HOSPITALITY RATIO ANALYSIS
Financial Statements provide a wealth of important information to investors,
creditors, managers and other users. To be most meaningful, though, financial
statements must be analyzed.
A major approach to analyzing financial statement is the use of ratio analysis.
By themselves, ratios simply express numerical relationships between figures.
For ratios to become meaningful and provide users with a basis for evaluating
the financial statements, the computed ratios must be compared against some
standard. There are basically three different standards that are that are used
to evaluate the ratios computed for a given operation for the given period.
First, ratios can be compared to corresponding calculations from the
prior period.
Second, industry averages provide another useful benchmark against which
to compare ratios.
Third and best, ratios are compared against planned ratio goals.
Individually each ratio reveals only a part of overall financial condition of an
operation. Collectively, however these ratios communicate a great deal of
information that may not be immediately apparent to someone simply reading the
figures reported in financial statements.
Five common classes of ratios are as follows:
Liquidity
Solvency
Activity
Profitability
Operating.
Liquidity Ratios are divided into:
· Current
Ratio
· AcidTest
Ratio
· Accounts
Receivable Ratio
· Operating
Cash Flows to Current Liabilities Ratio
Solvency Ratios are divided into:
· DebtEquity
Ratio
· LongTerm
Debt to Total Capitalization Ratio
· Number
of times Interest Earned Ratio
· Fixed
Charge Coverage Ratio
· Operating
Cash Flows to Total Liabilities Ratio
Activity Ratios are:
· Inventory
turnover
· Fixed
Asset Turnover
· Asset
Turnover Ratio
· Paid
occupancy Percentage
· Complimentary
Occupancy Percentage
· Average
Occupancy per Room
· Multiple
Occupancy Percentage
Profitability Ratios are subdivided into following:
· Profit
Margin
· Operating
Efficiency Ratio
· Return
on Assets
· Gross
Return on Assets
· Return
on Equity
· Earning
per share
· Price
earning Ratio
· Market
Value to Book Value per Share Ratio
Operating Ratios are as under:
· Average
Room Rate
· Revenue
per available room
· Average
food service Check
· Food
cost percentage
· Beverage
cost percentage
· Labor
cost percentage.
Now, an insight into different types of Ratios:
a) Liquidity Ratios:
The ability of a hospitality firm to meet its current obligations is important
in evaluating its financial position. Several ratios can be computed that
suggest an answer to this question. Current Ratio is the ratio of total current
assets to total current liabilities. Hence, a current ratio of $1.21 means that
for every one dollar of current liabilities the Hotel has $1.21 of current
assets. Thus, there is a cushion of $.21 every dollar of current debt.
Current Ratio = Current Assets / Current Liabilities
AcidTest Ratio measures liquidity by considering ‘quick assets’ and near
cash assets. Excluded from current assets are inventories and prepaid expenses.
The difference between Current Ratio and Acid Test Ratio is a function of
inventory amounts and prepaid expenses relative to current assets.
Acid Test Ratio = Cash, Marketable Securities and Accounts Receivable /
Current Liabilities.
Accounts Receivable Turnover: In the normal operating cycle, accounts
receivable are converted into cash. The Account Receivable Turnover measures the
speed of the conversion. The suppliers as well as the owners prefer a high
account receivable turnover because this means that hospitality establishments
will have more cash readily available to pay them.
Accounts Receivable Turnover = Total Revenue / Average Accounts Receivable
Operating Cash Flows to Current Liabilities Ratio includes operating cash
flow from the statement of cash flow as the numerator and the average current
liabilities from the balance sheet as the denominator.
Operating Cash Flow to Current Liability Ratio = Operating Cash Flows /
Average Current Liabilities
b) Solvency Ratios:
Solvency Ratios measure the hospitality enterprise’s degree of debt financing
and are partial indicators of the establishment’s ability to meet its debt
obligations. These ratios reveal the equity cushion that is available to absorb
any operating losses.
Debt Equity Ratio is the most common solvency ratio and compares the
hospitality establishment’s total debt to its net worth (owner’s equity). The
debt equity ratios indicate the establishment’s ability to withstand adversity
and meet its longterm debt obligations.
Debt Equity Ratio = Total Liabilities / Total Owner’s Equity
Longterm Debt to Total Capitalization Ratio is similar to the debt and
owner’s equity, commonly called total capitalization. This ratio is similar to
the debt equity ratio except that current liabilities are excluded from the
numerator and longterm debt is added to the denominator of the debtequity
ratio. Current liabilities are excluded because current assets are normally
adequate to cover them; therefore they are not a longterm concern.
Long Term Debt to Total Capitalization Ratio = Long term Debt / Longterm
debt and Owner’s Equity
Number of Times Interest Earned Ratio is based on financial figures from the
income statement and expresses the number of times interest expense can be
covered by available ‘income’ (actually EBIT).
Number of times Interest Earned Ratio = E. B. I. T / Interest Expense
Fixed Charge Coverage Ratio is a variation of the number of times
interest earned ratio and considers lease payments as well as interest expense.
Those hospitality establishments that lease property equipment may find this
ratio is more useful than the number of times interest earned ratio.
Fixed charge coverage ratio = E.B.I.T + Lease Expense / Interest Expense and
Lease Expense
Operating Cash Flows to total Liabilities Ratio: This Solvency Ratio
using figures from both the statement of cash flow and balance sheet, compares
cash flow from operations to total liabilities. This ratio overcomes the
deficiency of using debt at a point in time by considering cash flows for a
period of time.
Operating cash flows to total liabilities ratio = Cash flows from operations
/ Average total liabilities
c.) Activity Ratios:
Activity ratios measure management’s effectiveness in using its resources.
Management is entrusted with inventory and fixed assets to generate earnings for
owners while providing products and services to guests. Management must
adequately control the inventory to minimize its cost of sales.
Inventory Turnover shows how quickly inventory is moving. All things
being the same, generally, the quicker the inventory turnover, the better,
because inventory can be expensive to maintain.
Food Inventory Turnover = Cost of Food Used / Average Food Inventory
Beverage Turnover Ratio = Cost of Beverage Used / Average Beverage Inventory
All parties (owners, creditors and management) prefer high inventory turnover
ratios to low ones. Too low an inventory turnover suggests that food is
overstocked and in addition to the problems, the potential cost of spoilage may
become a problem.
Fixed Asset Turnover measures management’s effectiveness in using fixed
assets. A limitation of this ratio is that it places a premium on using older
(depreciated) fixed assets, since their book value is low.
Fixed Asset Turnover = Total Revenue / Average Fixed Revenue
Asset Turnover Ratio examines the use of total assets in relation to
total revenues. The limitations of fixed asset ratio are also inherent in this
ratio to the extent that fixed assets make up total assets. For most hospitality
establishments especially lodging businesses, fixed assets constitute the
majority of operation’s total assets.
Following four ratios are viewed as excellent measures of management’s
effectiveness in selling space:
Paid Occupancy Percentage is a key Indicator of management’s success in
selling its product. A comparable ratio in food service operations is seat
turnover, which is calculated by dividing number of people served by the number
of seats available.
Annual Paid Occupancy Percentage = Paid Rooms Occupied / Available
Rooms
Complimentary Occupancy Percentage is determined by dividing the number
of complimentary rooms for a period by the number of rooms available.
Complimentary Occupancy Percentage = Complimentary Rooms / Rooms
Available
Average Occupancy per Room is the result of dividing the number of room
guests by the number of rooms occupied. The average occupancy per room is
generally highest for resort properties, where it can reach as high as 2.0
guests per room and is generally lowest for transient lodging properties.
Average Occupancy Per Room = No. of guests / No. of rooms Occupied
Multiple Occupancy Percentage is also called, less accurately, double
occupancy percentage. The owners, creditors and management prefer high occupancy
ratios as they imply greater use of facilities.
d.) Profitability Ratios:
Profitability Ratios reflect the results of all areas of management’s
responsibilities. All the information conveyed by liquidity, liquidity, solvency
and activity ratios affects the profitability of the of the hospitality
enterprise. The profitability ratios considered here measure management’s
overall effectiveness as shown be returns on sales ( profit margin and operation
efficiency ratio) , returns on assets ( return on assets and gross return on
assets), and return on common stockholder’s equity.
Profit Margin is determined by dividing net income by total revenue. It
is an overall measurement of management’s ability to generate sales and control
expenses, thus yielding the bottom line.
Profit Margin = Net Income / Total Revenue
If the profit margin is lower than expected, then revenue and expenses should be
reviewed. To identify the problem area, management should first analyze the
operated departments margins. If the operated departments margins are
satisfactory, the problem would appear to be with overhead expense.
Operating Efficiency Ratio is a better measure of management’s
performance than the Profit Margin because, unlike the profit margin, it
considers only those expenses that management can generally control. This ratio
is the result of dividing income before fixed charges by total revenue.
Operating Efficiency Ratio = Income Before fixed Charges / Total Revenue
Return On Assets (ROA) ratio is a general indicator of the profitability
of the hospitality enterprise’s assets. ROA compares bottom line profits to the
total investment, that is, to the total assets. A very low ROA may result from
inadequate profits or excessive assets. A very high ROA may suggest that older
assets require replacement in the near future or that new assets need to be
added to support growth revenues and profits.
Return On Assets = Net Income / Average Total Assets
Gross Return on Assets: The computation Gross Return On Assets, ignores
any debtfinancing by using income before interest and income taxes as its
numerator. Interest is excluded because it is a financing cost, and income taxes
are not considered because interest expense is deductible in calculating the
operation’s tax liability.
Gross Return On Assets = Earnings Before Interest and Taxes / Average Total
Assets
Return On Equity: A key profitability ratio is Return on Equity ( ROE).
This ratio compares the net income of the hospitality enterprise to the owner’s
investment.
Return On Equity = Net Income / Average Owner’s Equity
Earnings per Share is usually shown on hospitality establishments income
statements issued to external users.
Earnings per Share = Net Income / Average common shares outstanding
Price Earnings Ratio: Financial analysts often use the price earnings
(PE) ratio in presenting investment possibilities in hospitality enterprise.
Price Earning Ratio = Market Price Per Share / Earning per Share
PE Ratio may vary significantly for different hospitality enterprises and
depends on relative risk, stability of earnings, perceived earnings trends and
perceived growth trends of the stock.
Market Value to Book Value Per Share Ratio: This ratio compares the value
per share of stock as reflected by the market to the underlying value per share
per accounting records.
Market Value to Book Value Per Share Ratio = Market Value Per Share / Book
Value per Share
e.) Operating Ratios:
Operating Ratios assist management in analyzing the operation of a hospitality
establishment. Detailed information necessary for computing these ratios is
normally not available to creditors or owners not actively involved in
management. Operating ratios relate expenses to revenues and are useful for
control purposes.
Mix of Sales: To determine sales mix, the departmental revenues are
totaled and percentages of total revenues are calculated for each operated
department. The sales mix of hospitality operation is best mix of hospitality
operation is the best compared to the establishment’s objectives as revealed in
the budget.
Average Room Rate is simply also called average daily rate or ADR. The
best standard of comparison of use in evaluating an actual average room rate is
the rate budgeted as the goal for the rooms department’s operation during the
period. This average rate should also be calculated individually for each market
segment: business, groups, tourists, airline crews, and other categories of
guests served.
Average Room Rate =Rooms Revenue / Number of Rooms Sold
Revenue Per Available Room: The combination of paid occupancy percentage
and ADR is called REVPAR, and is calculated as follows:
REVPAR = Rooms Revenue / Available Rooms Or
Paid Occupancy Percentage X ADR.
Using REVPAR provides more complete information than using occupancy percentage
or ADR separately.
Average Food and Service Check is determined by dividing total food
revenues by the number of food covers sold during the period.
Average Food and Service Check =Total Food Revenue / Number of Food Covers
Food Cost Percentage compares the cost of food sold to food sales. Most
managers rely heavily on this ratio for determining whether food costs are
reasonable. A lower food cost percentage may indicate that the quality of food
served is lower than desired, or that smaller portions are being served than are
specified =by standard recipes. A food cost percentage in excess of the
objective may be due to poor portion control, excessive food costs, theft,
waste, spoilage, and so on.
Food Cost Percentage = Cost of Food Sold / Food Sales
Beverage Cost Percentage is obtained by dividing cost of beverage sold
with beverage sales.
Beverage Cost Percentage = Cost of Beverages Sold / Beverage Sales
Labor Cost Percentage is determined by dividing total labor costs by
total revenue. The largest expense in hotels, motels, clubs and many restaurants
is labor. The general labor cost percentage is simply a benchmark for making
broader comparisons.
Labor Cost Percentage = Total Labor Cost / Department Revenue
Ratios are of varying usefulness to users. Management considers Operating Ratios
to be the most useful class of ratios, followed by activity ratios. Owners are
perceived to consider Profitability Ratios as the most useful class of ratios,
followed by Solvency Ratios. Creditors are perceived to consider Solvency Ratios
as the most useful class of ratios, followed by profitability ratios.
