Chapter05(Revised)

7/28/2019 Chapter05(Revised)

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Andrew, Damitio, Schmidgall

Financial Management for the Hospitality Industry

2007 Pearson Education, Inc.

Upper Saddle River, NJ 07458

Chapter 5Financial Statement Analysis


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Financial Management for the Hospitality



Three Approaches to

Financial Statement Analysis Horizontal analysis

Vertical analysis

Ratio analysis


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Horizontal Analysis

Illustration: Differences

2009 2010 Dollar %

Cash $10,000 $15,000 + $5000 50%

1. Compares two financial statements2. Shows dollar and percentage differences

3. When reviewing financial statements focus on

significant differences!


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Vertical Analysis1. Financial statements reduced to

percentages

2. Balance sheet:a. Assets = 100%

b. Liabilities & OE = 100%

3. Income statement:net revenue = 100%


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ALPHA Co. BETA Co.

Illustration Dollars % Dollars %

Net revenue $100,000 100% $500,000 100%

Cost of sales 35,000 35 200,000 40Labor costs 30,000 30 150,000 30

Other expenses 30,000 30 190,000 28

Net income $5,000 5% $10,000 2%

Which company has the best performance?Why?


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Ratio Analysis Comparing two related numbers from

financial statements

Expressed as $, %, times, days, etc.

Purposes for managers:

Express goals for business

Track performance of the operation Communicate financial performance

Result must be compared to a standard


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Standards Budget

Prior period

Industry average


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Classes of Ratios Liquidity can the firm meet its short-term

obligations?

Solvency can the firm meet its long-termobligations?

Activity how is management using thepropertys assets?

Profitability how profitable is the business?

Operating how efficient is management inrunning the business?


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Liquidity Ratios Current Ratio indicates relationship between

current assets and current liabilities

Formula: CR = Current Assets/CurrentLiabilities


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Acid-Test RatioAcid-Test Ratio:

A more stringent measure than the CR asinventories and prepaid expenses are excluded

sLiabilitieCurrent

AssetsQuick


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Accounts Receivable Turnover This ratio shows the number of times the average

accounts receivable have been collected.

AR T/O: Total revenue/Average accounts

receivable Note: When comparing figures from a stock

statement (balance sheet) and a flow statement(income statement) use an average for the figuresfrom the balance sheet!


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Average Collection Period (ACP) ACP is another to view the collection of

AR

ACP = 365/AR T/O Expresses average number of days

receivables are outstanding


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Operating Cash Flows to

Current Liabilities Ratio Purpose of ratio is compare operating cash

flows to current debt. (Cash pays the bills, not

CA!)

OCF to CL Ratio = OCF/Average CL


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Liquidity Evaluation IllustrationSelected liquidity ratios for AW Corporation areas follows:

Evaluate the change in liquidity for AWcorporation

2008 2009 2010CR 1.4 1.45 1.5Acid-test 1.2 1.25 1.3AR T/O 12 11 10OCF to CL 70% 72% 74%


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EvaluationThe current and acid-test ratios are increasingthroughout the 2008-2010 period. The ART/O is decreasing resulting in relatively moreaccounts receivable outstanding. ACP was30.4 days at the end of 2008 and increased to36.5 days at the end of 2010. This increaseshould be further investigated. Operating

cash flows are increasing overtime in relationto the current obligations. Overall liquidity isimproving; however, there is some concernregarding accounts receivable.


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Solvency Ratios Two major perspectives balance sheet

and income statement

Balance sheet Debt-equity

LTD to total capitalization

Income statement

Number of times interest earned (TIE) Fixed charge coverage

SCF: OCF to total liabilities ratio


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Debt-Equity Ratio Shows amount of debt for each $1 of

owners equity

DE Ratio: total liabilities/total ownersequity


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Long-Term Debt to Total

Capitalization Ratio Total capitalization = LTD + Owners Equity

Shows LTD as % of total capitalization

LTD to Total Cap. Ratio = LTD/LTD + OE


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Number of Times Interest

Earned (TIE) Indicates the number of times interest can

be covered with income

TIE = EBIT/Interest Expense


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Fixed Charge Coverage Ratio Lease expense is added to the numerator

and denominator of the TIE ratio

FCC Ratio = (EBIT + Lease Expense)/(Interest + Lease Expense)


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Operating Cash Flows to Total

Liabilities Ratio Uses figures from Balance Sheet and SCF

OCF to TL Ratio = OCF/Average

TotalLiabilities


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Solvency Evaluation IllustrationBC, Inc., has solvency ratios for 2008 2010 asfollows:

Evaluate the changing solvency of BC, Inc. overthe three years

2008 2009 2010Debt-Equity 70% 60% 50%LTD to Total Cap. Ratio 41% 38% 33%TIE 4 times 4.2 times 4.4 timesFCC Ratio 3 times 2.8 times 2.6 timesOCF to TL Ratio 20% 22% 24%


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EvaluationBoth the debt-equity and LTD to total capitalizationratios reveal relatively less debt to equity over thethree years. The increasing TIE and OCF to TL

ratios suggest an increasing ability to pay the long-term liabilities. The decreasing fixed chargeaverage ratio suggests lease expense (and mostlikely the number of leases) are increasing over

time. Overall solvency has improved and in partthis has happened by switching to leasing as ameans of finance.


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Activity Ratios Inventory Turnover

Property and Equipment Turnover

Asset Turnover

Non-financial ratio: occupancy


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Inventory Turnover This ratio shows how quickly inventory

is moving

A separate turnover should bedetermined for each type of inventory,

i.e., food, beverage, gift shop etc.


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Food Inventory Turnover

Food Inventory Turnover =

Cost of Food Used: BI + purchases EI

InventoryFoodAverage

UsedFoodofCost


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Food Inventory Holding Period

(FIHP) Provides the average number of days inventory is

held prior to sale

FIHP =TurnoverInventoryFood

365


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Property and Equipment

Turnover (PET) Measures managements effectiveness in using

property and equipment

PET =EquipmentandPropertyAverage

RevenueTotal


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2007 Pearson Education, Inc.Upper Saddle River, NJ 07458

Asset Turnover Ratio Measures managements use of all assets

Asset Turnover Ratio:AssetsTotalAverage

RevenueTotal


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Andrew, Damitio, SchmidgallFinancial Management for the Hospitality


Paid Occupancy Percentage A non-financial key indicator of managements

success in selling rooms

Paid occupancy % =

Rooms sold include all rooms occupied except for

complimentary rooms

Rooms available include rooms that could be soldand generally exclude out-of-order rooms

AvailableRooms

SoldRooms


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Activity Evaluation IllustrationThe Dirk Companys activity ratios over a threeyear period were as follows:

How has managements use of the companysresources changed over the three year period?

2008 2009 2010Food inventory T/O 12 13 14Property and equipment T/O 2 2.1 2.2

Asset turnover 1 1.1 1.2Paid occupancy % 72% 71% 70%


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EvaluationFood inventory is turning more quickly from2008 through 2010 as is both property and

equipment and total assets. This result isconsidered good. Paid occupancy isdeclining slightly. Management appears tobe selling few rooms; however, the ADR

(price per room) could be a major factor.This requires additional managementattention.


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Profitability Ratios These ratios measure the overall

effectiveness of management

Major ratios include: Profit Margin

Operating Efficiency Ratio

Return on Assets

Return on Equity

EPS

PE Ratio


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Profit Margin Measures the profits from sales

Profit Margin = RevenueTotal IncomeNet


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Operating Efficiency Ratio Measures managements performance based

on expenses they control

Operating Efficiency Ratio:

RevenueTotal

ExpensesOperatingstributedafter UndiIncome


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Return on Assets (ROA) Indicator of profitability compared to the firms

assets

ROA = AssetsTotalAverageIncomeNet


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Return on Equity (ROE) Measures profitability of firm compared to

owners investment

ROE = EquityOwners'AverageIncomeNet


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Earnings per Share (EPS)

Shows the amount earned per each share ofowners common stock

EPS = gOutstandinSharesCommonAverageIncomeNet


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Price Earnings Ratio (PE) Reflects the relationship between the market

price per share and the EPS

PE = EPSshareperpriceMarket


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Profitability Evaluation IllustrationThe Mellow Motel Corporations profitability ratios for 2008through 2010 were as follows:

Evaluate the corporations changing profitability over thethree-year period.

2008 2009 2010Profit Margin 6% 6.5% 7%Operating Efficiency Ratio 30% 29% 28%ROA 12% 13% 14%ROE 15% 16% 17%

EPS $2.00 $2.10 $2.20PE 10 11 12


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EvaluationProfit margin is increasing each year even though theoperating efficiency ratio is in decline. ROA, ROE,

and EPS are increasing each year. This suggeststhat greater profits are being achieved by relativereductions in fixed charges such as interest expenseand depreciation. The market appears to be reacting

favorably to these changes since the PE ratio hasincreased from 10 times in 2008 to 12 times in 2010.The market price at the end of 2008 was $20 and atthe end of 2010 it was $26.40.


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Operating Ratios Assist management in analyzing the

operations of the business

Major ratios covered include Average daily rate (ADR)

REVPAR

Food Cost Percentage

Labor Cost Percentage


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Average Daily Rate (ADR) Reveals average price per room sold

ADR = SoldRoomsofNumberRevenueRooms


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REVPAR Measures a combination of paid occupancy %

and ADR

REVPAR = Paid OCC % X ADR


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Food Cost Percentage Key food service ratio that compares the cost

of product (food) sold to product (food) sales

Food Cost % = SalesFoodSoldFoodofCost


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Labor Cost Percentage Reveals the relationship between

labor costs and revenue

Labor cost generally is the highestsingle cost of a hospitality organization

Labor costs include salaries, wages,fringe benefits, and payroll taxes

Ratio should be computed for eachprofit center of the operation


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Labor Cost %

Labor Cost % =

RevenuesalDepartment

CostsLaboralDepartment


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Evaluation of Operations

IllustrationThe Wisker Restaurant Inn has selected operating ratiosfor 2008-2010 as follows:

Evaluate the operating activities of the Wisker Restaurant& Inn over the three-year period based on the above fourratios

2008 2009 2010ADR $85 $86 $87REVPAR $59.50 $59.34 $59.16Food Cost % 34% 33.5% 33%Labor Cost % 30% 29.5% 29%


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Evaluation First, one should be very careful when evaluating anyaspect of business with so few ratios. Even so, these fourratios suggest

Prices are increasing but the amount per room available isdecreasing from 2008 through 2010. This appears tosuggest some price resistance and management shouldundertake further evaluation.

Both food cost and labor cost percentages are decreasingover the three year period. If quality is not sacrificed this isgood from a financial perspective.


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Limitations of Ratio Analysis Only indicators

Must be based on two related numbers

Most useful when compared to a standard

Be careful when comparing financial ratiosof different firms

Are they in the same industry?

Are they using the same or similaraccounting procedures?


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Summary Financial analysis includes horizontal, vertical

and ratio analysis

Ratios can be used to efficiently communicate,

control and set targets

Major classes of ratios include liquidity,solvency, activity, profitability, and operating

Ratios vary in importance to major usergroups

Ratios must be compared to a standard to bemeaningful

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Chapter05(Revised)

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