Finance in Hospitality Industry

Table of Contents
Introduction ................................................................................................................................ 1 Industry Background .................................................................................................................. 1 1: Understanding Sources of Funding and Income Generation for Business and Service Industry ...................................................................................................................................... 2 1.1 Sources of Funding .......................................................................................................... 2 1.2 Evaluation of income generating methods ....................................................................... 3 2: Elements of Cost .................................................................................................................... 3 2.1 Elements of Cost, Gross Profit Percentage and Selling Price for Product and Services . 3 2.2 Evaluation of Methods of Stock Controlling and Cash in a Business and Service Environment ........................................................................................................................... 5 3: Evaluating Business Accounts ............................................................................................... 6 3.1 Sources and Structure of the Trial Balance...................................................................... 6 3.2 Business Accounts, Adjustments and Notes .................................................................... 7 3.3 Process and Purpose of Budgetary Control ..................................................................... 9 3.4 Variance from Budgeted and Actual Figure .................................................................. 10 4: Analysis of Business Performance by the Application of Ratios ........................................ 11 4.1 Ratio Analysis ................................................................................................................ 11 4.2 Recommendations .......................................................................................................... 12 5: Concepts of Marginal Costing ............................................................................................. 12 5.1 Categorise Costs............................................................................................................. 12 5.2 Contribution per Customer and the Cost Relationship .................................................. 13 5.3 Profit and Loss Potential ................................................................................................ 13 Conclusion ............................................................................................................................... 14 References ................................................................................................................................ 15 Appendix .................................................................................................................................. 16

Table of Figure
Figure 1 Sectors of the Hospitality industry .............................................................................. 2 Figure 2 Cost Element ............................................................................................................... 4 Figure 3 Nominal Ledger ........................................................................................................... 7 Figure 4 Horizontal format of Profit and Loss Account ............................................................ 8 Figure 5 Format of Balance Sheet ............................................................................................. 8 Figure 6 Format of Balance Sheet ............................................................................................. 9 Figure 7 Process of Budgetary Control ...................................................................................... 9 Figure 8 BEP Analysis ............................................................................................................. 14

List of Tables
Table 1Trial Balance .................................................................................................................. 6 Table 2 Restaurant Budget ....................................................................................................... 10 Table 3 Comparison of Budgeted and Actual Figure .............................................................. 10 Table 4 Summary of Final Accounts ....................................................................................... 11 Table 5 Ration Analysis ........................................................................................................... 11

Introduction
UK hospitality industry is a varied and broad industry which is ranging from organization of a single person to worldwide corporations. This industry plays a major role in economic recovery in UK. Prime minster of UK, David Cameron has placed as the heart of UKs economic recovery (Sweetland, 2010). But like all other industries hospitality also require finance to operate its functions. Finance can be defined as the key success factor for any business as it has own importance from stating of a business to till the end. This report will interpret and explain the basic financial information as well as accounting tools in the context of hospitality industry in UK. This report includes the study of fundamental principles of accounting including control system, income generation and methods of measuring and analysing costing. The aim of this report is to provide the understanding of accounting techniques to reader and support managers in making effective short term decisions about finance. This report will be divided into five different parts; each of them has their own importance. The first part will describe about sources of funding and income generation for business and service industry. The next will provide the study of business in term of the elements of cost. The third phrase will evaluate the business accounts then next will analyse the business performance by the application of rations. Fifth part will apply the concept of marginal costing in within hospitality industry. At last conclusion part will provide a summary of this report.

Industry Background
Hospitality is the fifth largest industry in UK which is directly employing about 2.4 million people along with this it also has contribution of about 34 billion in revenue from gross tax to UK government (London Council, n.d). UK hospitality industry is not bounded in just hotel and restaurants; it has 12 different sectors shown as bellow:

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Figure 1 Sectors of the Hospitality industry (Source: Pearson Schools, nd.)

1: Understanding Sources of Funding and Income Generation for Business and Service Industry
1.1 Sources of Funding Sources of funding identify those sources from where an organization can collect fund for their functions (Thorn and lack, 1977). There are various sources available to the companies for arrange their finance like retained profits, banks loans, investors, small business schemes, hire purchase, sponsorship, lease schemes, etc. Choosing an appropriate source is depends on the nature of business. Some of the major sources of funding are as below: Retain Earning: it is the key source of funding which as no costs. Company can use earned profits rather than distributing them in shareholders or other participants. Bank Loans: company can take help from banks for arranging required fund. Banks provide loans under various offers and company can get the fund from them on a particular rate of interest which has to be paid by the company on annual or monthly bases. Government grants: government offers various schemes under which company can get the fund on less interest compare to bank. Company can arrange fund from central government, regionally distribution central government funding, local government funding, etc. Rights Issue: Company can ask their existing shareholders to buy additional shares these additional shares are issued on a fix price within a fix time frame. Special Financial Institutions: there are number of financial institutes in UK which provides loans to business. These institutes are set up by the state and central governments for 2|Page

expansion of business as well as service industry in UK. Some of these institutes are enlargement monetary institutions and expansions banks (European parliament, 2011). Leasing: It includes an agreement between companies and the lesser that company will use the equipment other than owning it and will pay rent to lesser for this. 1.2 Evaluation of income generating methods As hospitality industry has number of sectors and each sector has their different source of revenue. Hotels, restaurants and tourism are major sector of hospitality and represent the largest part of total revenue of this industry. The major source of revenue is always the sale of goods and services. Hospitality industry generates most of the revenue through selling of services in various sectors. Sector wise sources of revenue in hospitality industry: Hotels: hotel provides rooms like sleeping room and meeting or function room and provides food and beverage outlets as well. Many of the hotels have bars and pubs which provides additional income to the hotel. There are about 577 hotels in UK with average hotel size of 182 bedrooms and the average room rate is about 140.19 (Langston, 2012). Restaurants: restaurant generates their income through selling of food products and drinks. There are more than 71 thousand restaurants in UK which has total revenue of about 19bn (productive investors UK, 2010). Tourism: UK tourism is one of the major sources of income in hospitality industry. Tourism generate income through accommodation services for visitors, food and beverage serving, railway, road, water and air passenger transport services, travel agencies and other reservation services. Total revenue from tourism was about 125bn in 2011 (Tourism alliance, 2012). Other then these three other sectors like gambling, holiday parks and membership clubs also contribute in income of hospitality industry.

2: Elements of Cost
2.1 Elements of Cost, Gross Profit Percentage and Selling Price for Product and Services Elements of cost: there are three elements of cost bases on the system of business as material, labour and expenses. All the three elements can be direct and indirect.

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Figure 2 Cost Element (Source: Harries and Hazzard, 1992) The above figure indicates the classification of various elements of cost. In a hotel and restaurant business it would be food and beverage (material), salaries, overtime and wages (labour), energy, advertising, cleaning, insurance, guest supplies, laundry and travel agents commotion (expenses). In tourism sector transportation, fuel, accommodation and food are the major elements of cost. Gross Profit Percentage: This is a very significant term in accounting under hospitality industry. This is the most widely used profitability ratio which calculates the percentage of profit on the basis of sales revenue and cost of goods or services sold. It is used as the major control mechanism over various costs (Kotas and Conlan, 1997). For example if a retardants required gross profit 65% of the sale then material + wages + expenses would be 35 percent. This present can be calculated as:

Selling Prices for Product or Services: Deciding the price of product or services is one of the most important decisions for any organization. The competition in hospitality industry does not allow managers to set their prices too high and low prices will not allow them to provide all faculties which can satisfy their customers (Wasserman, 2010). So it is very important to

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set such a price range which can lead them to higher number of customers as well as high customer satisfaction. Price = Cost (Material + Expenses + wages) + Profit Selling price of a product or service depends on the cost and profit margin of the company. Each company tries to minimum their costs so that they can get maximum profit on a fix price of service. 2.2 Evaluation of Methods of Stock Controlling and Cash in a Business and Service Environment In order to optimum utilization of fund it is very important to manage a flexible amount of cash as well as stock. Stock control indicates that how much stock company should have in a particular time frame and how to maintain this quantity. Hotels and restaurants have to maintain a fix amount of stock for food and beverage services so stock controlling is very important. A big amount of stock can block the fund and less stock can result shortage of it when needed. There are number of stock controlling methods which can be used by hotels and restaurants to maintain a sound quantity of stock, they can also use mixture of two or more methods. Minimum stock level: Hotels can identify a minimum level of stock and re-order when it reaches to this level. Stock review: Hotel can review their stock on regular basis and after every review it and order can be placed for predetermined level of stock. Cash controlling represents the liquidity of company. Hotels are the only place where a customer enjoy credit facility from the time he check-in and it is very impotent for hotel to maintain a sound amount of cash in hand so that it can fulfill every requirement of their customers. There are number of methods which can be used for cash controlling some them are as below: Petty cash fund: hotel can maintain a petty cash fund and maintain their cash according to it. It includes a fix amount of cash and based on the documented expenditures. It focus on maintain a fix amount. Electronic funds transfer: this is more appropriate method of maintaining cash. Hotel can transfer its all receipts directly to bank account rather than collecting cash and make payments through it (Needles and Powers, 2008).

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3: Evaluating Business Accounts

3.1 Sources and Structure of the Trial Balance Trial Balance can be defined as an accounting statement that includes the summary of all accounting ledgers. By doing so the accuracy of accuracy of double entry is checked. It is structured as a list where heading raw contains the heading of trial balance along the name of company and date of preparation. There are three parts particulars, debit and credit. The name of ledgers is mentioned in particulars and their balance is noted down accordingly in debit or credit side. An example of trial balance is being provided below: Table 1Trial Balance Trial Balance of The Hotel for the Year Ended March 31, 2012 Particulars Cash Balance Credit Card Receivable Prepaid Insurance Building Food Inventory Beverage Inventory Equipment Accounts Payable Payroll Payment Sales Capital Notes Payable Cost Of Goods Sold Salaries Wages Misc. Expenses Depreciation Utility Expense Total Of Accounts Nominal Ledgers: Debit 50000 1000 1500 150000 2000 1000 800 2000 1000 500000 120000 4000 120000 5000 1200 3000 500 1000 237000 Credit

237000

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Figure 3 Nominal Ledger 3.2 Business Accounts, Adjustments and Notes Final account of the business represents the various accounting statements of the business at the end of financial year, including Trading, Profit & Loss and Balance Sheet. Trading account contains all those transactions which are directly occurred during trading process and related to goods. Profit and loss account includes all the earnings and expenses during the financial year along with payments and receivables. Balance sheet represents all the assets and liabilities of the company on the end of the year. Adjustment of entries can be done as below: Bad debts: show it into the profit and loss only as an expense. Provision for Bad debts: show in profit and loss account as expense and deduct from debtors in balance sheet Accruals: show as current liability in balance sheet and credit in profit and loss account. Prepayments: include in current assets in balance sheet and debit in profit and loss account. Deprecation: deprecation is treated as an expense in profit and loss account and amount of deprecation is deducted from particular asset. Notes provide detailed information about a trisection. For example if the restaurant charges 100 as bad debts then notes will describe about the debtor who will not make the payment along with date of transaction and other relevant information. Format of Final Accounts: Horizontal Profit and Loss:

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Figure 4 Horizontal format of Profit and Loss Account Vertical Format of P&L: It is the standard format of Profit and Loss Account

Figure 5 Format of Balance Sheet Balance Sheet:

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Figure 6 Format of Balance Sheet 3.3 Process and Purpose of Budgetary Control Budget is a quantitative statement that includes which is prepared prior to a defined time frame and related to a particular policy. Budgetary control represents the process of comparing actual performance with planed in budget.

Figure 7 Process of Budgetary Control (Source: Manven, 2012) The above figure indicates the process of budgetary control first step is planning the budget and identifies the measure of performance, second step is checking the performance. 9|Page

On this step actual performance is compared to budgeted performance. This step indicates that any action should be taken or not. The main purpose of budgetary control is planning, coordination and performance evaluation. Planning includes selecting the criteria of performance, coordination defines to lead according to budget and evaluation indicates the compression of actual performance and budgeted criteria. The key aim of creating cash budget is to be prepared to cover upcoming expenses so that business plans and strategies can work effectively. Other objectives of cash budget are anticipating revenue; anticipating expenses addressing shortfalls and managing funds accordingly. Eg. Sales Budget of Restaurant: Table 2 Restaurant Budget 2009 2010 Restaurant Sales % Increase on Previous year Bar Sales % Increase on Previous Year Sundry sales % Increase on Previous Year Total Sales % Increase on Previous Year 445 0.05 210 0.05 45 0.05 700 0.05 455 0.1 225 0.15 50 0.05 730 0.1 2011 470 0.15 245 0.2 60 0.1 775 0.15

3.4 Variance from Budgeted and Actual Figure Variance analysis provides the understanding of difference between actual figures and standard figures that were defined in budgets. It can be done either for profit, cost or sales. The aim of analysing variance is to identify the loopholes so that improvements could be made. Table 3 Comparison of Budgeted and Actual Figure Budget '00 Restaurant Sales Bar Sales Sundry sales Total Sales 455 225 50 730 Actual '00 450 230 47 727 Variance Favourable '00 or Adverse -5 A 5 F -3 A -3 A

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The above table indicates the actual figure of restaurant for the year 2010 and its comparison from budgeted figure for the same year. All sales are adverse excluding bar sales which is increasing and favourable for the restaurant. Suggestions: Restaurant should focus on quality of food as well as marketing, it well increase their customer base. Restaurant sales are the key element of income the effect of unfavourable variance can be seen in variance of total sale. Other than this restaurant can also review their budget and make changes by setting achievable targets.

4: Analysis of Business Performance by the Application of Ratios

4.1 Ratio Analysis InterContinental Hotels Group: it is a British multinational hotel group headquartered in UK. The balance sheet and of the group is given in appendix (Slomons, 2007); all the ratios would be calculated on the basis of the balance sheet. The below figure has been adopted from final accounts of the group given in appendix. Table 4 Summary of Final Accounts Current Assets Current Liabilities stock NP sales GP 455 643 3 247 960 405 total assets total liabilities total long term liabilities equity NP before tax Shareholders equity 1893 1207 562 686 288 678

Table 5 Ration Analysis Ratio Liquidity Current Ratio Quick Ratio Profitability Net Profit Margin Gross Profit margin Gearing Ratio Debt Ratio Debt to Equity Investment Return Return on Investment Current Assets/Current Liabilities Current Assets-Stock/Current Liabilities Net Profit/Net Sales*100 Gross Profit/Net sales*100 Total Liabilities/Total Assets*100 Total Long term Liabilities/Equity Net Profit Before tax/ Shareholder equity 0.71 0.70 25.73% 42.19% 63.76 0.82 0.42 Formula Solution

The above table presents major ratios of the group, which indicates the financial prostitution of this. 11 | P a g e

4.2 Recommendations Liquidity ratio indicates the liquid position of the group which means how quickly it can arrange the money in negative situations. For an ideal business liquidity ratio should be 1, which means group have enough fund to pay their immediate expenses. Stock is not so quick like other current assets; it indicates that it is hard to convert stock into cash immediately. Group net and gross profit margins are really good on the other hand Debt ratio indicates that group has less debt then their assets which mean group has less risk for investors. Return on investment ratio defines the profit to investors on their investment. On the basis of above ratio analysis below these recommendations can be given to the group: 1. Group should focus on their liquidity and try to increase it. 2. Group can increase their stock for high current ratio. 3. Difference in Gross profit and Net profit indicates that group must be paying a big amount in taxes. Group should focus to maintain a sound amount from gross profit to net profit.

5: Concepts of Marginal Costing

5.1 Categorise Costs Fixed Costs: it includes all those costs which are not depended on sales. No matter how much a hotel or restaurant sells or not, these costs have to be paid by them (Vasigh, Tacker and Fleming, 2008). Eg: for a restaurant or hotel rent of the premises, salary of management, depreciations are fixed costs. Variable Costs: these costs are fully deepened on sales volume. These costs are increase and decrees proportionally with sales. Eg: for a restaurant or hotel food and beverage costs, commission of agents, delivery charges can be included in this category. Semi-variable Costs: these costs are not fully fixed or fully variable, these costs move in sympathy with not in proportion to the sales. Eg: gas, telephone, renewals can be included in this cost. For the above trial balance shown in Table 1 for the hotel, cost categories will be as below: Fixed Costs: Building, Salaries, insurance and Depreciation. Variable Costs: accounts payable, payroll, notes payment, cost of goods sold and wages. 12 | P a g e

Semi-variable costs: Misc. Expenses, utility expenses and equipments. 5.2 Contribution per Customer and the Cost Relationship Contribution margin concept is used with break even analysis. It indicates the amount of money which a company has to cover after paying all variable costs to pay fixed costs (Kotas, 1999). Scenario: Total Fixed costs of the hotel = 157000(150000+5000+1500+500) Total Variable Costs of the hotel= 28200(2000+1000+4000+20000+1200) Average rent of room (Assumed) = 1000 Total rented rooms= 500 (500000/1000) Variable cost per unit= 56.4 (28200/500) The above figures indicate that total hotel rented total 500 rooms in a month with the average room rent of 1000. The total sale of the hotel was about 500000. Total variable cost was 28200 and so contribution of each room is 56.4. BEP Calculation: P = 1000 V/C = 56.4 F/C = 157000 1000X = 56.4X + 157000 1000X 56.4X = 157000 X = 157000/ 943.6 BEP = 166.38 Rooms The above analysis indicates that if the hotel sales only 166 rooms in a month then there will be no profit or no loss situation. 5.3 Profit and Loss Potential Rooms Rent Revenue Fixed cost Variable Cost Profit 150 1000 150000 157000 8460 -15460 160 1000 160000 157000 9024 -6024 166 1000 166000 157000 9362.4 -362.4 167 1000 167000 157000 9418.8 581.2 175 1000 175000 157000 9870 8130 200 1000 200000 157000 11280 31720

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BEP analysis and P & L potential

40000 30000 20000 Profit 10000 0 150 -10000 -20000 Rooms 160 166 167 175 200

Figure 8 BEP Analysis The above chart indicate the Profit and loss potential of the hotel, if the hotel sale less than 166 room then it will have to stand on loss but on the other hand if hotel sale more it will get profit. 166 is the breakeven point for the hotel where it will have no loss, no profit situation.

Conclusion
This present report analysed accounting techniques in context of hospitality industry. Numbers of accounting and financial techniques are used to make a clear understanding of accounting concepts. This report has provided an in-depth study of accounting principles as well as various accounting concepts and book keeping in hospitality.

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References
Books Basigh, B., Tacker, T. and Fleming, K. 2008. Introduction to Air Transport Economics: For Theroy to Application. England: Ashgate Publishing Ltd. Harris, P. J. and Hazzard, P. A. 1992. Managerial Accounting in the Hospitality Industry, 5th Ed. Cheltenham: Stanley Thornes. Kotas, R. 1999. Management Accounting for hospitality and Tourism, 3rd Ed. UK: Cengage Learning. Kotas, R. and Conlan, M. 1997. Hospitality Accounting. UK: Cengage Learning. Needles, B. N. and Powers, M. 2008. Financial Accounting, 9th Ed. New Delhi: Dreamtech. Thorn, P. and Lack, J. 1977. Banking and Sources of finance in the European community. Banker Research Unit, Financial Times Ltd. Online Langston, J. N. 2012. HotStats UK Chain Hotels Market Review November 2012. [Online] Available through: < http://www.hospitalitynet.org/news/4058931.html > [Accessed on 18th January, 2013]. London Council, n.d. Background to the Initiative. [Online] Available through: < http://www.staff-wanted.org/background.html> [Accessed on 18th January, 2013]. Manven, R. 2012. purpose of Budgetary controls. [Online] Available through: < http://accmana3d.tripod.com/id2.html > [Accessed on 18th January, 2013]. Productive investors UK, 2010. Restaurant Group reports revenue and profit growth. [Online] Available through: < http://www.proactiveinvestors.co.uk/companies/news/13982/restaurant-group-reportsrevenue-and-profit-growth-in-2009-13982.html > [Accessed on 18th January, 2013]. Solomons, R. 2007. Group balance sheet. [online] Available through: <http://www.ihgplc.com/files/reports/ar2006/index.asp?pageid=15> [Accessed on 19th January, 2013]. Sweetland, V. 2010. David Cameron on UK Tourism: Industry Reaction. [Online] Available through: <http://www.hotel-industry.co.uk/2010/08/uk-tourism/> [Accessed on 18th January, 2013]. Tourism alliance, 2012. UK tourism Statics. [pdf] Available through: Website: < http://www.tourismalliance.com/downloads/TA_327_353.pdf > [Accessed on 18th January, 2013]. Wasserman, E. 2010. How to price your products. [Online] Available through: < http://www.inc.com/guides/price-your-products.html> [Accessed on 18th January, 2013].

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Appendix
Balance sheet of InterContinental Hotels Group 31st December 2006 ASSETS Property, plant and equipment Goodwill Intangible assets Investment in associates Other financial assets Total non-current assets Inventories Trade and other receivables Current tax receivable Cash and cash equivalents Other financial assets Total current assets Non-current assets classified as held for sale Total assets 2006 2005 m m 997 109 154 32 96 1,388 3 237 23 179 13 455 50 1,893 1,356 118 120 42 113 1,749 3 252 22 324 106 707 279 LIABILITIES Loans and other borrowings Trade and other payables Current tax payable Total current liabilities Loans and other borrowings Employee benefits Trade and other payables Deferred tax payable Total non-current liabilities Liabilities classified as held for sale Total liabilities EQUITY 2006 2005 m m 10 402 231 643 303 71 109 79 562 2 1,207 2 468 324 794 410 76 107 210 803 34 1,631

IHG shareholders' equity 2,735 Minority equity interest Total equity

678 8 686

1,084 20 1,104

2006 for the year ended 31 December 2006 Revenue Cost of sales Administrative expenses m 960 (485) (180) 295 Depreciation and amortisation Other operating income and expenses Operating profit Financial income Financial expenses Profit before tax Tax Profit after tax (64) 27 258 26 (37) 247 41 288

2005 m 1,910 (1,217) (224) 469 (130) (22) 317 30 (63) 284 (80) 204 16 | P a g e

2006 for the year ended 31 December 2006 Gain on disposal of assets, net of tax charge of 6m (2005 38m) Profit for the year Equity holders of the parent Minority equity interest Profit for the year Earnings per ordinary share: Basic Diluted Adjusted Adjusted diluted 104.1p 101.5p 42.9p 41.8p m 117 405 405 405

2005 m 311 515 496 19 515

95.2p 93.1p 38.2p 37.3p

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