Copyright © 2007 by John Wiley & Sons, Inc. All rights reserved Chapter 12 Tying it All Together

Copyright © 2007 by John Wiley & Sons, Inc. All rights reserved

Chapter 12

Tying it All TogetherTying it All Together


Review

• Hospitality Industry Financial ChallengesHospitality Industry Financial Challenges

• Reading, Interpreting, and Analyzing Reading, Interpreting, and Analyzing Financial Statements and Management Financial Statements and Management ReportsReports

• Managing Working CapitalManaging Working Capital

• Growing the BusinessGrowing the Business


Review

• Knowing the Sources, Types, and Costs of Knowing the Sources, Types, and Costs of CapitalCapital

• Investment AnalysisInvestment Analysis

• The Investment PackageThe Investment Package

• Crafting and Negotiating the DealCrafting and Negotiating the Deal


Hospitality Financial Challenges

Labor intensive

Fluctuating sales volume

Low profitability

Capital intensive

Reliance on discretionary incomes

A multi-faceted industry


Accounting Standards

• Develop StandardsDevelop Standards– Financial Accounting Standards Board Financial Accounting Standards Board

(FASB)(FASB)

– Securities and Exchange Commission Securities and Exchange Commission (SEC) (SEC)

• Generally Accepted Accounting Generally Accepted Accounting Principles (GAAP)Principles (GAAP)

– Govern all accounting and financial reportingGovern all accounting and financial reporting


Uniform Systems of Accounts

• Uniform System of Accounts for the Lodging IndustryUniform System of Accounts for the Lodging Industry

• Uniform System of Accounts for RestaurantsUniform System of Accounts for Restaurants

• Uniform System of Financial Reporting for ClubsUniform System of Financial Reporting for Clubs

• Other systems:Other systems:

– TimeshareTimeshare

– CondominiumCondominium

– Health, racquet, and sports clubsHealth, racquet, and sports clubs

– SpasSpas


Income Statement

• Presents operating results over a specific period of timePresents operating results over a specific period of time

• Sections of the income statement:Sections of the income statement:– Revenues or SalesRevenues or Sales

– Operating ExpensesOperating Expenses

• For hotel properties:

– Departmental expenses

– Unallocated expenses

– Capital Expenses or Fixed CostsCapital Expenses or Fixed Costs

– Net Income or Profit and LossNet Income or Profit and Loss


Balance Sheet

• Provides a snapshot of a company’s financial positionProvides a snapshot of a company’s financial position

• Categories of accounts:Categories of accounts:– AssetsAssets

• Current Assets

• Fixed Assets

– LiabilitiesLiabilities

• Current Liabilities

• Long Term Liabilities

– EquityEquity

Assets = Liabilities + Equity


Statement of Cash Flow

• Three sections:Three sections:

– Cash Flow from OperationsCash Flow from Operations

– Cash Flow from Investing ActivitiesCash Flow from Investing Activities

– Cash Flow from Financing ActivitiesCash Flow from Financing Activities


Management Reports

• Daily Revenue ReportDaily Revenue Report

• Daily Payroll Cost ReportDaily Payroll Cost Report

• Rooms Revenue ForecastRooms Revenue Forecast

• Food and Beverage Menu AbstractFood and Beverage Menu Abstract

• Accounts Receivable Aging ScheduleAccounts Receivable Aging Schedule


Types of Analysis

• Vertical AnalysisVertical Analysis

– Used to analyze variable expensesUsed to analyze variable expenses

– All accounts are sized using either:All accounts are sized using either:

• Total revenue or

• Departmental Revenue

– Variable expenses should increase or Variable expenses should increase or decrease with the level of salesdecrease with the level of sales


Sample Vertical AnalysisShae's

Income Statement

For the month ended June 30, 2008

Revenues: Amount Percent

Food $ 890,000 78.20

Beverage 220,000 19.33

Others 28,100 2.47

Total Revenues $ 1,138,100 100.00

Cost of Sales:

Food $ 320,400 36.00

Beverage 48,400 22.00

Others 15,455 55.00

Total Cost of Sales $ 384,255 33.76

Gross Profit:

Food $ 569,600 50.05

Beverage 171,600 15.08

Others 12,645 1.11

Total Gross Profit $ 753,845 66.24

• Accounts are divided by total Accounts are divided by total revenues revenues

– $1,138,100$1,138,100

• Cost of Sales is divided by its Cost of Sales is divided by its respective revenue amountrespective revenue amount

– EX: FoodEX: Food

– $320,400 / $890,000 = 36%$320,400 / $890,000 = 36%


Types of Analysis

• Horizontal AnalysisHorizontal Analysis

– Tracks and Analyzes:Tracks and Analyzes:

• Income Statement

• Balance Sheet

– Focuses on both $$ and % changesFocuses on both $$ and % changes

– Analyzes changes over timeAnalyzes changes over time

• Month to Month

• Year to Year


Sample Horizontal AnalysisDanforth Hotels

Horizontal Analysis for the Balance Sheets

As of December 31

(in millions)

2007 2008 $ change % change

Cash $ 82 $ 298 $ 216 263.4

Accounts Receivable 288 269 (19) -6.6

Marketable Securities 100 112 12 12.0

Inventory 193 158 (35) -18.1

Other current assets 64 90 26 40.6

Total Current Assets 727 927 200 27.5

Furniture, Fixture & Equipment, net 3,641 3,520 (121) -3.0

Management and Franchise Contracts, net 383 347 (36) -9.4

Goodwill 1,230 1,230 - 0.0

Long term Investments 568 599 31 5.5

Other long term assets 260 328 68 26.2

Long Term Assets 6,082 6,024 (58) -1.0

Total AssetsTotal Assets $ 6,809 $ 6,809 $ 6,951 $ 6,951 $ 142 $ 142 2.12.1


Important Ratios

• OccupancyOccupancy– Rooms Sold / Rooms AvailableRooms Sold / Rooms Available

• Average Daily RateAverage Daily Rate– Rooms Revenue / Rooms SoldRooms Revenue / Rooms Sold

• RevPARRevPAR– Rooms Revenue / Rooms AvailableRooms Revenue / Rooms Available

• Food Cost PercentFood Cost Percent– Food Cost / Food RevenueFood Cost / Food Revenue

• Beverage Cost PercentBeverage Cost Percent– Beverage Cost / Beverage RevenueBeverage Cost / Beverage Revenue


Important Ratios

• Payroll Cost PercentPayroll Cost Percent– Payroll Cost / Departmental or Total RevenuePayroll Cost / Departmental or Total Revenue

• Profit MarginProfit Margin– Profit / Departmental or Total RevenueProfit / Departmental or Total Revenue

• Accounts Receivable TurnoverAccounts Receivable Turnover– Total Revenue / Average Accounts ReceivableTotal Revenue / Average Accounts Receivable

• Inventory TurnoverInventory Turnover– Departmental Revenue / Cost of Goods SoldDepartmental Revenue / Cost of Goods Sold

• Return on InvestmentReturn on Investment– Cash Flow / EquityCash Flow / Equity


Management Applications

• Employee schedulingEmployee scheduling

• Labor cost controlLabor cost control

• Food and beverage pricingFood and beverage pricing

• Revenue managementRevenue management

• Profit flexingProfit flexing

• Cost-volume-profit analysisCost-volume-profit analysis


Working Capital

• Amount of working capital is impacted by:Amount of working capital is impacted by:

– Mix of cash and credit salesMix of cash and credit sales

– Credit card transaction processingCredit card transaction processing

– Accounts receivablesAccounts receivables

– Food and beverage turnoverFood and beverage turnover

– Vendor termsVendor terms

– GrowthGrowth


Working Capital

• Ways to minimize working capitalWays to minimize working capital

– Cash discountsCash discounts

– Inventory turnoverInventory turnover

– Good credit ratingGood credit rating

– Managing accounts payablesManaging accounts payables

– Tracking transactionsTracking transactions


Cash Forecast

• Assists in determining the amount of Assists in determining the amount of working capitalworking capital

• Management estimates cash inflows and Management estimates cash inflows and projects cash needs for 90 daysprojects cash needs for 90 days

• Alerts management to probable cash Alerts management to probable cash shortages or surpluses in advanceshortages or surpluses in advance


Shareholder Value

• Shareholder Value = Market ValueShareholder Value = Market Value

• Market ValueMarket Value

– Public CompanyPublic Company

• Current market price of common stock multiplied by number of shares outstanding

– Private CompanyPrivate Company

• Sale price of the company on the open market


Benefits of Growth

• Clear career paths for employeesClear career paths for employees

• Attract qualified employeesAttract qualified employees

• Increase market shareIncrease market share

• Limit new competitionLimit new competition

• Diversify riskDiversify risk


Growth Strategies

• Increase sales and Productivity of Existing Increase sales and Productivity of Existing PropertiesProperties

• Expansion of Physical FacilitiesExpansion of Physical Facilities

• FranchisingFranchising

• Management ContractsManagement Contracts

• Mergers and AcquisitionsMergers and Acquisitions


Types of Capital

• DebtDebt

– Fixed obligation or liability of the business that Fixed obligation or liability of the business that must be paid back, with interest, over a must be paid back, with interest, over a specified period of time.specified period of time.

• EquityEquity

– Ownership in the business that does not Ownership in the business that does not require immediate repayment, but requires a require immediate repayment, but requires a return on the capital invested.return on the capital invested.


Cost of Capital

• Cost of DebtCost of Debt

– Interest expense the borrower pays the lenderInterest expense the borrower pays the lender

• Cost of EquityCost of Equity

– Portion of cash flow the sponsor of a deal Portion of cash flow the sponsor of a deal allocates to the investorallocates to the investor


Weighted Average Cost of Capital or WACC

• Amount of interest expense and cash flow Amount of interest expense and cash flow allotted to equity investors divided by the allotted to equity investors divided by the amount of capitalamount of capital

• Takes into consideration:Takes into consideration:

– Capital mixCapital mix

– Tax effectTax effect

• Interest portion of debt service treated as an expense for tax purposes in the US


WACC Calculation

WACC = wWACC = wdd k kdd (1-T) + w (1-T) + wee k kee

Weight of debt = wWeight of debt = wdd

Cost of debt = kCost of debt = kdd (1-T) (1-T)

Tax rate of business = TTax rate of business = T

Tax effect = (1-T)Tax effect = (1-T)

Weighted cost of debt = wWeighted cost of debt = wdd k kdd (1-T) (1-T)

Weight of equity = wWeight of equity = wee

Cost of equity = kCost of equity = kee

Weighted cost of equity = wWeighted cost of equity = wee k kee


Market Value

• Present value of the sum of future cash Present value of the sum of future cash flow factoring in:flow factoring in:

– The amount of annual cash flow projectedThe amount of annual cash flow projected

– The timing of when the cash flow will be The timing of when the cash flow will be receivedreceived

– The risk associated with the generation of the The risk associated with the generation of the cash flowcash flow

– The WACC required to finance the projectThe WACC required to finance the project


Investment Analysis Tools

• Payback PeriodPayback Period

– Amount of time a project requires to pay back Amount of time a project requires to pay back the initial equity investmentthe initial equity investment

• Advantage

– Easy to calculate

• Disadvantages

– Does not include the time value of money

– Ignores cash flow after the required payback period



• Net Present Value (NPV)Net Present Value (NPV)

– Calculates the difference between an asset’s Calculates the difference between an asset’s present value and purchase pricepresent value and purchase price

• Advantages

– Takes into account all cash flows

– Takes into consideration the TVM

• Disadvantage

– Difficult to compare multiple investment opportunities with different costs



• Internal Rate of Return (IRR)Internal Rate of Return (IRR)

– Discount rate that makes the NPV of an Discount rate that makes the NPV of an investment equal to zeroinvestment equal to zero• Advantage

– Compare multiple deals with varying sales prices and costs

• Disadvantages– Assumes cash flows generated by the project are

reinvested at the IRR calculated

– Multiple IRRs when cash flows go from negative to positive


Need for the Investment Package

• First step in gaining approval for funding is First step in gaining approval for funding is the preparation of a professional the preparation of a professional investment packageinvestment package

• Investment package should tell the story Investment package should tell the story and sell the project to capital sourcesand sell the project to capital sources


Parts of the Investment Package

• Executive summaryExecutive summary

• Fact sheetFact sheet

• Business planBusiness plan

• Source and use of fundsSource and use of funds

• Photographs or renderingsPhotographs or renderings

• Third-party confirmationThird-party confirmation

• Project budgetProject budget

• Qualifications of the project teamQualifications of the project team

• Investment analysisInvestment analysis

• Personal financial dataPersonal financial data


Lender Evaluation of theInvestment Package

• How strong is this project and is it really How strong is this project and is it really feasible?feasible?

• Is the project team really qualified?Is the project team really qualified?

• What is the risk of this venture failing?What is the risk of this venture failing?

– Investment package should clearly state risks Investment package should clearly state risks and how they will be minimizedand how they will be minimized


Owner/Equity Investor Evaluation of the Investment Package

• How much equity is the sponsor group How much equity is the sponsor group investing in the deal?investing in the deal?

• What annual ROI can I expect to receive?What annual ROI can I expect to receive?

• What’s the payback period?What’s the payback period?

• What is the net present value of the deal?What is the net present value of the deal?

• What is my projected IRR?What is my projected IRR?


Owner/Equity Investor Evaluation of the Investment Package

• How much is the sponsor group making on How much is the sponsor group making on the deal?the deal?

• What is the exit strategy?What is the exit strategy?

– The shorter and more clearly defined the exit The shorter and more clearly defined the exit strategy, the more likely the outside investor strategy, the more likely the outside investor will be to invest in the dealwill be to invest in the deal


Terms of Lender Importance

• PrincipalPrincipal

• Interest rateInterest rate

• Points chargedPoints charged

• CollateralCollateral

• Personal guaranteePersonal guarantee


Terms of Investor Importance

• Amount of equity they are asked to investAmount of equity they are asked to invest

• Percentage ownership they will receivePercentage ownership they will receive

• Probability of achieving their IRR hurdle Probability of achieving their IRR hurdle raterate

• Exit strategyExit strategy

• Decision making power on when to Decision making power on when to execute the exit strategyexecute the exit strategy


Negotiating Skills

• Borrowers must:Borrowers must:

– Learn about the person they will be negotiating withLearn about the person they will be negotiating with

– Dress professionallyDress professionally

– State the benefits of the ventureState the benefits of the venture

– Address any objections raisedAddress any objections raised

– Close the dealClose the deal

• Think like an owner and act like a manager!Think like an owner and act like a manager!

Documents

Copyright © 2007 by John Wiley & Sons, Inc. All rights reserved Chapter 12 Tying it All Together