Financial Planning

The best way for managers to find useful information is by comparing their current figures with previous sets of numbers. There are a few different comparisons which can be useful:

Previous Year: This is an obvious comparison to start with: simply compare the current year’s results with the same results from last year. They are either going to be worse, the same, or (hopefully) better.

The Budget: Actual results from specified reporting periods (monthly, quarterly etc.) are compared to the one-year financial operating plan (also known as the budget). This enables managers to see if the business is on track with its financial goals in terms of revenues, profits and productivity. Budgets will either have been missed, met or exceeded.

Forecasts: Forecasts are used to adjust and update budgets, according to current business conditions. Forecasting can occur within both short term and longer-term periods of time and are useful for anticipating business performance in comparison to the budget.

Previous Periods: These are generally monthly measurements and are important for identifying trends.

Pro Forma: Pro forma are the projections for new business that do not have previous financial operating histories to build on. Managers, with the help of financial experts, will put together a pro forma based on current market conditions and expected returns. This is used for the first year only and is replaced by a budget once there is sufficient financial information to prepare it.

Explaining Performance

When analysing financial reports, managers need to know where changes occur and what caused them. Changes could come from:

• Revenues (volume and rate)
• Expenses (sales, wages, benefits, operating costs: direct, indirect, variable)
• A single department or many departments

Changes are measured by comparing actual performance to previous performance and are measured by units, money or percentages.

Percentages

Percentages are very useful in financial reporting because they show changes in relationships between numbers. When percentages change it is important to identify where the change has occurred.

Food Percentages apply to the cost of producing food in a restaurant. The same relationship applies to the cost of the food ingredients used against the revenue generated by selling it. One method used by restaurant managers set menu prices is to base them on the food cost and use a food cost percentage to calculate a selling price. As a rule of thumb, food cost percentages are usually kept between 20% and 30% of the sale price. The actual percentage can vary as food costs change or food revenues change.

• Productive scenario: food costs stay the same or decrease and revenues increase.
• Unproductive scenario: food costs increase but revenue does not, or food costs stay the same but revenues decrease.

Video Title: Food Costs Formula: How to Calculate Restaurant Food Cost Percentage (Updated)
Watch Time: 12:00 minutes
Video Summary: An explanation of what food costs are and how to calculate menu prices from a restaurant owner.
Pre Watch Question: Why is knowing how much your food costs are so important to any hospitality business which has a food offer?

Source: The Restaurant Boss
Post Watch Task: Reassess your ideas on the importance of food costs – have your ideas about this subject changed?

Types of Percentages

1. Cost/Expense Percentages

Usefulness: Shows how much specific expenses are in relation to the overall revenue: wages are 12.5% of the revenue.

2. Profit (or Loss) Percentages

Usefulness: Shows how much revenue remains once all expenses have been accounted for.

Product costs are the expenses directly related to creating and delivering the goods and services that a business offers to its customers. These costs are a fundamental component of financial planning as they significantly influence a business’s pricing strategies, profit margins and the overall health of the organisation.

Product costs can be broadly categorised into several components:

Raw Material Costs

These are the costs associated with purchasing ingredients, beverages, and other consumables. In a restaurant setting, this might include the cost of fresh produce, meats, and wines. For a hotel, it might also encompass items like toiletries, linens, and cleaning supplies.

Direct Labour Costs

These include wages paid to employees who are directly involved in producing and delivering the service or product. This could be chefs, kitchen staff, waitstaff, or housekeeping personnel who contribute to the customer experience. Efficient management of labour costs is vital to ensuring that staff levels are appropriate for business demands without leading to overstaffing or excessive payroll costs.

Production-related Overhead Costs

While not always classified as product costs, overheads such as utilities, maintenance, and depreciation of kitchen equipment or room furnishings also contribute to the total cost of providing a service. Though they are indirect, managing these costs effectively can significantly impact profitability.

Waste and Spoilage

In hospitality, especially in food and beverage operations, waste and spoilage are inevitable. However, these can be minimised with proper inventory management and portion control. The costs associated with waste directly affect the overall product cost, and reducing waste can lead to significant savings.

Packaging and Service-related Costs

These are the costs of packaging for take-away services, or any other additional costs tied to delivering the product to the customer, such as transportation for room service meals.

Case Study

Product Costs – Pauanui Ocean Resort

Pauanui Ocean Resort provides high-end accommodation and features a fine dining restaurant renowned for its locally sourced menu. The management team is responsible for continuously reviewing costs and exploring opportunities to make savings where possible through supplier contracts, reducing waste, introducing energy efficiencies etc. Managing product costs is crucial for the resort in order to balance profitability with offering a premium guest experience. Analysis of monthly product costs for running the resort show an average of $70,000 per month, and a breakdown of those costs looks like this:

1. Food Costs $25,000

Pauanui Ocean Resort’s restaurant offers a menu that includes fresh seafood, locally sourced meats, and organic produce. Monthly food costs are significant, accounting for $25,000. The challenge lies in sourcing high-quality ingredients while managing supplier contracts and preventing waste in the kitchen.

2. Beverage Costs $10,000

With a focus on premium wines and artisanal cocktails, the resort’s costs are approximately $10,000 per month. Effective inventory management and pricing strategies are essential to maintain a balance between cost and profitability.

3. Housekeeping Supplies $5,000

For guest room maintenance, the resort spends $5,000 per month on housekeeping supplies, including cleaning products and luxury toiletries. Efficient use of these supplies helps control costs without compromising service quality.

4. Direct Labour Costs $30,000

The resort’s chefs, kitchen staff, waitstaff, and housekeeping team are vital to delivering exceptional guest experiences. Monthly labour costs amount to $0,000, making this one of the largest expenses for the resort. Scheduling and staff optimisation are critical to ensuring costs remain manageable.

Revenue and profit are the drivers of a business’ success and are key indicators or its financial health. These terms are often used together, but have different meanings which must be understood:

Key Terms

Revenue

Revenue is the money generated from normal business operations but does not include any costs from doing business. It known as the “top line” figure or “gross” amount a business brings in.

Profit

Profit is the money remaining after the costs of doing business are deducted from the revenue brought in. If the revenue is more than the costs associated with conducting business, then there is a profit. However, if the costs are greater than the revenue the result is a loss.

COGS

COGS is an acronym for Cost of Goods Sold and refers to the direct costs incurred in the production of good or services and includes the cost of raw materials and direct labour. It does not include indirect costs such as overheads or operating expenses. Typical COGS for a hospitality business include food ingredients, beverage purchase, housekeeping supplies and labour (salaries, wages of staff involved in the delivery of the products and services of the business).

Gross Profit

Gross profit is the profit made after direct costs associated with production and selling (COGS) have been deducted from the revenue brought in but does not include costs such as overheads, administration and taxes and can be represented by the equation:

Gross Profit=Total Revenue-COGS

Contribution Margin

Contribution margin appears similar to Gross Profit but is used in a slightly different way. Contribution margin focuses on the profitability of individual products or services and is calculated by subtracting the variable costs associated with production or sales from the selling price. This gives you a profit margin per unit and shows how much each unit contributes to profitability and is a metric used to identify the performance of individual products or services.

Net Profit

Net profit is the best indicator of an organisation’s performance, as this is a calculation of the profit made after ALL costs incurred by the business have been deducted. These costs include the direct costs included in the gross profit calculation, with other costs (e.g. interest, taxes etc.) have also been accounted for. Net Profit can be represented by the equation:

Net Profit=Total Revenue–Total Expenses

Revenue Streams

There are many possible revenue streams available to a hospitality business, depending on which area of the industry it occupies. Some examples are:

Accommodation

This is the income generated from renting out rooms or other lodging facilities. The occupancy rate, average daily rate (ADR), and revenue per available room (RevPAR) are critical metrics for measuring accommodation revenue.

Food and Beverage

Restaurants, bars, and catering services contribute significantly to a hospitality business's revenue. This stream is influenced by factors such as menu pricing, guest spending habits, and the popularity of dining options. One key metric to measure revenue for F&B is revenue per available seat hour (RevPASH). Read this article for more information on what the metric is and how to calculate and use it.

Events

Hosting events, such as weddings, conferences, and banquets, can be a substantial source of revenue. Successful event management requires efficient pricing strategies and cost control to ensure profitability.

Ancillary

This includes income from additional services such as spa treatments, tours, room service, and other guest amenities. Ancillary services can enhance the guest experience while contributing to overall revenue.

Online/Direct Bookings

Revenue generated from direct bookings through a business’s website or third-party platforms is increasingly important. Maximising online revenue requires effective marketing strategies and managing commission fees.

Profitability Management

Profitability in the hospitality industry is determined by the ability to control costs while maximising revenue.

Profit Margin is a key metric in profitability management which expresses profit as a percentage of revenue. For example, if a restaurant generates $100,000 in revenue and has a net profit of $20,000 then its profit margin = (20,000/100,000)*100 = 20%.

To improve profit margin, a business needs to control costs, review pricing strategies and increase revenue.

Break-even analysis is a crucial financial tool used by hospitality businesses to determine the point at which total revenue equals total costs, resulting in neither profit nor loss. This point is known as the break-even point (BEP). Understanding the break-even point allows managers to make informed decisions about pricing, cost control, and profitability.

Video Title: Break Even Point (in sales dollars) Example
Watch Time: 2:51 minutes
Video Summary: An explanation of how to calculate a break-even point for selling an ice cream cone.
Source: YouTube Channel Edspira

Components of Break-even Analysis

Fixed Costs

These are costs that do not change with the level of business activity. For a hospitality business, fixed costs include expenses like rent, insurance, and permanent staff salaries. These costs must be paid regardless of how many guests or services are sold.

Variable Costs

Variable costs fluctuate with the level of business activity. In hospitality, this includes costs like food and beverage ingredients, housekeeping supplies, and wages for hourly staff. These costs increase or decrease based on how many customers the business serves.

Sales Revenue

Sales revenue is the income the business earns from selling its products or services. In a hospitality context, this could be from room bookings, restaurant sales, or event hosting. Sales revenue is key to understanding how much money the business brings in before deducting any costs.

Contribution margin

Contribution margin is the difference between sales revenue and variable costs. It shows how much money is left after covering the variable costs, which then contributes to covering the fixed costs and generating profit. The higher the contribution margin, the quicker the business can reach its break-even point.

Break-even Point

The break-even point is the point at which total revenue equals total costs, resulting in neither profit nor loss. It can be calculated by dividing total fixed costs by the contribution margin per unit. This calculation tells the business how many units it needs to sell (or services it needs to provide) to cover all its costs.

Calculating the Break-even Point

The contribution margin and contribution margin ration can be calculated according to the formulae:

The break-even point can be calculated according to the formula:

For businesses dealing with multiple revenue streams, the break-even point can be expressed in terms of total sales revenue needed to cover all costs:

Case Study

Break-even Point Calculations

A boutique hotel has costs and revenues as follows:

• Fixed costs: $200,000 per year, including rent, salaries and utilities
• Variable cost per room night $50, including cleaning, guest amenities and utilities
• Average room rate $150

Break-even point calculation:

1. Contribution Margin per Room Night (i.e. units): Contribution Margin = 150-50=$100
   So the Contribution Margin is $100 per Room Night
2. Break-even Point in Room Nights (i.e. units): Break-even point = 200,000/100=2,000
   This means the hotel needs to sell 2,000 room nights per year to cover all of its costs. Any further room nights sold will contribute to profit.

Video Title: Break Even Analysis using Excel
Watch Time: 9:30 minutes
Video Summary: A step by step guide to creating a spreadsheet to calculate break-even point and to then create a chart showing the break-even analysis. The chart created can be used to show the break-even information in other presentation documents, such as a business plan.
Pre Watch Question: You will be able to download a copy of an Excel spreadsheet template which is formatted according to the example in this video. In addition, the template has another example with more data points, and also includes a third (blank) sheet for you to practice with other data and to enter your own data for calculating the BEP for your new product or service..

Source: YouTube Channel: Steve Lobsey
Post Watch Task: Complete the activity below.

Download your copy of the Excel spreadsheet here.

Using The Break Even Analysis To Make Decisions

Understanding the implications of the Break Even Analysis is an important task for a manager. The information it provides allow the manager to react to a volatile business environment and understand what changes need to be made to ensure maximum profitability for the organisation. Using the boutique hotel case study for example, think about what you would do if it is realised that the Break-even Point of selling 2,000 room nights in a year cannot be reached. There are some options open to the manager to make changes in reaction to this and to ensure profitability is maintained.

New analysis shows that only 1,700 room nights are forecast to be sold in the current year

What should the new room rate be to make a Break-even Point of 1,700 room nights work?

(If you can’t work this out yourself, there is a sheet in the Excel template provide to help you calculate this!)

Importance of Break-Even Analysis in Hospitality

Break-even analysis helps hospitality managers to maximise the potential of their business in many ways, including:

1. Set Pricing: By understanding the break-even point, businesses can set prices that ensure all costs are covered and desired profit margins are achieved.
2. Make Investment Decisions: Knowing the break-even point aids in assessing the financial feasibility of new investments, such as expanding facilities or launching new services.
3. Manage Costs: By analysing fixed and variable costs, managers can identify areas for cost reduction, helping to lower the break-even point and improve profitability.
4. Plan for Seasonality: Hospitality businesses often experience fluctuations in demand due to seasonality. Break-even analysis helps in planning for off-peak periods by ensuring that pricing and cost control measures are in place to maintain profitability during slower times.

Cash flow projection is a vital financial management tool for hospitality businesses. It involves forecasting the expected cash inflows and outflows over a specific period, typically on a monthly or quarterly basis. The goal is to ensure that the business has enough cash on hand to meet its obligations, such as paying staff, suppliers, and other operating expenses, while also being able to invest in growth opportunities.

Importance of Cash Flow Projection

In the hospitality industry, where cash flow can be highly variable due to factors like seasonality, demand fluctuations, and economic conditions, having a clear cash flow projection is essential for maintaining financial stability. Without accurate cash flow forecasting, even profitable businesses can face liquidity challenges, leading to difficulties in paying bills or seizing new opportunities.

Components of Cash Flow Projection

Cash Inflows

• Revenue from Operations: This includes all cash generated from the core activities of the business, such as room bookings, restaurant sales, and event hosting. In cash flow projections, it's important to estimate when this revenue will be received, as there may be delays between bookings and payments.
• Other Income: This could include interest earned on savings, grants, or one-time revenue sources like asset sales.

Cash Outflows

• Operating Expenses: These include all the regular expenses required to run the business, such as wages, utilities, rent, and the cost of goods sold (COGS). Accurate estimation of these costs is crucial for understanding the business's ongoing cash needs.
• Capital Expenditures: Investments in property, equipment, or renovations are considered capital expenditures. While these are not regular operating expenses, they are significant cash outflows that need to be planned for.
• Debt Payments: Any loans or interest payments that need to be made should be accounted for in the cash outflows. Failing to plan for debt repayments can lead to liquidity problems.

Net Cash Flow

The difference between total cash inflows and total cash outflows for a specific period. If inflows exceed outflows, the business has positive cash flow; if outflows exceed inflows, it has negative cash flow. Understanding net cash flow helps the business plan for surpluses or shortages in advance.

Opening and Closing Cash Balance

The cash flow projection begins with the opening cash balance (the amount of cash the business has at the start of the period). The closing cash balance is calculated by adding the net cash flow to the opening balance. This closing balance then becomes the opening balance for the next period.

Sales Forecasting

Sales forecasting differs from cashflow forecasting in its focus and purpose but is also an important metric for hospitality managers to use. It is the basis for determining future growth and making decisions about expenses, profits and staffing. Sales forecasting focuses on when sales are expected to occur, regardless of when the cash will be received.

• Focus: Sales forecasting focuses on predicting the revenue that the business expects to generate from selling its products or services over a future period. It estimates the quantity of goods or services that will be sold and the expected revenue.
• Purpose: The main goal of sales forecasting is to guide business planning in areas like production, inventory management, staffing, and marketing. It helps businesses set realistic sales targets and align their resources accordingly.
• Data Involved: Sales forecasts are based on historical sales data, market trends, customer behaviour, and sales strategies. It involves projecting future sales volumes and the associated revenue, but it does not account for the timing of cash inflows and outflows.
• Outcome: The outcome of a sales forecast is a projection of future revenue, which can be used to set business goals, plan marketing and sales efforts, and manage inventory and production.

A sales forecast is a process of estimating future sales, so the figures you project are unlikely to be 100% accurate. Therefore a sales forecast should be treated as a live document and be updated frequently. Estimating sales is not an easy task. Some of the ways to work out sales estimates per sales period include:

• Educated guess – based on the current business environment and your own experience
• Sales volume of existing products
• Talking to stakeholders – customers, potential customers, suppliers etc.
• Conduct surveys
• Pilot the new product/service.

A Profit and Loss forecast (P&L forecast) is a projection over a period of time of the revenue generated by selling products or services and how much profit will be made after deducting expenses and can be expressed as a simple equation: Profit = Revenue – Expenses. A P&L statement includes the following information:

• Revenue: This is the money your business earns from all sources, before you pay expenses, taxes and other bills.
• Direct Costs: The amount of money needed to make the product or service you are selling.
• Gross Margin: Revenue minus Direct Costs
• Operating Expenses: The cost of running the business (aka overheads): rent, marketing etc.
• EBIT (Earnings Before Interest and Taxes): Gross Profit (i.e. gross margin minus operating expenses)
• Interest: Interest payable on loans
• Taxes: Taxes liable on profits
• Net Profit: The bottom line – i.e. the actual amount of money the business makes after paying all of its expenses, including taxes. This is the true indicator of the health of the business.

P&L Statement Example

Developing a Budget

A budget provides an estimated picture of expenditure and income over a specified period of time. The budget should be used to drive decisions on spending or reducing spending – for example on marketing or hiring staff. It is also used to direct the allocation of resources and for the evaluation of performance. A budget should itemise:

• Estimated revenue
• Fixed and variable costs
• Planned profit

Steps in Developing a Budget

A completed yearly budget might look similar to this:

The final step in the Financial Planning section is to create an Executive Summary. This is a document written once the business plan is complete and is a brief summary of the key information the business plan contains and is used to head up the plan. The executive summary should contain:

• A statement identifying the market need or gap which you have identified
• A statement outlining how your product or service concept provides a solution to a perceived problem or gap in the market.
• The intended target market.
• A description of your sales and marketing strategy
• A summary of key financial details.

You’ve reached the end of the learning material for this topic and for this course. You should be well into creating the financial plan you need to provide for your new hospitality product or service for Assessment DHM603A1, so make sure you are on track and go back through the information and activities to help you.