Profits-Are you falling prey to the monthly bottom line illusion?

Did you know that there is a profits illusion that affects month to month business results in the hotel industry?

Not recognizing this illusion can lead to disaster.

Sadly, often hotel managers overlook this insidious enemy.

I will lay out a strong case with examples and strategies to overcome this stealth killer.

You would want that wouldn’t you?

Let us get right into it then.

This Blog Post will cover:

This concluding Part 5 of 5 post is a continuation from last week's post.

If you missed earlier parts, click links below to read Parts 1 to 4

So, what is this profits illusion that I am taking about?

This first has something to do with business volume or occupancy in relation to the Rooms department.

One of the most difficult decisions to take in the hotel operation is relating to months when business volume dips.

It is when your occupancies come down sharply that some typical problems surface.

All of. these problems have an impact on the month’s profits.

Here starts the profit illusion.

Profits Illusion - Paradise Hotel Peak Lean Month Occupancy

In the six months of performance KPIs you see in the above statement, seasonality is reflected in the three color coded manifestations of business volume - peak, lean and standard months.

Hotels use forecasting as a tool for projecting revenue, expenses and profits on a monthly basis.

However, it is easier said than done.

Did you know that seasonality does not feature in a hotel profit and loss statement?

What? you sputter in outrage.

It is true.

You can only take a ballpark basis using levels of occupancy which reflect the business volume of the hotel for the Rooms department.

The Profits Illusion owes big to this ballpark basis used.

This is also where the power of having a seasonality criterion becomes evident.

Profits Illusion Example

For example, say, the current month is a peak month, like May 2019 in the Paradise Hotel Statement.

Paid occupancy is at 91% and you are forecasting for the rest of the year including the following month June 2019.

Notice how paid occupancy dives 30% points to 61% in June 2019.

This has significant implications for revenue, expenses and profits.

To begin with, revenue is going to drop by $380,000.

While variable expenses will go down as well, however, the bottom line or departmental profits are reduced by a whopping $367,000.

This is a drop equivalent to more than 90% of the revenue decrease.

So, the profits illusion is contributed a great deal by this up and down occupancy levels.

Profits and The Occupancy Trigger

This is one of the most important elements of the occupancy trigger reflected through the seasonality factor in a hotel PNL.

The lesson from this is more deep than even what the above mentioned drop in profits suggests.

It emphasizes the need for the forecasting process to identify the drop much earlier than just the month before.

More importantly, laying out a strategy to augment occupancy through raising business volume.

This approach can be applied to individual market segments to identify ones where the volume can be pushed up.

On the other hand, the situation is reversed when a lean month is followed by a peak month.

Here, the occupancy trigger plays a different role.

So, it is important to ensure that employee complement, supply levels are enough to bridge the gap between a 61% occupancy climbing to 91% in the peak month.

Also the peak occupancy will bring with it problems associated with a high volume operation.

This is for example, equipment breaking down (to be replaced or repaired quickly) and employees getting stressed out.

It will boil down to good planning and scheduling for varying levels of occupancy.

This is the reason why occupancy is such a powerful trigger for different levels of operation and the entire process of revenue generation, expenses incurring and profits retention.

Profits and Lean Months Woes

Let us now see what are some typical problems of a lean month when occupancies are down appreciably.

To begin with, you must first ensure that your Variable Expenses Unit Costs are being utilized for good expenses management.

You learned about Variable expenses in previous posts of this 5 post series.

Quickly, Variable Expenses are those which increase or decrease with increase or decrease in occupancy levels.

In a low occupancy month, you should be able to bring down your Variable Expenses as proportionately as is possible using Unit Costs.

Many hotels do not treat this importantly.

Wastage, losses, pilferages are often discovered when a line item Variable Expense Unit Cost does not seem to show stability.

Watch out for this situation.

There can be no worse predicament than bleeding profit through variable expenses which are out of control.

Compare your lean month just gone by with an earlier one or the same month the previous year to discover any anomalies.

This is why a comparison with a previous year same month is priceless.

Unit Costs of line item Variable Expenses also throw up abnormal events.

For example, if there was a particular loss that was written off in the previous year, that Variable Expense will stick out when a comparison with the current year is made.

Be alert for these kind of outliers.

We have been talking about Unit Costs which only affect Variable Expenses during Lean months.

Let us now see something else that also impacts Lean months critically.

How does Seasonality affect the Profits Illusion?

Why is knowing this seasonality such a big deal?

First, you saw how the difference between the occupancy % of February (60%) and May 2019 (91%) is 30 percentage points.

It can also be said that the May 2019 occupancy is 50% higher than the February month.

This simply means that the revenues in May 2019 will be significantly higher than the month of February.

Second, if you are currently in the month of February 2019, your next three months will have occupancies above 80% and highest at 91%.

This is powerful information for you to take action and ensure that you meet your revenue budgets and forecasts.

On the other hand, if you are currently in the month of May 2019, next month your occupancy is going to drop by 30 percentage points.

You need to be prepared for this.

You need to counter this with strategies to push your occupancies at least by 10% points otherwise your revenue will suffer.

Third, the above is only about the revenue.

By understanding standard, lean and peak months you can manage your expenses way better.

In Part 4 of this 5 part blog post series, you saw how Expenses can be a slow fuse in draining profits.

Missed Part 4? Click below to read that.

In particular, you should be adopting strategies to optimize your expenses in the Lean months.

Now do you see how knowing this seasonality information is so powerful.

We have only looked at occupancy %.

But you can apply that to average daily rate, RevPAR, Total Revenue, Total Expenses and Net Income (Profits) or any other KPI you think is important.

Adopt the strategies laid out in the Steps You Can Take Right Now at the end of this blog post in your own hotel operation.

The Profits Illusion - How to distinguish between the slow fuse expenses and others

To identify the slow fuse expenses from others, you must first have a clear understanding of how expenses behave.

Let us see that briefly here.

Expenses can broadly be:

• Fixed and Variable Expenses
• Total and Unit Cost (expenses)
• Controllable and Non-Controllable Expenses

Fixed Expenses are those which do not change with change in business volume (occupancy in Rooms, covers served in Food & Beverage departments).

Variable Expenses as we saw earlier on the other hand are those which do change with change in business volume (occupancy in Rooms, covers served in Food & Beverage departments).

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

The next category is about whether expenses are considered in accumulation as Total Costs.

Or when they are calculated per unit of business volume as Unit Costs.

Example

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, the above Cleaning Supplies expense total can be divided by the rooms occupied for that month.

That will result in a Unit Cost, as in Expense 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.

Variable Expenses can also be considered controllable while Fixed expenses are considered non-controllable.

Expense Behaviors

In one of the earlier parts of this 5 part blog post series, we touched upon the cost of doing business.

Cost of doing business is all about the expenses needed to be incurred to earn revenue.

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

So, you could conclude that if you have a good handle on how expenses behave, you can manage the profits illusion.

If you further understood how seasonality affects occupancy, revenue and expenses, you will be able to master the profits illusion.

How can you boost your hotel profit through better expense management?

Earlier, you learned about Variable Expenses and Unit Costs.

Let us first revisit that concept briefly before diving into application.

One categorization is about whether expenses are considered in accumulation as Total Costs or when they are calculated per unit of business volume as Unit Costs.

You saw earlier that Unit Costs are normally calculated only for Variable Expenses.

With the above background, let us now see why unit costs will feature so heavily in your decision making.

You also learned earlier that Fixed Expenses are those that do not move with business volume.

So, basically, a good chunk of decision making is related to Variable Expenses in the hotel operation.

However, there is an issue to tackle.

Variable Expenses keep moving with changes in business volume.

This we saw earlier is mainly represented by occupancy and covers served in the Rooms and Food & Beverage departments respectively.

Moreover, there is one more quirk to Variable Expenses.

They do not all move the same way.

Some are proportionate to the business volume and others are not.

That makes it difficult to have a measure that can be used as a benchmark for expense management.

Enter Unit Costs.

Unit Cost Power to Manage the Profits Illusion

Unit Costs allow you to determine how much you are spending per unit of business volume.

Or per unit of:

• occupied room night or 
• covers served.

This is a powerful measure.

Since Variable Expenses as a total may not be useful considering how much they move with business volume, unit costs are the answer.

This is also the reason why unit costs are central in budgeting or forecasting.

Remember, budgets and forecasts are estimates.

They thus need a stable measure that will represent the differing business volumes.

Remember our discussion on peak, lean and standard months.

So, the process of conquering the profits illusion is two fold:

• First, harnessing the power of unit costs and
• Second, producing accurate budgets and forecasts

Your strategy in terms of specific steps to be taken is as follows:

• Categorize all your line item expenses in the Profit and Loss Statement into Fixed and Variable expenses
• Although in the real world, expenses often tend to be semi variable or semi fixed, it is important not to muddy the waters and create confusion; stick to fixed and variable
• Take each Variable Expense line item and determine whether it is in the Rooms or Food & Beverage (or other) operation
• If it is in the Rooms department, use occupied rooms or sold rooms as the business volume
• If it is in the Food & Beverage department, use covers served as the business volume
• Divide each line item Variable Expenses by occupied rooms or covers served for whatever period you are measuring performance
• Interpret the results - as in, see what the Unit Cost is showing
• Remember that when comparing a budget or forecast with an actual, the former are estimates
• See if there are significant changes in unit cost numbers across months which normally should not happen
• Ironically, Unit Costs do not fluctuate much across months although the Variable Expenses they relate to do

Unit Costs take away the hit or miss approach to expense management by providing a stable measure for Variable Expenses.

That is the reason why they rule budgets and forecasts so much.

For that matter, they generally rule actuals too!

In the process, they take the profits illusion head on helping achieve the highest margin of profits possible with superior expense management.

That concludes this 5 part blog post series on how profits draining can be reduced or even eliminated through focused strategies.

Strategies on accruals, accounts receivables, inventories, slow fuse expenses, seasonality, forecasting and unit costs.

What strategies do you apply in your hotel operation?

How are you tackling the profits illusion?

Comment below, I will be keen to know your thoughts.

Steps You Can Take Right Now

STEP 1

Categorize all your line item expenses in the Profit and Loss Statement into Fixed and Variable expenses

STEP 2

Take each Variable Expense line item and determine whether it is in the Rooms or Food & Beverage (or other) operation

STEP 3

Divide each line item Variable Expenses by occupied rooms or covers served for whatever period you are measuring performance

STEP 4

Interpret the results - see what the Unit Cost is showing

STEP 5

See if there are significant changes in unit cost numbers across months which normally should not happen

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