Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
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 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
Standards Budget
Prior period Industry average
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Classes of Ratios Liquidity can the firm meet its short-term obligations? Solvency can the firm meet its long-term obligations? Activity how is management using the propertys assets? Profitability how profitable is the business? Operating how efficient is management in running the business? 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
Liquidity Ratios
Current Ratio indicates relationship between current assets and current liabilities Formula: CR = Current Assets/Current Liabilities
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Acid-Test Ratio Acid-Test Ratio: Quick Assets Current Liabilitie s
A more stringent measure than the CR as
inventories and prepaid expenses are excluded
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
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 figures from the balance sheet!
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
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
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
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
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Liquidity Evaluation Illustration
Selected liquidity ratios for AW Corporation are as follows: CR Acid-test AR T/O OCF to CL 2008 1.4 1.2 12 70% 2009 1.45 1.25 11 72% 2010 1.5 1.3 10 74%
Evaluate the change in liquidity for AW corporation
Andrew, Damitio, Schmidgall Financial Management for the Hospitality 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Evaluation The current and acid-test ratios are increasing throughout the 2008-2010 period. The AR T/O is decreasing resulting in relatively more accounts receivable outstanding. ACP was 30.4 days at the end of 2008 and increased to 36.5 days at the end of 2010. This increase should be further investigated. Operating cash flows are increasing overtime in relation to the current obligations. Overall liquidity is improving; however, there is some concern regarding accounts receivable. Andrew, Damitio, Schmidgall Financial Management for the Hospitality 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
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 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
Debt-Equity Ratio
Shows amount of debt for each $1 of owners equity DE Ratio: total liabilities/total owners equity
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
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
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Number of Times Interest Earned (TIE)
Indicates the number of times interest can be covered with income TIE = EBIT/Interest Expense
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
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)
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Operating Cash Flows to Total Liabilities Ratio
Uses figures from Balance Sheet and SCF OCF to TL Ratio = OCF/Average TotalLiabilities
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Solvency Evaluation Illustration
BC, Inc., has solvency ratios for 2008 2010 as follows: Debt-Equity LTD to Total Cap. Ratio TIE FCC Ratio OCF to TL Ratio 2008 70% 41% 4 times 3 times 20% 2009 60% 38% 4.2 times 2.8 times 22% 2010 50% 33% 4.4 times 2.6 times 24%
Evaluate the changing solvency of BC, Inc. over the three years Andrew, Damitio, Schmidgall Financial Management for the Hospitality 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Evaluation Both the debt-equity and LTD to total capitalization ratios reveal relatively less debt to equity over the three years. The increasing TIE and OCF to TL ratios suggest an increasing ability to pay the longterm liabilities. The decreasing fixed charge average ratio suggests lease expense (and most likely the number of leases) are increasing over time. Overall solvency has improved and in part this has happened by switching to leasing as a means of finance. Andrew, Damitio, Schmidgall Financial Management for the Hospitality 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Inventory Turnover This ratio shows how quickly inventory is moving
A separate turnover should be
determined for each type of inventory, i.e., food, beverage, gift shop etc.
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Food Inventory Turnover
Food Inventory Turnover =
Cost of Food Used Average Food Inventory
Cost of Food Used: BI + purchases EI
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Food Inventory Holding Period (FIHP)
Provides the average number of days inventory is held prior to sale FIHP = 365 Food Inventory Turnover
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Property and Equipment Turnover (PET)
Measures managements effectiveness in using property and equipment PET = Total Revenue Average Property and Equipment
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Asset Turnover Ratio
Measures managements use of all assets Asset Turnover Ratio: Total Revenue Average Total Assets
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Paid Occupancy Percentage
A non-financial key indicator of managements success in selling rooms Paid occupancy % = Rooms Sold Rooms Available
Rooms sold include all rooms occupied except for complimentary rooms Rooms available include rooms that could be sold and generally exclude out-of-order rooms 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
Activity Evaluation Illustration
The Dirk Companys activity ratios over a three year period were as follows: Food inventory T/O Property and equipment T/O Asset turnover Paid occupancy % 2008 12 2 1 72% 2009 13 2.1 1.1 71% 2010 14 2.2 1.2 70%
How has managements use of the companys resources changed over the three year period?
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Evaluation Food inventory is turning more quickly from 2008 through 2010 as is both property and equipment and total assets. This result is considered good. Paid occupancy is declining slightly. Management appears to be selling few rooms; however, the ADR (price per room) could be a major factor. This requires additional management attention. Andrew, Damitio, Schmidgall Financial Management for the Hospitality 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
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 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
Profit Margin
Measures the profits from sales Profit Margin = Net Income Total Revenue
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Operating Efficiency Ratio
Measures managements performance based on expenses they control Operating Efficiency Ratio: Income after Undi stributed Operating Expenses Total Revenue
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Return on Assets (ROA)
Indicator of profitability compared to the firms assets ROA = Net Income Average Total Assets
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Return on Equity (ROE)
Measures profitability of firm compared to owners investment ROE = Net Income Average Owners' Equity
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Earnings per Share (EPS)
Shows the amount earned per each share of owners common stock EPS = Net Income Average Common Shares Outstanding
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Price Earnings Ratio (PE)
Reflects the relationship between the market price per share and the EPS
PE =
Market price per share EPS
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Profitability Evaluation Illustration
The Mellow Motel Corporations profitability ratios for 2008 through 2010 were as follows: 2008 6% 30% 12% 15% $2.00 10 2009 6.5% 29% 13% 16% $2.10 11 2010 7% 28% 14% 17% $2.20 12
Profit Margin Operating Efficiency Ratio ROA ROE EPS PE
Evaluate the corporations changing profitability over the three-year period.
Andrew, Damitio, Schmidgall Financial Management for the Hospitality 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Evaluation Profit margin is increasing each year even though the operating efficiency ratio is in decline. ROA, ROE, and EPS are increasing each year. This suggests that greater profits are being achieved by relative reductions in fixed charges such as interest expense and depreciation. The market appears to be reacting favorably to these changes since the PE ratio has increased from 10 times in 2008 to 12 times in 2010. The market price at the end of 2008 was $20 and at the end of 2010 it was $26.40. Andrew, Damitio, Schmidgall Financial Management for the Hospitality 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Operating Ratios Assist management in analyzing the
operations of the business Major ratios covered include
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Average Daily Rate (ADR)
Reveals average price per room sold ADR = Rooms Revenue Number of Rooms Sold
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
REVPAR
Measures a combination of paid occupancy % and ADR REVPAR = Paid OCC % X ADR
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Food Cost Percentage
Key food service ratio that compares the cost of product (food) sold to product (food) sales Food Cost % = Cost of Food Sold Food Sales
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Labor Cost Percentage
Reveals the relationship between
labor costs and revenue Labor cost generally is the highest single cost of a hospitality organization Labor costs include salaries, wages, fringe benefits, and payroll taxes Ratio should be computed for each profit center of the operation 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
Labor Cost %
Labor Cost % =
Department al Labor Costs Department al Revenues
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Evaluation of Operations Illustration
The Wisker Restaurant Inn has selected operating ratios for 2008-2010 as follows: 2008 $85 $59.50 34% 30% 2009 $86 $59.34 33.5% 29.5% 2010 $87 $59.16 33% 29%
ADR REVPAR Food Cost % Labor Cost %
Evaluate the operating activities of the Wisker Restaurant & Inn over the three-year period based on the above four ratios Andrew, Damitio, Schmidgall Financial Management for the Hospitality 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Evaluation
First, one should be very careful when evaluating any aspect of business with so few ratios. Even so, these four ratios suggest Prices are increasing but the amount per room available is decreasing from 2008 through 2010. This appears to suggest some price resistance and management should undertake further evaluation. Both food cost and labor cost percentages are decreasing over the three year period. If quality is not sacrificed this is good from a financial perspective.
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
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 ratios of different firms
Are they in the same industry? Are they using the same or similar accounting procedures? Andrew, Damitio, Schmidgall Financial Management for the Hospitality 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
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 user groups Ratios must be compared to a standard to be meaningful 2007 Pearson Education, Inc. Upper Saddle River, NJ 07458
Andrew, Damitio, Schmidgall Financial Management for the Hospitality
