By David Lund
When we cross the bridge in the hospitality financial world to the greater business world, the concept of an asset and how it is used comes full circle. I am going to explore what is unique about hospitality assets and how we record and use them. I am only going to talk about current assets in this article.
First of all, an asset is something you have paid for or earned previously that can be used to generate more income. That is the critical test: Can you use this item to make more money, to create more economic activity? If you bought it or created it previously and can use it to generate more income, it is an asset. Items like tenderloin, tequila, guest and city ledgers are all good examples of things you can use to make more $$. You prepare the tenderloin and tequila and sell it for four-six times what you paid for it. You can use guest and city ledgers once they are collected to buy more tenderloin and tequila. And on it goes.
An asset is part of the balance sheet and it can travel over to the sister statement, the P&L, as an expense or cost of goods sold. In hospitality, current assets typically consist of cash, accounts receivable, inventory and prepaids. That’s pretty much it for a hotel. For sure there are others but on a hotel balance sheet, you will always find these four. In other industries, current assets will be made up of what is unique to that business. If making cars, assets are probably cash, steel, wire, tires. If selling clothes, current assets might include cash, sweaters, and jeans. Each different industry is unique.
One thing you will not find that my workshop students find interesting when we talk about assets is people. We always say that people are our number one asset in the hotel business. Brand slogans and company cultures are built on this steadfast ideal. In most cases, it is true that our people are our most valuable asset. However, we do not account for this value on our balance sheets. We do not account or measure this on any device, report, app or valuation. It is sad that we have not figured this one out. Note to self: Think more about how we can do just that, put an economic value on our most important asset.
Some unique aspects of hotel current assets that trip people up are the guest ledger and the city ledger. These sound like descriptions of an institution locked in a time warp. Let’s demystify them. The word ledger simply means list. The guest ledger is the value of the accounts in-house for all our current guests, their rooms, taxes, restaurant charges, parking, etc. It is a total of what each one owes the hotel while in-house. Imagine if you will that we line all our guests up in the lobby, each one owes us money and the sum of all the guest accounts is the total guest ledger. And guess what? You can use this money to make more money. The city ledger is the value of all the credit arrangements and the resulting billings that the guests and groups have made with the hotel.
The city ledger, when you think about it, is unique to the hotel service world. We extend our guests credit! Can you imagine your airline giving you a master account? Never. So why do we extend credit like we do with our guests? The answer is twofold. One, we have always done this. In our business, the practice of extending credit goes back to and beyond time, even before currency. The second more apparent reason is our competition does too. This means we also need to give credit or we risk losing a competitive edge. Now that I think about it, the whole credit world in hotels is ripe for some disruption!
Here are some principles to help understand current assets:
Cost Record an asset at the time you acquire it at the cost at that time. A good example is wine. You buy wine and sit on it sometimes hoping the value will increase as it ages and tastes better. However, should the value move you probably do not recognize the movement on the balance sheet. If you bought some wine for $30 per bottle three years ago and it is now in its prime, you can sell it for a premium, but you do not ever change the value of the asset on your balance sheet. This is referred to as the “cost principle” and simply-stated assets are recorded at cost at the time they are acquired at their price at that time. Assets are not revalued at their cost today—they are consumed at the price you paid.
Materiality I am going to use applying the materiality principle to inventory in the hotel trade where only “material assets” are recognized. That is to say, we recognize some things we use as material and some not so material. The difference: How we treat them on a transaction basis.
Tenderloin and toilet paper are two useful opposite examples of materiality in hotels. When you buy tenderloin, it is put it into the inventory account on the balance sheet. This is done because it is valuable and you sell filet mignon with a nice markup. With toilet paper, you buy it and immediately expense it, bypassing the balance sheet altogether and going directly to the profit and loss statement. You do this with toilet paper because it has a much lower value, you do not sell it and people are not likely to run off with it. Treat these two items differently because tenderloin is material and toilet paper is immaterial—in the hotel business. This principle also helps maintain a level of efficiency when it comes to the number of items we need to “put on the balance sheet.”
Consistency Simply put, this means operating consistently from one reporting period to the next. Not changing policies or methods of recording transactions in the business regularly. Again, I will use tenderloin and toilet paper.
Tenderloin is purchased, then put it into inventory on the balance sheet and the value of the inventory is recognized on the books using one of four different methods. Also, cost of sales is calculated the same way each month. You want to be consistent with this practice from month to month. If you change the way you recognize the tenderloin this month and expense it all, you create a financial hiccup that changes earnings unnecessarily and inconsistently. The readers of financial statements—the stakeholders—do not like this. With the consistency principle, the same applies to toilet paper. If you change the method and no longer expense it when it was purchased and rather put it into inventory on the balance sheet and recognize costs after counting it each month, you would have the same income hiccup. The particular method a hotel chooses is usually fine as long as it makes sense and is above all consistently applied over time.
Current assets live on the balance sheet and they serve one purpose and that is to fuel the profit and loss statement. If we take the tenderloin example again and start at the beginning and go through its life cycle it looks like this:
The owner invests his money and adds cash to the business as a current asset. The cash is used to buy tenderloin. The tenderloin is used to sell filet mignon and the asset leaves the balance sheet and travels to the profit and loss statement as the cost of goods. Cost of goods is an expense and, at the same time, it creates income and corresponding payment for the four-six times sale price. Now there is more cash to buy more tenderloin and toilet paper, and on it goes.
You can look at any current asset in the same light. They do not all directly get sold like the tenderloin but they all fuel the profit and loss statement and eventually find their way there.
Understanding current assets in the hotel business is manageable for anyone who is a department head or aspires to be one. Do not get fooled into thinking it is a big complicated dance. Remember the three principles: cost, materiality and consistency. The next time your hotel financial statement lands on your desk or in your mail go see your friendly financial professional and review the current assets:
- Which ones do you have in your hotel?
- How does your hotel treat certain items?
- Which items are put on the balance sheet and which items are expensed?
- What unique current assets does your hotel have?
Expand your understanding a step at a time. Being a leader in hospitality that has financial leadership skills is totally within your grasp.
Do you want a leg up on your leadership competition? Consider a coach in your corner. Ever wonder why great actors and athletes all have coaches? The answer: They are committed to being the very best they can be at what they do and finding an advantage over their competition.
