HOSP ITAL I TY

F I N A N C I A L

MANAGEMENT

HOSP I TAL I TY

F I N A N C I A L

MANAGEMENT

Agnes L. DeFranco & Thomas W. Latt in

J O H N W I L E Y & S O N S , I N C .

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Library of Congress Cataloging-in-Publication Data:

DeFranco, Agnes L., 1961–

Hospitality financial management / by Agnes DeFranco & Thomas Lattin.

p. cm.

Includes index.

ISBN-13: 978-0-471-69216-4 (cloth)

ISBN-10: 0-471-69216-6 (cloth)

1. Hospitality industry—Finance. I. Lattin, Thomas W. II. Title.

TX911.3.F5D44 2006

647.94068�1—dc22

2006007280

Printed in the United States of America

10 9 8 7 6 5 4 3 2 1

CONTENTS

Preface ix

Acknowledgments xi

1 Finance and the Hospitality Industry 1

Introduction 5

Hospitality Industry Financial Challenges 6

Chapter Structure 8

Chapter Topics 9

2 Financial Reporting 15

Financial Reporting 17

Accounting as the Language of Business 17

Financial Statements 21

Management Reports 25

Accounting System—CP 3 System 38

3 Analyzing Financial Statements 53

Analysis of Financial Statements 56

Readers of Financial Statements 56

Types of Analyses 57

Management Decision Making 74

Readers of Financial Statements Beware! 78

4 Managing Working Capital and Controlling Cash 91

Managing Working Capital and Controlling Cash 94

Working Capital 94

Cash 97

5 Growing the Business 112

The Need for Growth 115

Shareholder Value 115

Other Benefits of Growth 118

CONTENTSvi

Growth Strategies 120

Increase Sales and Productivity of Existing Properties 120

Expansion of Physical Facilities 122

Franchise Brand Rights 123

Secure Additional Management Contracts 124

Mergers and Acquisitions of Competitors 125

Going Public 125

6 Financing Growth 134

The Need for Capital 138

Capital 139

Loan Terminology 145

Types of Loans 147

Sources of Loans 150

Equity 153

Hotel Financing Trends and Schemes 158

The Golden Age of Hotel Financing 159

Savings and Loans 159

Investment Tax Credits 159

Influx of Foreign Capital 159

Accelerated Depreciation 160

Real Estate Tax Shelters 160

The Tax Reform Act of 1986 160

The Resolution Trust Corporation (RTC ) 160

New Financing Schemes 161

7 The Time Value of Money 177

Concept of Time Value of Money 179

Time Value of Money 179

Market Value 180

Calculating Time Value of Money 182

Time Period and Compounding 205

8 Investment Analysis 221

Investment Analysis 223

Weighted Average Cost of Capital (WACC ) 224

Discount Rate 225

Capitalization Method of Valuation 226

Investment Analysis Tools 227

Factors Affecting Tools of Investment Decisions 236

9 Hospitality Industry Applications of Time Value of Money

Concepts and Skills 247

Time Value of Money Applications 250

Loan Questions 250

Equity Questions 256

CONTENTS vii

Use of Sensitivity Analysis 258

Hospitality Applications 259

Using ROI, NPV, and IRR 271

10 The Investment Package 286

The Need for an Investment Package 289

Executive Summary 291

Fact Sheet 291

Business Plan 294

Source and Use of Funds 295

Photographs or Renderings 297

Third-party Confirmation 298

Project Budget 298

Qualifications of Project Team 301

Investment Analysis 302

Personal Financial Data 302

Evaluation of the Investment Package 302

Lenders: Debt 303

Owner/ Investor: Equity 304

11 Crafting and Negotiating the Deal 315

The New Business Venture 318

The Business Entity 319

The Debt and Equity Mix 325

Negotiating Loans with Lenders 325

Principal 327

Interest Rate 328

Points Charged 328

Additional Collateral 328

Personal Guarantees 329

Other Lender Issues 329

Deal Sponsor’s Goals 330

Negotiating the Equity Investment 331

Amount of Equity 332

Percentage of Ownership 332

Investor Hurdle Rates 333

Exit Strategy and Decision-making Power on When to Sell 333

Negotiating Skills 333

Be Prepared 333

Be Professional 334

Use Proven Selling Skills 334

12 Tying It All Together 345

Introduction 348

Hospitality Industry Financial Challenges 348

CONTENTSviii

Financial Reporting 349

Analysis of Financial Statements and Management Reports 350

Analysis of Financial Statements 350

Analysis of Industry Reports 351

Applications of Financial Analyses 351

Managing Working Capital 351

Growing the Business 352

Shareholder Value 352

Increasing Shareholder Value 352

Other Benefits of Growth 353

Growth Strategies 353

Financing Growth 356

Types of Capital 356

Cost of Capital 356

Mix of Capital 356

Investment Analysis 357

The Time Value of Money 357

Investment Analysis Methods 358

Favorable or Unfavorable? 358

Factors Impacting the Analysis 359

Hospitality Industry Applications 359

Debt and Equity Negotiations 359

The Investment Package 360

What Lenders Want to Know 360

What Equity Investors Want to Know 361

Crafting and Negotiating the Deal 362

Business Decisions to Make 363

Negotiating the Loan 363

Negotiating the Equity Investment 363

Negotiating Skills 363

Index 365

PREFACE

Our goal in writing this book is to present a practical approach to hos-

pitality financial management that provides students with a clear de-

scription of the financial management concepts, skills, and tools they

need to become successful managers or entrepreneurs in the hospitality indus-

try. The target audience for this applied finance book is undergraduate students

taking a hospitality financial management course. However, it can also be used

as a supplementary text in a graduate-level hospitality financial management

course. Hospitality Financial Management is entrepreneurial in nature and em-

phasizes that to succeed in the world of business, whether you work for a large

or small company, a public or private company, for others or yourself, you must

always think like an owner while acting like a manager. The more you assume

that the money you are spending, collecting, and investing is your own, the

better business decisions you will make and the more financial rewards you will

earn.

The unique and colorful image incorporated in the cover of this text is a

photograph of the Portland Head Light, a famous and historic lighthouse in

Cape Elizabeth, Maine, which was first lit in 1791. We chose this scenic land-

mark because it symbolizes the essence and entrepreneurial spirit of the hos-

pitality industry and small business.

Pedagogical Features That Help Students

F E AT U R E S T O RY: Each chapter begins with a Feature Story, based on a real-

world restaurant, hotel, or small business, that relates to the financial concepts

presented within the chapter. An additional Feature Story is also included

within the body of the chapter.

PREFACEx

L E A R N I N G O U T C O M E S : A list of Learning Outcomes follows each chapter’s Feature Story. This

list highlights the key concepts covered in the chapter.

P R E V I E W O F C H A P T E R : A Chapter Preview outlines the main topics and subtopics within each

chapter.

T H E R E A L D E A L : Boxed inserts in each chapter emphasize the relevance of the text content by

relating financial concepts to fun facts relating to situations students either have or will en-

counter in their everyday lives.

F I N A N C E I N A C T I O N : Finance in Action problems provide real-world scenarios where a particular

calculation or analysis relating to chapter-specific concepts is needed. A stepped-out solution is

provided for each problem to walk the student through the necessary financial calculations.

A P P L I C AT I O N E X E R C I S E S : Application Exercises at the end of each chapter reinforce student

comprehension of the key concepts presented in it.

C O N C E P T C H E C K S : Mini-cases with discussion questions based on real-world situations are in-

cluded at the end of each chapter to enhance student understanding.

W H E R E W E A R E G O I N G , W H E R E W E H AV E B E E N : This section summarizes what has been covered

in a particular chapter and what will be covered going forward in the text.

K E Y P O I N T S : A bulleted list of the key concepts related to each of the learning outcomes pre-

sented at the beginning of each chapter appears within the end-of-chapter material.

K E Y T E R M S : These are bolded when they first appear within the chapter and then listed at the

end of each chapter with their definitions.

Resources for Instructors

I N S T R U C T O R ’ S M A N U A L : Includes lecture outlines, quizzes, solutions to application exercises

and concept checks, and a test bank.

C O M PA N I O N W E B S I T E : Includes electronic files for the Instructor’s Manual with Test Questions

and PowerPoint slides containing lecture outlines for every chapter.

ACKNOWLEDGMENTS

Books are not written single handedly. We are grateful to Ms. Tanya Venegas and Ms. Jacqueline

Lee, both graduates of the Conrad N. Hilton College, for their very able assistance in researching

the feature stories that appear in each chapter and developing the exercises and concept checks

that appear at the end of each chapter. We also wish to thank the following individuals for

providing much of the material used for the numerous illustrations throughout the book: John

Bowen, Cathleen Baird, Alan Gallo, Brian Hanna, David Manglos, R. P. Rama, Albert Ramirez,

Arlene Ramirez, Michael Scott, and Rosa Tang.

Special thanks are also due to Randy Smith and Mark Lomanno of Smith Travel Research

and Frank Wolfe of the Hospitality Financial and Technology Professionals for their generosity

in sharing their knowledge and publications. We also wish to thank Joseph Jackson, Tom Latour,

and Chuck Warczak for their valuable contributions, insights, and, most of all, their time and

patience during our interviews. We also appreciate all the efforts Cindy Rhoads and Nigar Hale

of John Wiley and Sons have made to make this project a pleasure.

Also, we would not be able to ensure this book will meet the needs of our target audience

without the expertise and excellent suggestions provided by our reviewers. For this, our thanks

go to: Rhomi Kher, International College of Hospitality Management; Woody Kim, School of

Hotel and Restaurant Administration at Oklahoma State University; Don St. Hilaire, The Collins

School of Management at California State Polytechnic University at Pomona; and Jenny Staskey,

Northern Arizona University.

This book is dedicated to Dr. Gerald and Jean Lattin, who encouraged us to write it and

have served as role models to both of us throughout our careers in the world of business and

academics; to our spouses, Linda Lattin and John DeFranco, who have been so supportive and

understanding of the many hours it has taken to write this book; and to the professors, teachers,

and trainers who will, we trust, find this book a valuable and useful tool when preparing our

young people for a career in the exciting and financially rewarding hospitality industry.

AGNES DEFRANCO

THOMAS LATTIN

University of HoustonHouston, Texas