FINANCIAL MANAGEMENT - American Hotel & …

1 FINANCIAL MANAGEMENTDISCLAIMERThis publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be the Declaration of Principles jointly adopted by the American Bar Association and a Committee of Publishers and contained in this publication shall constitute a standard, an endorsement, or a recommendation of the Educational Institute of the American Hotel & Lodging Association (AHLEI) or the American Hotel & Lodging Association (AH&LA). AHLEI and AH&LA disclaim any liability with respect to the use of any information, procedure, or product, or reliance thereon by any member of the hospitality rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means-electronic, mechanical, photocopying, recording, or otherwise-without prior written permission of the MANAGEMENT TABLE OF CONTENTS chapter 1 The Balance Sheet.

2 1 chapter 2 The Income Statement ..15 chapter 3 Operations Budgeting ..29 chapter 4 Capital Budgeting ..43 chapter 5 Lease Accounting ..58 chapter 6 System Selection ..69 chapter 7 Basic Cost Concepts ..81 chapter 8 Cost-Volume-Profit Analysis ..89 chapter 9 Cost Approaches to Pricing ..100 chapter 10 Managing Productivity and Controlling Labor Costs ..109 chapter 11 Managing Inventories ..1272016 American Hotel & Lodging Educational InstituteFINANCIAL MANAGEMENT12016 American Hotel & Lodging Educational InstitutePurposes of the Balance Sheet ..2 Limitations of the Balance Sheet ..3 Balance Sheet Formats ..4 Content of the Balance Sheet ..5 Current Accounts ..5 Property & Equipment ..7 Long-Term Liabilities ..7 Balance Sheet Analysis ..8 Horizontal Analysis ..8 Vertical Analysis ..9 Base-Year Comparisons ..13 Wrap Up ..14 Review Questions ..14 chapter 1 THE BALANCE SHEET CONTENTS & COMPETENCIES 1 Explain the purposes of the balance sheet.

3 2 Identify the limitations of the balance the various elements of assets, liabilities, and owners equity as presented on the balance balance sheets using horizontal and vertical analysis as well as base-year comparisons. FINANCIAL MANAGEMENT2 chapter 12016 American Hotel & Lodging Educational InstitutePURPOSES OF THE BALANCE SHEETO ther major FINANCIAL statements the income statement, the statement of owners equity, and the statement of cash flows pertain to a period of time. The balance sheet reflects the FINANCIAL position of the hospitality operation its assets, liabilities, and owners equity at a given date. It is the FINANCIAL statement that reflects, or tests and proves, the fundamental accounting equation (assets equal liabilities plus owners equity).Balance sheet statement of the FINANCIAL position of the hospitality establishment at a given date, giving the account balances for assets, liabilities, and owners , although generally more interested in the income statement and related department operations statements, will find balance sheets useful for conveying FINANCIAL information to creditors and investors.

4 In addition, MANAGEMENT must determine if the balance sheet reflects to the best extent possible the FINANCIAL position of the hospitality operation. For example, many long-term loans specify a required current ratio (which is current assets divided by current liabilities). Failure to meet the requirement may result in all long-term debt being reclassified as current and thus due immediately. Since few operations could raise large sums of cash quickly, bankruptcy could result. Therefore, MANAGEMENT must carefully review the balance sheet to determine that the operation is in compliance. For example, assume that at December 31, 20X1 (year-end), a Hotel has $500,000 of current assets and $260,000 of current liabilities. Further assume that the current ratio requirement in a bank s loan agreement with the Hotel is 2 to 1. The required current ratio can be attained simply by taking the appropriate action. In this case, the payment of $20,000 of current liabilities with cash of $20,000 results in current assets of $480,000 and current liabilities of $240,000, resulting in a current ratio of 2 to ratio ratio of total current assets to total current liabilities expressed as a coverage of so many times; calculated by dividing current assets by current are interested in the hospitality operation s ability to pay its current and future obligations.

5 The ability to pay its current obligations is shown, in part, by a comparison of current assets and current liabilities. The ability to pay its future obligations depends, in part, on the relative amounts of long-term financing by owners and creditors. Everything else being the same, the greater the financing from investors, the higher the probability that long-term creditors will be paid and the lower the risk that these creditors take in investing in the are most often interested in earnings that lead to dividends. To maximize earnings, an organization should have FINANCIAL flexibility, which is the operation s ability to change its cash flows to meet unexpected needs and take advantage of opportunities. Everything else being the same, the greater the FINANCIAL flexibility of FINANCIAL MANAGEMENT3 chapter 12016 American Hotel & Lodging Educational Institutethe hospitality operation, the greater its opportunities to take advantage of new profitable investments, thus increasing net income and, ultimately, cash dividends for addition, the balance sheet reveals the liquidity of the hospitality operation.

6 Liquidity measures the operation s ability to convert assets to cash. Even when a property s past earnings have been substantial, this does not in itself guarantee that the operation will be able to meet its obligations as they become due. The hospitality operation should have sufficient liquidity not only to pay its bills, but also to provide its owners with adequate the ability of an operation to meet its short-term (current) obligations by maintaining sufficient cash and/or investments easily convertible to of several balance sheets for several periods will yield trend information that is more valuable than single-period figures. In addition, comparison of balance sheet information with projected balance sheet numbers (when available) will reveal MANAGEMENT s ability to meet various FINANCIAL of the Balance SheetAs useful as the balance sheet is, it is generally considered less useful than the income statement to investors, long-term creditors, and especially to MANAGEMENT .

7 Since the balance sheet is based on the cost principle, it often does not reflect current values of some assets, such as property and equipment. For hospitality operations whose assets are appreciating rather than depreciating, this difference may be significant. Hilton Hotels Corporation may be a fair reflection of this difference. In an annual report that disclosed market values, Hilton revealed the current value of its assets (footnote disclosure only) to be $ billion, while its balance sheet showed the book value of its assets to be $ billion. The difference between current value and book value was $ billion. The assets reflected in the balance sheet for Hilton were only 47 percent of their current value. This understatement, if unknown or ignored by MANAGEMENT , investors, and creditors, could lead to less than optimal use of Hilton s limitation of balance sheets is that they fail to reflect many elements of value to hospitality operations.

8 Most important to hotels, motels, restaurants, clubs, and other sectors of the hospitality industry are people. Nowhere in the balance sheet is there a reflection of the human resource investment. Millions of dollars are spent in recruiting and training to achieve an efficient and highly motivated work force, yet this essential ingredient for successful hospitality operations is not shown as an sheets are limited by their static nature; that is, they reflect the FINANCIAL position for only a moment. Thereafter, they are less useful because they become outdated. Thus, the user of the balance sheet must be aware that the FINANCIAL position reflected at year-end may be quite different one month later. For example, a hospitality operation with $1,000,000 of cash may seem financially strong at year-end, but if it invests most of this cash in fixed assets two weeks later, its FINANCIAL flexibility and liquidity are greatly reduced. This situation would generally only be known to the user of FINANCIAL documents if a balance sheet and/or other FINANCIAL statements were available for a date after this investment had , the balance sheet, like much of accounting, is based on judgments; that is, it is not exact.

9 Certainly, assets equal liabilities plus owners equity. However, several balance sheet items are based on estimates. The amounts shown as accounts receivable (net) reflect the estimated amounts to be collected. The amounts shown as inventory reflect the lower of the cost or market (that is, the lower of original cost and current replacement cost) of the items expected to be sold, and the amount shown as property and equipment reflects the cost less estimated depreciation. In each case, accountants use estimates to arrive at values. To the degree that these estimates are in error, the balance sheet items will be format a possible arrangement of a balance sheet that lists assets first, followed by liabilities and owners format a possible arrangement of a balance sheet that lists the asset accounts on the left side of the page and the liability and owners equity accounts on the right MANAGEMENT4 chapter 12016 American Hotel & Lodging Educational InstituteBalance Sheet FormatsThe balance sheet can be arranged in either the account or report format.

10 The account format lists the asset accounts on the left side of the page and the liability and owners equity accounts on the right side. Exhibit illustrates this arrangement. The report format shows assets first, followed by liabilities and owners group totals on the report form can show either that assets equal liabilities and owners equity or that assets minus liabilities equal owners equity. Exhibit illustrates the report Balance Sheet Account FormatMASON MOTELBALANCE SHEETDECEMBER 31, 20X1 Balance sheets are limited by their static nature; that is, they reflect the FINANCIAL position for only a moment. Thereafter, they are less useful because they become outdated. FINANCIAL MANAGEMENT5 chapter 12016 American Hotel & Lodging Educational InstituteExhibit Balance Sheet Account FormatMASON MOTEL BALANCE SHEET DECEMBER 31, 20X1 ASSETSC urrent Assets:Cash$ 2,500 Accounts Receivable5,000 Cleaning Supplies2,500 Total Current Assets10,000 Property and Equipment:Land$ 20,000 Building300,000 Furnishings and Equipment50,000 Less: Accumulated Depreciation125,000 Net Property and Equipment245,000 Total Assets$ 255,000 LIABILITIES AND OWNER S EQUITYC urrent Liabilities:Notes Payable$ 23,700 Accounts Payable8,000 Wages Payable 300$ 32,000 Long-Term Liabilities:Mortgage Payable120,000 Total Liabilities152,000 Owner s Equity:Melvin Mason, Capital at January 1, 20X164,500 Net Income for 20X138,500 Melvin Mason, Capital at December 31, 20X1103,000 Total Liabilities and Owner s Equity$ 255,000 CONTENT OF THE BALANCE SHEET The balance sheet consists of assets, liabilities, and owners equity.