The income statement, also called Statements of Income and Expense or Statements of Profit and Loss (P&L), is the key report you will use to oversee your hotel’s financial performance. Income statements are produced monthly and compare monthly and year to date performance to the prior year and to budgets. On the income statement, you find KPIs (Key Performance Indicators), revenues and expenses for each department, overhead expenses, and your profit or loss. You will use the income statement to monitor the asset, encourage management performance and plan strategically for the asset.
P&L (Income and Expense)
Hotel income statements follow a standardized set of accounts called the Uniform System of Accounts for the Lodging Industry (USALI). The basic structure of USALI Summary P&L includes the following sections:
- Statistics and Key Performance Indicators (KPIs): rooms available, rooms occupied, occupancy percent, average rate, RevPAR (revenue per available room) and sometimes other statistics are presented at the top of the statement
- Revenue: revenue by department starting with the rooms department, then food and beverage and then assorted other departments and revenue sources such as lease income and interest. These are then summed in a line for total revenue
- Departmental Expenses: expenses for each of these departments; because revenues and expenses are shown by department, each department can have its own budget, managers can be evaluated, and the department can be evaluated for its own revenues, expenses and contribution to profit
- Total Departmental Profit: the first sub-total line and nets departmental expenses from total revenues; some statements have a section that shows profit by department and then total departmental profit
- Undistributed Operating Expenses: expenses for the overhead departments that are shared by the operating departments; these are Administrative and General, Information and Telecommunications Systems, Sales and Marketing, Franchise Fees, Property Operation and Maintenance, and Utilities
- Gross Operating Profit (GOP): the second sub-total line which nets undistributed expenses from departmental profits; GOP and all components of the statement leading to GOP are the responsibility of management and this is a critical component of management evaluations
- Management Fees: these are netted from GOP for the third subtotal which is Income Before Non-Operating Income and Expense
- Non-Operating Expenses: include rent, property and other taxes, property and liability insurance and sometimes other less common expenses
- Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA): the fourth subtotal is used by owners and lenders, among others, to evaluate the hotel as an investment
- Replacement Reserve (CapEx Reserve): funds, usually 4 or 5 percent of revenue, accumulated to pay for capital expenses (CapEx); the fund is typically held by the mortgage company and is roughly half of the total that is likely to be used for CapEx
- EBITDA Less Replacement Reserve: the fifth subtotal
- Net income after interest: subtracts mortgage interest from EBITDA less replacement reserve
USALI has supporting statements that are matched to the nature of the hotel operation. Sometimes undistributed expenses are allocated by department in these statements. For instance, an allocated statement would show utilities expense in each department. Supporting statements usually include the following, among others:
- Rooms Department: detailed revenues and expenses for the rooms department including housekeeping, laundry and front desk, travel agent commissions, and direct expenses
- Food & Beverage Department: detailed revenues and expenses for restaurants, lounges, banquets, room service and other outlets including payroll, food, beverage, operating supplies, entertainment and other direct expenses
- Other Operated Departments: detailed revenues and expenses for every other revenue generating department in the hotel as though each department were its own operating business
- Undistributed Department Statements: detail of the expenses for each overhead department; for instance, the Property Operations and Maintenance Department statement shows payroll detail by position, supplies, sub-contractors, specialty service providers like electricians, equipment purchases, etc.
- Payroll Reports: detailed payroll by department and position, benefits and other costs of employees, and performance statistics; for instance, minutes per room to clean
- Market Statistics: detailed reports in areas such as bookings by segment and source (transient business booked directly at the front desk, through brand.com, through Expedia and each other source, then group business by booking source, etc.)
While these are the rows of USALI P&L, the columns compare periods and budgets. So, columns show current period (month or week or year-to-date) actual results compared to budget and prior year.
Each type of expense in the P&L has its own metrics for comparison and analysis.
- Per Occupied Room (POR): Expense items that are controllable and variable, meaning that the expense increases for each additional room rented, are analyzed using POR. For instance, guest supplies like soap and shampoo, and housekeeper hours, can be budgeted and analyzed for each room sold because their use increases incrementally for each room sold/occupied (POR).
- Per Available Room (PAR): Expense items that are largely fixed, meaning that they are the same no matter how many rooms are sold, are analyzed using Per Available Room (PAR). For instance, information and telecommunications systems vary little, regardless of how many rooms are sold.
- Percent of Revenue: Expense items that are based on revenue, like franchise fees, are tracked on as a percent of revenue. Overall departmental expenses are also tracked as a percent of overall revenue. For instance, Sales & Marketing is measured as a percent of total revenue. Operating departments also use percent of departmental revenue statistics. For instance, rooms department expenses are tracked as a percent of rooms department revenue to focus on overall departmental profitability.
Analyzing expenses PAR, POR and percent of revenue enables comparison from one hotel to another (ideally within a comparable set) well as to industry standards. It also enables comparison from one period (week, month, year) to another. The following chart shows the typical revenues and expenses for a hotel and which metrics are used to analyze each:
WIIFM (What’s In It For Me?)
Everyone who involved with the hotel uses the P&L for their specific purposes. While everyone benchmarks the P&L to prior periods, budgets, other hotels, and industry standards, below is a further look at the focus for each player:
- The general manager uses budgets and projected occupancy to drive decisions about staffing, ordering supplies from food to linen, and planning energy conservation, marketing, and maintenance. The general manager’s goal is to improve operations and profits, and the general manager’s bonus is likely calculated based on the GOP.
- The management company uses the P&L to drive property performance. They evaluate performance to budget and prior year and use statistics to optimize business mix, develop strategies to increase ancillary revenues, control labor and other costs, negotiate with suppliers, etc. The goal is to earn management fees for the management company, but also to increase asset value for the owner and to enhance their own reputation.
- Asset managers use the P&L to identify areas for additional revenue and opportunities to control expenses. Their goal is to preserve and enhance the value of the asset given the investment horizon and eventual sale.
- Lenders use the P&L to track the financial health and commensurate risk of the loan. Their underwriters use the P&L to evaluate the safety, or riskiness, of the loan. Loan originators use the P&L to present the opportunity to prospective lenders.
- Appraisers use the P&L to analyze the market value of the hotel. They may be engaged by the lender or owner, at loan origination and/or on a regular basis according to internal controls.
- Brokers use the P&L to determine the value of the hotel and identify possible opportunities for the buyer to improve the value, thus engaging interest from prospective buyers.
- Owners/Investors use the P&L to evaluate their returns, ensure that they comply with debt covenants, plan cash distributions, report to investors, and decide about re-investing in the hotel for renovations or upgrades.
Castell P&L video
Hotels are an unusual form of real estate in that the entire business cycle transpires in just 24 hours. Rooms are marketed, booked, rented, occupied, cleaned, and turned back into inventory each day. Because of this, prices can fluctuate dramatically depending on demand. For example, demand may rise due to an external pressure, such as a major event in town.
Revenues fluctuate by day of week, season, weather patterns, event schedules and other variables. Layered onto this revenue pattern is that some bookings pay in advance, some pay on departure, which may be after a stay of several weeks, and some pay from invoices which may take a couple of months.
Payments fluctuate according to a different set of triggers. Payroll, utilities, insurance, contracted services, property tax and administrative expenses, among others have a significant fixed component and have to be paid whether or not the hotel is full. Variable expenses like guest room supplies and linens may be paid before the room is occupied and revenues are received. Sales and occupancy taxes as well as franchise fees are paid shortly after revenues are booked, but often before the cash is received. The mortgage must be paid, even during slow seasons.
In one aspect of cash management, hotels record taxes collected on behalf of the local government from sales including room rentals, food and beverage, and retail sales. These can exceed 20 percent of hotel revenues. While taxes are recorded at the time the sale is made, the cash may not be received until the Account Receivable is collected. Taxes are generally due 30 to 60 days after the sale is made. The hotel requires enough cash on hand to pay the taxes.
For these reasons, cash management is important.
Hotels budget by month, and sometimes by week, to plan their cash requirements and make sure the bills can be paid.
Cash reserves are built up during peak periods to cover slower seasons.
Hotels use working capital loans to smooth unexpected mismatches between revenues and expenses.
Budgets and Forecasts
Forecasts are educated guesses, based on performance metrics, that give you a better understanding of future performance so you can adjust and plan.
Forecasting is how hotel management predicts time frames that will bring higher or lower occupancy, demand and revenue. A good forecast drives rate to make the most of peaks in demand and may adjust rate down to bolster occupancy during valleys. A forecast is also used to plan staffing, maintenance, purchases of food and other supplies, and other aspects of operations. You will see three types of forecasts as an owner.
- Operational forecasts are used to manage resources such as the number of housekeepers to clean rooms or how much food to prep for anticipated diners.
- Financial forecasts give owners and investors an outlook for revenues and profits.
- Revenue management forecasts are detailed pictures of future demand used to optimize revenue.
The quality of forecasts depends on the quality of information that the hotel captures through its property management systems, reservation systems, and attention from the front desk. When hotel management generates good data, the forecasts are more reliable and performance can be optimized.
Budgets are projections for upcoming periods, whether for the next month, next year or next five years. They are a plan. Managers and management companies are expected to deliver on their budgets so their incentives and bonus
ses typically ride on meeting or exceeding budgets.
As an owner, you will review, negotiate and approve budgets. Since management’s incentives ride on the budget, you are balancing two agendas:
- You want management to be able to meet or exceed the budget because you want them to be motivated. You don’t want the budget to be unrealistically high.
- You don’t want to pay excessive bonuses or incentives so you want the budget to be attainable but not “sandbagged”. You don’t want the budget to be unrealistically low.
You have tools to help you thread this needle including past performance, industry benchmarks (from CBRE and STR, for example), performance compared to prior budgets, staffing guides, productivity reports (labor is your biggest cost and productivity reports are the control), wage rates compared to other area hotels and prior years, zero-based budgets for key expenses and so on.
Most importantly, you have the opportunity to ask questions and observe operations. With budgets, you should dig into the details. Budgets are prepared by department and you should discuss each department separately. These discussions bring you closer to the operation and it lets management know that their work is important to you.