Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Chapter 3 Introduction This chapter will provide a review of the major financial statements and selected key ratios used in the industry. Financial statements reviewed:  Income statements  Balance sheet  Statement of retained earnings  Statement of cash flows

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Income Statement Details revenues and expenses for a period of time Income statements can be as detailed as necessary for use by managers and investors:  Summary for outside users  Detailed departmental statements for insiders

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Uniform System of Accounts Widely used format for income statements in the hospitality industry Focuses primarily on departmental performance  Revenues and expenses specifically attributable to that department Undistributed operating expenses include items like marketing and maintenance

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Uniform System For Restaurants Restaurants also follow a specific format. First expense shown is cost of goods sold for both food and beverage. This is followed by other expenses. Not completed on a departmental basis like hotels because the restaurant is really only one department.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Review of Balance Sheet Shows financial position of an organization at a particular point in time Assets, liabilities, and owner’s equity Current items listed first  “Current” meaning convertible to cash or paid in cash within a year Retained earnings are not the same as cash

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Relationship Between Balance Sheet and Income Statement Assets used to generate revenue and cash flow:  For a hospitality business this is land, building, and equipment. Liabilities are related to expenses.  Accrued wages and accounts payable Retained earnings will increase with net income, less any dividends declared.  This is the link to the income statement.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Statement of Retained Earnings Often consolidated into a consolidated statement of owner’s equity Basic calculation  Balance at beginning of period  Plus: net income  Less: dividends declared  Equals: ending balance There is no cash in retained earnings. It is simply accrued earnings less dividends declared to the shareholders.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Statement of Cash Flows Its purpose is to show where cash flow came from and where it went during a period of time. Three major sections of the statement:  Operating activities  Investing activities  Financing activities Recent accounting scandals have placed a premium on a company’s ability to earn cash flows.

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Statement of Cash Flows Why has this become so important?  Balance sheet uses estimates.  Enron “hid” debt from its balance sheet.  Worldcom categorized expenses as “investments” (assets).  Income statement is completed on accrual basis (when do we recognize the revenue).  Cash flows represent the actual flows of cash and are more difficult to “invent.”

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Validity of Financial Statements Who is responsible?  Management is responsible for the accounting and financial reporting systems. Auditors are there to assess if the statements make a fair representation of firm position and performance. Investors learned a hard lesson in 2000–01 about financial statements and are aware of the need for change. Some potential remedies include:  Rotating auditors regularly  CEOs taking responsibility for veracity of financial statements

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Ratio Analysis Ratio analysis is used to take existing financial accounting information and generate new information. Ratios on their own are not very meaningful. Various ratios of a hospitality organization can be compared to industry averages. However:  Which segment of the hospitality industry?  Which companies are included in the industry averages?  Are there enough firms in the average to make the ratios meaningful?  Do all the firms use the same accounting methods?

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Classes of Ratios Liquidity—ability to meet current debts Turnover—management’s effectiveness regarding the management of assets Solvency—ability to meet long-term debts or the extent of long-term financing Profitability—how profitable the operation is Activity—involves key measures of operating performance Investor—those ratios of special significance to outside investors

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Liquidity Ratios Current ratio  Current assets/current liabilities Quick ratio  Cash + marketable securities + accts. rec. current liabilities Working capital = current assets less current liabilities Does current ratio always have to be greater than 1?

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Turnover Ratios Inventory turnover  Cost of sales / average inventory  Appropriate range for this number  Asset turnover  Revenue / total assets  Revenue per dollar of assets  Can management manipulate this figure?

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Solvency Ratios Debt ratio  Total debt / total assets Debt to equity ratio  Total debt / total equity  Hotel industry often has high debt Times interest earned  EBIT / interest expense  Gives lender a measure of “cushion” (how much earnings are available to pay interest)

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Profitability Ratios Profit margin  Net income / total revenue Return on assets  Measure amount of profit for every $1 in assets  Net income / total assets  Also a function of profit margin and asset turnover  Net income / total revenue x total revenue / total assets Return on equity  Net income / stockholder’s equity

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Activity Ratios Occupancy percentage  Occupied room nights key figure used in forecasting Average Daily Rate (ADR) REVPAR  Occupancy x ADR Food cost percentage  Cost of food sold / food revenue Beverage cost percentage  Cost of beverage sold / beverage revenue

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Investor Ratios P/E Ratio—price to earnings (net income)  Used by many investors as a buy/sell indicator Dividend payout ratio  % of earnings paid to shareholders Dividend yield  Annual dividend / market price per share  Not a holding rate of return for the stock

Hospitality Financial Management By Robert E. Chatfield and Michael C. Dalbor ©2005 Pearson Education, Inc. Pearson Prentice Hall Upper Saddle River, NJ Limitations of Ratio Analysis Be careful not to label ratios by themselves as “good” or “bad.” Different users of ratios have different perspectives.  Example: Lenders vs. owners regarding the current ratio Ratios may tell you there is a problem, but they don’t tell you what the problem is.  Example: high food cost  Why?