Lecture Managerial Accounting for the hospitality industry: Chapter 6 - Dopson, Hayes

Chapter 6 - Ratio analysis. Ratio analysis is used to analyze profitability and it is also used to examine, in detail, the asset, liability, and owners’ equity positions of a business. In this chapter you will learn how to compute and analyze the ratios used to evaluate each of these three major components of the basic Accounting Formula.

Chapter 6

Ratio Analysis

 Purpose and Value of Ratios

Chapter Outline

Learning Outcomes

ratios to analyze the health of a hospitality business

profitability, investor, and hospitality-specific ratios

the hospitality industry

another

numerator (top number) used in your division is a part of the denominator (bottom number)

the decimal two places to the left, that is, 50.00% =

0.50

the decimal two places to the right, that is, 0.50 =

50.00%

Value of Ratios to Stakeholders

profitability will care greatly about the effective operation

of a hospitality business These stakeholders may

Value of Ratios to Stakeholders

of the relative value of each of the ratios calculated for a

hospitality business

on investment (ROI), while lenders and creditors are mostly

concerned with their debt being repaid

especially troublesome to managers who have to please their constituencies

concept of financial leverage

Financial Leverage

be reinvested to generate a higher return on investment (ROI) than the cost of debt (interest)

To illustrate, assume a hospitality manager:

Borrows $10,000 to be repaid at 10% interest

Reinvests the same $10,000 in an investment that gains 12% ROI

And thus, creates a surplus of 2% gain

In this case, borrowing $10,000 and reinvesting the same $10,000 at a higher rate of return earns a net gain of 2% after the debt is repaid The manager, in this case, has leveraged debt to secure a gain

Financial Leverage

like to see debt on a company’s balance sheet because if it is reinvested well, it will provide more of a return on the money they have invested

too much debt on a company’s balance sheet because the

more debt a company has, the less likely it will be able to

generate enough money to pay off its debt

Ratio Comparisons

actual performance to a previous time period, competitor

company results, industry averages, or budgeted (planned for) results

differences (if differences exist) can tell you much about the financial performance (health) of the company you are

evaluating

income statement, balance sheet, and statement of cash flows.

Figure 6.1 Condensed Income Statement

Blue Lagoon Water Park Resort Condensed Income Statement For the Period: January 1 through December 31, 2010

Gross Operating Profit 7,535,880

Rent, Property Taxes, and Insurance 1,760,400

Income Before Income Taxes 3,243,480

Figure 6.2 Balance Sheet

Blue Lagoon Water Park Resort

Balance Sheet December 31, 2010

Cash 2,314,750 Marketable Securities 3,309,600 Net Receivables 1,053,950 Inventories 1,497,200 Total Current Assets 8,175,500

Property and Equipment Land 7,712,550 Building 22,290,500 Furnishings and Equipment 7,289,000 Less Accumulated Depreciation 4,668,900 Net Property and Equipment 32,623,150

Long-Term Liabilities Long-Term Debt 14,577,400 Total Liabilities 18,600,000

Common Stock 3,000,000 Paid in Capital 18,775,100 Retained Earnings 6,116,850 Total Owners’ Equity 27,891,950

Figure 6.3 Statement of Cash Flows

Blue Lagoon Water Park Resort Statement of Cash Flows December 31, 2010 Net Cash Flow from Operating Activities

Net Income 1,946,090 Adjustments to reconcile net income to net

cash flow from operating activities Depreciation 1,260,000 Decrease in Net Receivables 601,350 Increase in Inventories (600,000) Decrease in Accounts Payable (600,000) Decrease in Other Current Liabilities (550,000) 111,350 Net cash flow from operating activities 2,057,440

Net Cash Flow from Investing Activities

Decrease in Marketable Securities 800,000 Increase in Investments (800,000) Increase in Furnishings and Equipment (2,225,345) Increase in Other Assets (81,000) Net cash flow from investing activities (2,306,345)

Net Cash Flow from Financing Activities

Decrease in Notes Payable (784,355) Increase in Long-Term Debt 755,650 Increase in Capital Stock

(Common Stock + Paid in Capital) 1,000,000 Dividends Paid (778,440) Net cash flow from financing activities 192,855 Net decrease in cash during 2010 (56,050) Cash at the beginning of 2010 2,370,800 Cash at the end of 2010 2,314,750

Supplementary Disclosure of Cash Flow Information:

Cash paid during the year for:

Figure 6.4 Statement of Retained Earnings and Investor Information

Blue Lagoon Water Park Resort

December 31, 2010

Statement of Retained Earnings

Retained Earnings, December 31, 2009 4,949,200 Net Income for 2010 1,946,090 Subtotal 6,895,290 Cash Dividends Paid in 2010 778,440 Retained Earnings, December 31, 2010 6,116,850

Investor Information

Dividends paid to common shareholders $778,440 Common shares outstanding 1,000,000 Market price per share $25.00

Liquidity Ratios

converted to cash in a short period of time (less than 12

months)

readily current assets could be converted to cash, as well as

how much current liabilities those current assets could pay

Liquidity Ratios

Liquidity Ratios

Current Ratio Current ratio shows

the firm’s ability to cover its current liabilities with its current assets.

Numerator: Balance Sheet Denominator: Balance Sheet

Current Assets Current Liabilities

Quick

(Acid-Test) Ratio Quick ratio shows the firm’s ability to

cover its current liabilities with its

most liquid current

Numerator: Statement of cash flows Denominator: Balance sheet

Operating cash flows Current liabilities

Working Capital Working capital is

the difference between current assets and current liabilities.

Balance Sheet Current assets – Current liabilities

Solvency Ratios

to pay long term debt

and owners information about a business’s ability to

withstand operating losses incurred by the business These

ratios are:

Solvency Ratios

Solvency Ratio Solvency ratio shows the firms

ability to cover its total liabilities with its total assets.

Numerator: Balance Sheet Denominator: Balance Sheet

Total assets Total liabilities

liabilities with its operating cash flows.

Numerator: Statement of cash flows

Denominator: Balance sheet

Operating cash flows Total liabilities

Times Interest

Earned Ratio Times interest earned shows the firm’s ability to cover

interest expenses with earnings before interest and taxes.

Numerator: Income statement Denominator: Income statement

Earnings Before Interest and Taxes (EBIT) Interest Expense

Activity Ratios

management’s ability to effectively utilize the company’s

assets

selected assets by creating ratios that measure the number of times these assets turn over (are replaced)

inventories and long-term assets

Inventory Turnover

value of inventory has been purchased and replaced in an

accounting period

turnover ratios

ratios good or bad?”

turnover ratios

Figure 6.5 Condensed Food and Beverage Department Schedule

Blue Lagoon Water Park Resort Condensed Food and Beverage Department Schedule For the Period: January 1 through December 31, 2010

g o fig ure!       

For example, assume the Blue Lagoon food and beverage manager desires to

turn over food inventory 26 times per year This means that food inventory will

be replaced every two weeks (52 weeks per year/26 times = 2 weeks) The

following shows situations in which actual food inventory turnover is above and

below the Blue Lagoon target of 26 times

Blue Lagoon food inventory turnover:

Actual turnover (high) 32.0 times

A low turnover (20.9 times) might have occurred because sales were less than

expected, thus causing food to move slower out of inventory (bad) It could also

mean that the food and beverage manager decided to buy more inventory each

time (thus, making purchases fewer times) because of discount prices due to

larger (bulk) purchases (good)

A high turnover (32.0 times) might have occurred because sales were higher

than expected, thus causing food to move faster out of inventory (good) It could

also mean that significant wastage, pilferage, and spoilage might have occurred

causing food to move out of inventory faster, but not due to higher sales (bad)

Activity Ratios

Food Inventory

Turnover Ratio Food inventory turnover shows the speed (# of times) that food inventory

is replaced (turned) during a year

Numerator: Income statement Denominator: Balance sheet

Cost of food consumed Average food inventory*

*(Beginning food inventory + Ending food inventory)/2

Beverage Inventory

Turnover Ratio Beverage inventory turnover shows the speed (# of times) that beverage

inventory is replaced (turned) during a year

Numerator: Income statement Denominator: Balance sheet

Cost of beverage consumed Average beverage inventory**

**(Beginning beverage inventory + Ending beverage inventory)/2

Property and Equipment

(Fixed Asset) Turnover

Total Asset Turnover

Ratio Total asset turnover shows management’s ability to effectively

use total assets to generate revenues.

Numerator: Income statement Denominator: Balance sheet

Total Revenue Total Assets

Profitability Ratios

company’s owners, and profitability ratios measure how

well management has accomplished this task

Profitability Ratios

Profit Margin Profit margin shows management’s

ability to generate sales, control expenses, and provide a profit.

Numerator: Income statement Denominator: Income statement

Net income Total revenue

Gross Operating Profit

Numerator: Income statement Denominator: Income statement

Gross operating profit Total revenue

Return on Assets Ratio Return on assets shows the firm’s

ability to use total assets to generate net income.

Numerator: Income statement Denominator: Balance sheet

Net income Total assets

Return on Equity Ratio Return on equity shows the firm’s

ability to use owners’ equity to generate net income.

Numerator: Income statement Denominator: Balance sheet

Net income Total owners’ equity

Investor Ratios

of a company

monitor stocks they already own

stock investments:

prices than originally paid

dividends

Investor Ratios

Earnings Per Share

Ratio Earnings per share compares net income

to common shares.

Numerator: Income statement Denominator: Statement of Retained Earnings and Investor Information

Net income Total number of common shares outstanding

Price/Earnings (P/E)

Ratio Price/earnings ratio shows the perception

of the firm in the market about future earnings growth of the company.

Numerator: Statement of Retained Earnings and Investor Information

Denominator: Statement of Retained Earnings and Investor Information

Market price per share Earnings per share

Dividend Payout

Ratio Dividend payout ratio shows the percentage

of net income that is to

be paid out in dividends.

Numerator: Statement of Retained Earnings and Investor Information

Denominator: Statement of Retained Earnings and Investor Information

Dividends per share Earnings per share

Dividend Yield Ratio Dividend yield shows

the stockholders’

return on investment paid in dividends.

Numerator: Statement of Retained Earnings and Investor Information

Denominator: Statement of Retained Earnings and Investor Information

Dividends per share Market price per share

Hospitality Specific Ratios

daily, weekly, monthly or yearly operating reports that

managers design to fit their operational needs

Hotel Ratios

Occupancy Percentage

percentage (percentage of rooms sold in relation to rooms

available for sale) because occupancy percentage is one

measure of a hotel’s effectiveness in selling rooms

g o fig ure!       

Using the information provided in Chapter 1, you know that the Blue Lagoon Water Park Resort has 240 guestrooms and suites Assuming all rooms are available for sale and the resort operates 365 days in a year, the Blue Lagoon would have

240 rooms X 365 days = 87,600 rooms available for sale per year

If the Blue Lagoon actually sold 70,080 rooms in 2010, then the occupancy percentage would be calculated as follows:

Rooms Sold Rooms Available for Sale = Occupancy %

or

70,080 87,600 = 80%

This means that, on average, 192 out of 240 rooms (192/240 = 80%) were sold each day in 2010

Occupancy Percentage

renovation, or construction is being done and the rooms are not sellable and must be subtracted

on a complimentary or ‘comp’ basis - free of charge),

occupying each room)

or more people)

Occupancy Percentage

performance to previous accounting periods, to forecasted or budgeted results, to similar hotels, and to published industry averages or standards

available through companies such as Smith Travel Research (STR) Smith Travel Research is a compiler and distributor of hotel industry data

Average Daily Rate (ADR)

achieve during an accounting period

room types

rate

overall average daily rate is computed

g o fig ure!       

Assuming that the total number of rooms sold at the Blue Lagoon Water Park

Resort for the year was 70,080 and total rooms revenue was $14,016,000, the

ADR is computed as follows:

Total Rooms Revenue Total Number of Rooms Sold = Average Daily Rate (ADR)

or

$14,016,000 70,080 = $200

This confirms the information provided in Chapter 1 that the Blue Lagoon Water

Park Resort has an ADR of $200 including room and park admission fees

Revenue Per Available Room

(RevPAR)

rooms inexpensively, and high ADRs can be achieved at the sacrifice of significantly lowered occupancy percentages

combines these two ratios to compute revenue per available

room (RevPAR)

Another way to calculate RevPAR is:

Total Rooms Revenue Rooms Available for Sale = Revenue Per Available Room (RevPAR)

or

$14,016,000 87,600 = $160

Thus, the Blue Lagoon has a RevPAR of $160

g o fig ure!       

For example, a regional manager who wants to compare the performance of two

hotels in her region on the basis of occupancy percentages and ADRs might

have the following information:

Hotel A has an occupancy% of 80% and an ADR of $120 Hotel B has an occupancy% of 60% and an ADR of $180

Which hotel is performing better? The only real meaningful comparison she

could make would be on the basis RevPAR:

Hotel A has a RevPAR of 80% X $120 = $ 96 Hotel B has a RevPAR of 60% X $180 = $108

Therefore, Hotel B would have a higher RevPAR and thus, better overall

performance based on occupancy % and ADR

Revenue Per Available Customer

(RevPAC)

customer (RevPAC) (revenues generated by each customer)

because guests spend money on many products in a hotel in

addition to rooms

guests

that generate a lower RevPAC

g o fig ure!       

The total revenue figure for the Blue Lagoon Water Park Resort provided in Figure 6.1 was $25,201,800 Assuming all revenues reflect guest expenditures, this amount represents all revenues generated by areas in the resort including rooms, park admission, restaurants, lounges, snack bar, video arcade, retail store, tanning/spa facility, and exercise facility (see Chapter 1) Also, assuming

an average of three guests (family) per room sold, the total number of guests for the year would be 210,240 (3 guests X 70,080 rooms sold = 210,240 guests)

Using this information for the Blue Lagoon, RevPAC is computed as follows:

Total Revenue from Hotel Guests

or

$25,201,800 210,240 = $119.87

Thus, each guest (including children) on average is spending $119.87 in the resort