a hotel and restaurant profit.

And the scary thing is this cost is hidden.

You will not know you are incurring it unless you do some focused analysis.

What am I talking about you ask?

I am getting to that right now.

Let me illustrate with an example

EXAMPLE

Assume you are running a 24 hour All Day Dining restaurant.

In days past, the All Day Dining was also called The Coffee Shop.

Assume also that you running a high food cost of 42% for lunch in this particular month.

Your year average food cost for lunch is actually 35%.

Assume that you have a lunch buffet set up.

So, why are you running at 42% this month?

There are a couple of reasons this could be happening.

First, you may have added items to the buffet which increased the cost.

Second, Buffet price could be low.

However, we have eliminated the first reason because no buffet items were added this month.

We have also eliminated the second reason because the buffet price for lunch has not changed during the year.

So, that does not affect the high food cost (otherwise it would have affected the whole year if relevant).

Why then is Lunch Food Cost at 42% this month when year average is at 35%?

There is one other reason which could be possible.

But that reason is hidden.

It will need close analysis.

What am I talking about?

Hang on, I am almost there.

The 42% Food Cost is a figure derived after taking into account

• Opening Stock,
• Add Purchases
• Less Closing Stock
• Is Equal to Cost of Goods Sold

Or what we know as Food Cost.

That Food Cost which is 42% this month for Lunch.

Food Cost Analysis

However, we will never know the factor which could have impacted this 42% without analysis.

What kind of analysis?

And why is it hidden?

To begin with the Food Cost never shows wastages!

Aha, wastage is that hidden, deadly enemy doing damage to your hotel profit!

Wastages are ingredients which have been discarded due to various reasons.

• Incorrect preparation
• Faulty mis en plus (mis en plus is a French word broadly meaning “preparation”)
• Perishables remaining unconsumed beyond hygiene storage duration requirements

These are but some of the reasons.

The most critical thing to realize here is that they never show up in the Food Cost.

How do you then identify wastages?

Great question!

The only foolproof way is to compare the original recipe with the actual food cost.

The original recipe uses standard ingredient measurements to build up the recipe and applies cost to them.

The total of those ingredient costs is what results as a Potential Food Cost.

In other words, you compare the Original Recipe Potential Food Cost with the actual Food Cost.

Because a standard recipe does not factor in wastage, the difference with the actual food cost can only be that.

Some minor reasons could be differences in cost between recipe and actual.

However these are too minor to impact the actual Food cost.

It certainly cannot explain away a 7% point difference between yearly average and current month food cost.

ln effect, wastages could have added a whopping 7% in food cost to your expenses.

And nobody could be wiser without some focused analysis.

A scary situation you do not want your hotel to be in!

So, watch out for these hidden profit drainers.

Conduct thorough analysis of your recipes and compare potential with actuals regularly.

The results of that will be more than worth the time for analysis.

And result in a boost to your bottom line.

You would want that wouldn’t you?

To be Continued….

This post will be continued in Part 4 of this 5 part series next Friday.

You will see ways in which your hotel inventories could do serious damage to your profit through expenses in other ways.

It is something often missed by hotel managers.

You will learn about:

• The Inventories Triangle
• The Purchasing Function Interface
• Why Inventories are Cash Flow Drainers
• The Par Stock Paradise in Inventories Management

and much more….

Action Steps You Can Take Right Now

STEP 1

Find out if your hotel calculating Inventory Turnover Ratio each month

STEP 2

What is the Inventory Turnover Ratio showing? High or Low or just about right?

STEP 3

Pick up a Major category of inventories like meat items. Analyze what the Inventory Turnover Ratio is.

STEP 4

Does your hotel calculate potential costs based on food menu recipes? If not, how do you detect wastages?

STEP 5

Is your hotel following the principle of Holding What You Sell in related to hotel inventories?

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