By David Lund
The first thing you need to know about reading a hotel financial statement is there are basically two different statements you will want to get comfortable with. The two are the income statement—some call it the P&L or profit and loss statement—and the second is the balance sheet.
Now I know what you are thinking, balance sheets are for the accounting types and they are complicated. Nothing could be further from the truth and I am going to give you a new understanding and share a secret about the balance sheet and the relationship to the P&L.
Let’s start with the income statement
Something to note here: Hotel income statements are free-form items and are not all created equal. One characteristic they all have in common, however, is they are all set up by department. They always start with the rooms department, then F&B, then the minor operating departments like golf, spa, telephone and laundry. These departments are what are called operating departments because they all have income. Then you will find the non-operating departments, i.e., administration, sales and maintenance. These departments are called non-operating because they do not generate any income. I know some of you think the sales department makes money—not so fast. Sales book business but the rooms department generates the income when the guest actually stays in the hotel. Funny, the P&L is organized and laid out just like a hotel.
Inside each department you will see the same layout: income first, then cost of sales (if required), then payroll and last, expenses. The P&L usually starts with a great summary or overall report. This is where you will want to start your review. Here you should find total revenues for all hotel activities and the total costs, leading you to the gross operating profit and net operating profit lines. The statement is usually laid out so you can see the results of the month compared to the budget and or forecast for that same month and a last year comparison. In addition to the month’s numbers, you will want to see the accumulated year-to-date results, normally to the right of the monthly numbers.
In the YTD you want to see the accumulated result—let’s say for November vs. the accumulated budget values up until November and the accumulated YTD last year results for the prior year up until November. Always compare like periods of time in the budget and last year to the actual monthly and YTD amounts. A good summary P&L is probably the most read and highly anticipated financial statement in any hotel.
One thing to always keep in mind is the fact that many miss. That is, we do what we do the way we do it in hospitality, because of the book.
The 11th edition of the Uniformed System of Accounts for the Lodging Industry lays out in nauseating detail the standards for our industry. Click here to view.
It is a great resource for defining what goes where and standard formats, but it does not include several aspects like flow thru and productivity reporting that are incredibly powerful and useful tools. If you are serious about hotel financial knowledge, then I highly recommend you get yourself a copy.
Leaving the summary statement, you will find the balance of the income statement laid out by department in the same order you see the top level. Each of these departmental statements will have totals for revenue, cost of sales (F&B, Spa, Telephones), payroll and expense that need to tie back to the summary statement. Once people make this connection it all comes together rather quickly. What you previously thought was so complicated and confusing is pretty straightforward.
The profit and loss statement is the most interesting statement because it shows how you are doing as it relates to profit for a given period. It is a snapshot of what revenues and costs are for the period you are looking at. If you are looking at the June statement and it is December, it really is not relevant. The income statement tells how you are doing financially regarding operating profit. It is how you keep score relative to the budget (the promise) and last year. You can clearly see these comparisons for the most current month and year-to-date. You also can see where there are successes in operations and where there are challenges. This is pivotal. Seeing where you are not having the level of success you planned and having the ability to manage around that challenge is the highest sole purpose of the income statement.
How can you improve your results? Is payroll too high? Are expenses out of control? Are revenues falling short of the budget? It all comes out on the income statement. Like a report card and a wake-up call to pull up your socks and your marks too. This is where the income statement transcends the black and white piece of paper and becomes the vehicle for change and ideas. Get your team involved and change the way you manage.
That’s the result that’s possible using some financial leadership.
Balance Sheet
The second most common statement you want to be comfortable reviewing every month is the balance sheet. The balance sheet tests the fundamental accounting equation. The equation states that assets equal liabilities plus equity. Most people get quiet here when we start talking the mumbo jumbo but this concept is super easy and once you grasp it you are going to see the world of finance in a completely different light, like riding a bike.
When I teach my students this concept in my workshops they often comment that they had no idea that the fundamental accounting equation was so simple.
Here goes: I liken the explanation of the fundamental accounting equation to the ownership value relationship of a house. You—along with the bank—own the house. In this example, the house has a market value of $500,000 and you have a mortgage of $350,000 on the house through the bank. You subtract the two numbers and that’s your share or, as described in accounting terms, your equity or sometimes called owner’s equity:
$500,000 (assets) – $350,000 (liabilities) = $150,000 (equity)
This basic concept is exactly the same as the balance sheet mechanics. It is the “fundamental accounting equation.”
You can be the most complicated business in the world and it all boils down to the same concept: Assets-Liabilities=Equity. In the example of the house, you get the fact that the $150,000 is yours. That would be your right to the upside of the sale price less the mortgage. In business, the assets minus the liabilities is what the owner is entitled to, their equity. It is also important to remember that the equity can be a negative. Using the example of the house and given the recent financial crisis, you know houses can have bigger mortgages than value if the market goes down. In a business, you want to have a healthy asset to liability ratio but this is not always the case. So, knowing this simple equation you can now test the health of the business by examining the values of total assets and liabilities.
The quality of those assets in a hotel should be relatively easy to measure. Cash, receivables, inventory, prepaid expenses. You use these items to make money, hence they are assets. The liabilities are all the commitments you have that you must honor. Vendors to pay, deposits for future guests, taxes collected that need to be paid, employee wages and vacations to honor. In simplistic terms, you have the good stuff, the assets, less the bad stuff, the bills you need to pay, and the difference is the equity. Same concept as the house above.
The Link
The link between the income statement and the balance sheet is an important and powerful concept.
When you make a profit or have a loss in your business, you can see the bottom line number on the year-to-date column on the income statement.
The link.
What you also can see is that it is the same number you find on the balance sheet when you look at the current year’s retained income line in the equity section.
The other line called retained income from prior periods, is the accumulated profits and losses since that business was created. This is the link between the current year’s profit performance and the lifetime of the business’s accumulated results.
The business gets created when it is bought/sold. A new set of books is created and you start everything from the purchase price values. Everything from that point forward moves from the income statement each month to the balance sheet and its accumulated profit or loss is found in the equity. Assets – liabilities = owners’ equity. See? Not so difficult.
