Profitability and Financial Literacy

The three key financial statements used for financial analysis for a business are Income Statements (Profit and Loss Statements), Cashflow Statements and Balance Sheets.

Income Statements

Income statements, also known as profit and loss statements, are crucial financial documents that summarise a business’s revenues, costs, and expenses over a specific period. In the hospitality industry, understanding how to interpret and use income statements is essential for making informed decisions that affect a business's financial health.

An income statement typically includes key components such as revenue, cost of goods sold (COGS), gross profit, operating expenses, and net income. For instance, at Pauanui Ocean Resort, the revenue might include income from room bookings, food and beverage sales, spa services, and event hosting. If the resort hosts a large corporate retreat during peak season, this event would significantly boost the monthly revenue on the income statement.

Cost of Goods Sold (COGS)

COGS in the hospitality context could include the cost of food and beverages served, the supplies used in housekeeping, and other direct costs related to delivering services. For Pauanui Ocean Resort, this might involve the cost of sourcing premium seafood and organic produce for its on-site restaurant.

Gross profit

Gross Profit is calculated by subtracting COGS from total revenue. This figure is crucial as it shows the profitability of the core operations before accounting for operating expenses. For example, if the resort generates NZD 500,000 in revenue in a month and the COGS amounts to NZD 150,000, the gross profit would be NZD 350,000.

Operating expenses

Operating expenses include costs such as salaries, utilities, marketing, and maintenance. At Pauanui Ocean Resort, significant operating expenses might include the salaries of the highly skilled spa staff, marketing campaigns targeting international tourists, and maintenance of the resort's luxurious facilities.

Net income

Net income is determined by subtracting operating expenses from the gross profit. This figure represents the resort's actual profit after all expenses have been paid. A strong net income indicates a well-managed resort, while a low or negative net income could signal potential issues in cost management or revenue generation.

Understanding and analysing income statements enables hospitality managers to identify trends, control costs, and make strategic decisions to enhance profitability. For example, if Pauanui Ocean Resort notices a decline in net income during off-peak months, the management might explore strategies such as offering special winter packages or reducing certain variable costs to improve financial performance.

Cash Flow Statements

Cash flow statements are vital financial documents that track the flow of cash into and out of a business over a specific period. In the hospitality industry, managing cash flow effectively is crucial for ensuring that a business can meet its short-term obligations while maintaining operational stability.

A cash flow statement is divided into three main sections: operating activities, investing activities, and financing activities.

Operating activities

Operating activities reflect the cash generated or used by the core business operations. For Pauanui Ocean Resort, this might include cash received from room bookings, spa services, and restaurant sales. On the expenditure side, operating activities could involve payments for utilities, staff salaries, and suppliers of goods and services. For example, during the summer peak season, the resort might experience a significant inflow of cash from increased bookings and event hosting, reflected in this section of the cash flow statement.

Investing activities

Investing activities include cash flows related to the purchase and sale of long-term assets. At Pauanui Ocean Resort, investing activities might involve cash outflows for refurbishing beachfront villas or upgrading the resort's wellness facilities. Conversely, if the resort decides to sell an old property or equipment, the cash inflow from that sale would also be recorded under investing activities.

Financing activities

Financing activities involve cash flows related to borrowing or repaying debt, issuing shares, or paying dividends. For instance, if Pauanui Ocean Resort secures a loan to fund its expansion plans, the loan amount would be recorded as a cash inflow under financing activities. Similarly, any repayments on that loan would be recorded as cash outflows.

One key aspect of cash flow statements is the net cash flow, which is the sum of cash flows from operating, investing, and financing activities. This figure provides a clear picture of the resort’s liquidity and its ability to cover expenses and invest in growth. For example, if Pauanui Ocean Resort has a positive net cash flow, it suggests that the resort is generating more cash than it is spending, which is a good indicator of financial health. On the other hand, a negative net cash flow could signal cash shortages, prompting the management to reassess spending or find ways to boost cash inflows.

By carefully analysing the cash flow statement, hospitality managers can ensure they have sufficient cash on hand to cover operational costs, plan for future investments, and manage debt. For example, if the cash flow statement shows a significant outflow in investing activities due to major renovations, the resort's management might decide to delay other investments or seek additional financing to maintain a healthy cash flow balance.

Balance Sheets

A balance sheet is a fundamental financial statement that provides a snapshot of a business’s financial position at a specific point in time. In the hospitality industry, a balance sheet helps managers understand the relationship between what the business owns (assets), what it owes (liabilities), and the equity held by its owners.

The balance sheet is structured around three main components: assets, liabilities, and equity.

Assets

Assets are everything the business owns that has value. For Pauanui Ocean Resort, assets might include tangible items like the resort’s buildings, land, and equipment, as well as intangible assets like brand reputation and goodwill. Current assets, such as cash on hand, accounts receivable from guests, and inventory like food and beverages, are also included on the balance sheet. For example, the resort’s beachfront property would be listed as a long-term asset, reflecting its significant value to the business.

Liabilities

Liabilities represent what the business owes to others. This includes current liabilities like accounts payable (e.g., money owed to suppliers) and long-term liabilities such as loans or mortgages. For Pauanui Ocean Resort, liabilities might include a loan taken out to finance recent renovations or outstanding payments for luxury goods purchased for the resort’s operations. For instance, if the resort recently upgraded its spa facilities, the loan used to fund this investment would appear as a liability on the balance sheet.

Equity

Equity is the residual interest in the assets of the business after deducting liabilities. It represents the ownership value in the business, often referred to as "owner's equity" or "shareholder's equity." For Pauanui Ocean Resort, equity might include the initial capital invested by the owners as well as retained earnings, which are profits that have been reinvested into the business rather than distributed as dividends.

The balance sheet is crucial for assessing the financial stability of the resort. For instance, if Pauanui Ocean Resort has a high level of assets compared to its liabilities, it indicates a strong financial position and the ability to meet its obligations. However, if liabilities significantly outweigh assets, it could be a sign of financial distress, requiring careful management of debt and expenditures.

By regularly analysing the balance sheet, hospitality managers can make informed decisions about investments, financing, and overall strategy. For example, if the balance sheet shows a high level of equity, the resort may consider using some of this equity to finance further expansions or improvements. Conversely, if liabilities are growing, management might focus on reducing debt or improving cash flow to strengthen the resort’s financial health.

Assessing financial performance

Assessing financial performance is a crucial aspect of hospitality management, as it involves analysing financial statements to evaluate a business's profitability, efficiency, and overall financial health. For hospitality managers, understanding how to assess financial performance enables them to make informed decisions that drive growth and sustainability.

Key financial metrics used in assessing performance include profit margins, return on assets (ROA), and current ratio. Profit margins, derived from the income statement, measure how much of the revenue is converted into profit after all expenses are accounted for. For example, if Pauanui Ocean Resort reports a profit margin of 20%, it means that 20 cents of every dollar earned is profit, indicating efficient cost management.

Return on Assets (ROA) is another important metric, calculated by dividing net income by total assets, as shown on the balance sheet. ROA helps gauge how effectively the resort is using its assets to generate profit. A high ROA indicates that the resort is efficiently utilising its resources, such as its beachfront property and luxury facilities, to maximise earnings.

The current ratio, derived from the balance sheet, compares current assets to current liabilities and is a key indicator of liquidity. For Pauanui Ocean Resort, a current ratio above 1 suggests that the resort has more assets than liabilities in the short term, positioning it well to cover its immediate obligations without financial strain.

By regularly assessing these and other financial metrics, hospitality managers can identify strengths and weaknesses in their operations, adjust strategies, and ensure the long-term success of the business. For instance, if the analysis reveals declining profit margins, the management might investigate cost-saving measures or explore new revenue streams to improve profitability.

Glossary of Financial Terms

Term	Definition
Assets	Resources owned by a business that have economic value. Assets can be tangible, like buildings and equipment, or intangible, like brand reputation.
Balance Sheet	A financial statement that provides a snapshot of a business’s financial position at a specific point in time, detailing assets, liabilities, and equity.
Capital Expenditure	Funds used by a business to acquire, upgrade, or maintain physical assets such as property, industrial buildings, or equipment.
Cashflow Statement	A financial statement that tracks the flow of cash into and out of a business over a specific period, categorised into operating, investing, and financing activities.
Contingency Planning	The process of preparing for unexpected events or emergencies by setting aside funds or having strategies in place to mitigate potential risks.
Cost of Goods Sold (COGS)	The direct costs attributable to the production of goods sold by a company. In hospitality, this includes the cost of food, beverages, and other direct expenses related to service delivery.
Current Ratio	A liquidity ratio that measures a company’s ability to pay off its short-term liabilities with its short-term assets. A ratio above 1 indicates good financial health.
Equity	The residual interest in the assets of a business after deducting liabilities. It represents the ownership value held by the shareholders or owners.
Gross Profit	The profit a company makes after deducting the costs associated with making and selling its products or services (COGS). It is calculated as revenue minus COGS.
Income Statement	A financial statement that summarises a business's revenues, costs, and expenses over a specific period, showing the net profit or loss.
Investing Activities	Part of the cash flow statement that shows cash transactions related to the acquisition or sale of long-term assets, such as property, plant, and equipment.
Liabilities	Financial obligations or debts owed by a business to creditors. Liabilities can be current (due within a year) or long-term (due after more than a year).
Net Cash Flow	The total cash flow from operating, investing, and financing activities, indicating the overall liquidity of a business during a specific period.
Net Profit	The amount of money a business has left after all its expenses, including taxes and interest, have been deducted from total revenue.
Operating Expenses	The costs required for the day-to-day functioning of a business, such as salaries, utilities, and maintenance, as shown on the income statement.
Operating Activities	A section of the cash flow statement that includes cash generated or spent in the course of regular business operations, such as revenue from sales or payments to suppliers.
Profit Margin	A profitability ratio calculated by dividing net income by revenue, expressed as a percentage. It indicates how much profit a company makes for every dollar of revenue.
Return on Assets (ROA)	A financial ratio that indicates how profitable a company is relative to its total assets, calculated by dividing net income by total assets.
Revenue Forecasting	The process of estimating future income based on historical data, market trends, and expected business activities.
Working Capital	The difference between current assets and current liabilities, representing the short-term liquidity of a business.

Revenue Analysis Strategies

When viewing revenue reports hospitality managers need to understand where increases or decreases may have come from. In analysing the reports, the following kinds of questions might be asked:

• Did lower rates/prices cause higher volumes?
• Did a marketing campaign result in higher volumes?
• Did competition factor in lower volumes
• Did an increase in price cause lower volumes?

Identifying the cause can lead managers to either further capitalise on the good outcomes which would lead to increased profits, or to solve a problem which is causing the business to be less successful.

Profit Calculation

The formula to calculate profit is simple and easy to apply. For example, the profit calculation for the Rooms Division of a hotel might look something like this:

Total room revenue	$500,000
Employee Wages	$60,000
Other Operating Expenses	$44,000
Profit = $500,000-$60,000-$44,000=$396,000

Revenue per Available Room (RevPAR)

RevPAR is a key performance metric in the hospitality industry, particularly for hotels and resorts. It measures the average revenue a hotel generates per available room over a specific period, providing insight into both room occupancy and pricing strategy.

RevPAR is calculated using the following formula:

RevPAR = Average Daily Rate (ADR) / Occupancy Rate

Example: If Pauanui Ocean Resort has 100 rooms, and over the course of a day, 70 of those rooms are occupied at an average daily rate (ADR) of $200 per room, the RevPAR for that day would be: RevPAR = 70%×$200 = $140. This means that on average, each available room at the resort generated $140 in revenue that day, whether or not it was occupied.

RevPAR is particularly useful because it considers both how well rooms are filled (occupancy) and how much revenue is earned per room (pricing). It is a critical metric for hotel managers to monitor regularly to ensure the financial health and competitive positioning of their property.

Importance of RevPAR:

• Performance Indicator: RevPAR combines occupancy and room rate, making it a comprehensive indicator of a hotel's financial performance. High RevPAR indicates effective pricing and strong demand, while low RevPAR might suggest underutilisation or the need for a pricing review.
• Benchmarking: It allows hotels to compare their performance with competitors and industry standards. For example, if Pauanui Ocean Resort's RevPAR is below the regional average, it may need to reassess its pricing strategy or marketing efforts.
• Revenue Management: By tracking RevPAR, hotels can adjust their strategies to optimise both occupancy rates and pricing, thereby maximising revenue.

Video Title: Lesson 3.1 Occupancy, Average Daily Rate and Revenue Per Available Room
Watch Time: 8’17”
Video Summary: This video is part of a playlist which takes you through various aspects of Hospitality Revenue Management. This video looks at Occupancy, Average Daily Rate and Revenue Per Available Room and shows how to perform the appropriate calculations.
Source: YouTube Channel: DCT Online Academy

Gross Operating Profit and Net House Profit

After all of the hotel’s separate departmental profits have been calculated, the next step is to work out the overall remaining daily operating expenses for the hotel that must be paid. Some departments of a hotel (such as Administration, Maintenance, Sales & Marketing, Housekeeping etc.) do not generate profits, but are necessary to the overall success of the business. These departments have total department expenses instead of total department revenues. These expenses are then deducted from the overall profit to produce the Net House Profit or Gross Operating Profit.

There is one final deduction to be made: fixed or overhead expenses, which would have to be paid regardless of the levels of occupancy of the hotel. Examples include bank loans, mortgage payments, insurance costs, licenses, permits and fees, and depreciation.

Resource Allocation

In hospitality management, making informed decisions on resource allocation is essential for optimising operations, maximising profitability, and ensuring guest satisfaction. Resource allocation involves determining where to best invest time, money, and human resources within a business to achieve strategic goals. For example, at Pauanui Ocean Resort, management might decide to allocate more resources towards marketing during the off-peak season to attract more guests or invest in staff training to enhance service quality. These decisions should be guided by financial data, such as revenue trends and cost analysis, to ensure that resources are directed towards areas that will yield the highest return on investment. By carefully analysing financial statements, understanding market conditions, and assessing operational needs, hospitality managers can prioritise expenditures, avoid waste, and ultimately drive the business towards sustained growth and success.

You’ve reached the end of the learning material for this topic. Let’s recap the key points:

• Profitability
• Financial statements: there are three key financial statements which are vital for an organisation’s financial analysis:
  • Income Statements (Profit and Loss Statements)
  • Cashflow Statements
  • Balance Sheets
• Income Statements - Key terms:
  • COGS
  • Gross Profit
  • Operating Expenses
  • Net Income
• Cashflow Statements
  • Operating Activities
  • Investing Activities
  • Financing Activities
• Balance Sheets – Key Terms
  • Assets
  • Liabilities
  • Equity
• Assessing financial performance
• Revenue analysis strategies
• Profit calculation
• RevPAR
• Resource Allocation