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Financial Management in the Hospitality Industry

Instructor: James Blackburn

James has an MBA from Auburn University and a MA in Humanities from Cal State-Dominguez Hills He writes on leadership, business strategy and finance.

This lesson reviews the basic concepts of financial management in the hospitality industry. It also explores the concept of yield management used by hotels to maximize revenue.

Finance in the Hospitality Industry

During the winter of 2013, Red Roof Inns, a hotel chain with over 360 properties, used weather data to forecast shifts in demand. This data allowed the chain to market room availability to customers who were likely to experience flight cancellations. Forecasting demand, controlling expenses and adjusting room rates helped the chain capitalize on the 10% gain in occupancy during the 2013-2014 winter season.

Category (in millions) 2013 2014 2015
Revenue $298.90 $403.40 $463.40
Expenses $265.70 $356.30 $383.40
Net Income $5.80 $20.90 $124.40
Expense % 88.9% 88.3% 82.7%
Net Income % 1.9% 5.2% 26.8%

Disciplined financial management was very instrumental in helping Red Roof Inns grow to over 400 properties. Strong financial planning, fiscal control and decision-making improved net income from 1.9% to 26.8% of revenue over a two year period. Let's review some basic financial concepts.

Managing for Profitability

Financial Planning

Financial planning starts with the sales forecast. The sales forecast is used to establish the revenue for the budget. The finance manager acts as a reality agent to ensure sales forecasts are realistic and achievable. If the forecast is wrong, the foundation for the budget is flawed. Finance also works with departments to create operating budgets. These budgets include expected revenue, employee headcount, occupancy costs and other expenses.

Most companies use prior-year revenue and expenses as a guide for the current year. However, flexible and zero-based budgets are gaining popularity. Flexible budgets allow the business to adjust revenue and expenses based on revenue drivers. Zero-based budgets start with no expenses and require department leaders to justify every expense based on an activity driver.

Fiscal Control

Finance managers must hold department leaders accountable for achieving revenue targets and controlling expenses. Each month, the finance manager consolidates accounting information and updates the budget. When a line-item variance in revenue or expense exceeds the acceptable tolerance, the finance manager engages with the responsible department head to gain a better understanding on the cause of the variance. In most cases, the finance manager will require action plans to resolve the variance for future periods.

Decision-Making and Yield Management

One of the more difficult decisions in financial management in the hospitality industry is room pricing. Because of the complexity, finance models are created to assist in the decision. Demand, occupancy and expenses must all be included in the the pricing model. When room rates are adjusted to optimize both occupancy and revenue, the financial manager is practicing yield management. Let's briefly review how adjustments impact revenue.

If room rates are increased, the demand for the room is likely to decrease. Conversely, if the rate is lowered, the demand is likely to increase. If the increase in demand or increase in rate is not sufficient to increase overall revenue, the change will reduce profits. A good understanding of supply and demand is helpful to minimize this risk.

Supply, Demand and Revenue Optimization

For this example, we will assume supply is constant. New rooms are expensive and take time to build, so supply isn't likely to change over the short run. The chart below has three demand lines and demonstrates the effect of shifts on demand on price.


Demand Shift Illustration
Supply and Demand

A shift in demand from Z=2 to Z = 3 might occur during peak travel periods during the summer, holidays or city wide events. The price customers are willing to pay for a room increases during this period. Hotels maximize revenue by raising rates to accommodate the increase in demand. A shift from Z=2 to Z=1 requires hotels to lower rates to increase occupancy. Caution must be exercised to ensure the reduction in rate does not dilute profits. When demand is on line Z=2, finance managers can increase occupancy by adjusting the rate in smaller increments.

Rate Decision Example

Let's examine how rate changes impact the revenue per available room metric (REVPAR). REVPAR measures the revenue earned on occupied rooms and compares it to all available rooms. The measurement takes into account the impact of vacant rooms on revenue. This metric can be used to help with rate decisions. The calculation for REVPAR is:

REVPAR = Period Revenue / (Available Rooms x Period Days)

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