HFT 4464

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HFT 4464

• Chapter 3
• Review of Financial Statements Selected Ratios

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Chapter 3 Introduction

• This chapter will provide a review of the major
  financial statements and selected key ratios used
  in the industry.
• Financial statements reviewed
• Income statements
• Balance sheet
• Statement of retained earnings
• Statement of cash flows

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Income Statement

• Details revenues and expenses for a period of
  time
• Income statements can be as detailed as necessary
  for use by managers and investors
• Summary for outside users
• Detailed departmental statements for insiders

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Uniform System of Accounts

• Widely used format for income statements in the
  hospitality industry
• Focuses primarily on departmental performance
• Revenues and expenses specifically attributable
  to that department
• Undistributed operating expenses include items
  like marketing and maintenance

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Uniform System For Restaurants

• Restaurants also follow a specific format.
• First expense shown is cost of goods sold for
  both food and beverage.
• This is followed by other expenses
• Not completed on a departmental basis like hotels
  because the restaurant is really only one
  department.

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Review of Balance Sheet

• Shows financial position of an organization at a
  particular point in time
• Assets, liabilities, and owners equity
• Current items listed first
• Current meaning convertible to cash or paid in
  cash within a year
• Retained earnings are not the same as cash

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Relationship Between Balance Sheet and Income
Statement

• Assets used to generate revenue and cash flow
• For a hospitality business this is land,
  building, and equipment.
• Liabilities are related to expenses.
• Accrued wages and accounts payable
• Retained earnings will increase with net income,
  less any dividends declared.
• This is the link to the income statement.

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Statement of Retained Earnings

• Often consolidated into a consolidated statement
  of owners equity
• Basic calculation
• Balance at beginning of period
• Plus net income
• Less dividends declared
• Equals ending balance
• There is no cash in retained earnings.
• It is simply accrued earnings less dividends
  declared to the shareholders.

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Statement of Cash Flows

• Its purpose is to show where cash flow came from
  and where it went during a period of time.
• Three major sections of the statement
• Operating activities
• Investing activities
• Financing activities
• Recent accounting scandals have placed a premium
  on a companys ability to earn cash flows.

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Statement of Cash Flows

• Why has this become so important?
• Balance sheet uses estimates.
• Enron hid debt from its balance sheet.
• Worldcom categorized expenses as investments
  (assets).
• Income statement is completed on accrual basis
  (when do we recognize the revenue).
• Cash flows represent the actual flows of cash and
  are more difficult to invent.

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Validity of Financial Statements

• Who is responsible?
• Management is responsible for the accounting and
  financial reporting systems.
• Auditors are there to assess if the statements
  make a fair representation of firm position and
  performance.
• Investors learned a hard lesson in 200001 about
  financial statements and are aware of the need
  for change. Some potential remedies include
• Rotating auditors regularly
• CEOs taking responsibility for veracity of
  financial statements

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Ratio Analysis

• Ratio analysis is used to take existing financial
  accounting information and generate new
  information.
• Ratios on their own are not very meaningful.
• Various ratios of a hospitality organization can
  be compared to industry averages. However
• Which segment of the hospitality industry?
• Which companies are included in the industry
  averages?
• Are there enough firms in the average to make the
  ratios meaningful?
• Do all the firms use the same accounting methods?

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Classes of Ratios

• Liquidityability to meet current debts
• Turnovermanagements effectiveness regarding the
  management of assets
• Solvencyability to meet long-term debts or the
  extent of long-term financing
• Profitabilityhow profitable the operation is
• Activityinvolves key measures of operating
  performance
• Investorthose ratios of special significance to
  outside investors

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Liquidity Ratios

• Current ratio
• Current assets/current liabilities
• Quick ratio
• Cash marketable securities accts. rec.
• current liabilities
• Working capital current assets less current
  liabilities
• Does current ratio always have to be greater than
  1?

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Turnover Ratios

• Inventory turnover
• Cost of sales / average inventory
• Appropriate range for this number
• Asset turnover
• Revenue / Average Total Assets
• Revenue per dollar of assets
• Can management manipulate this figure?

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Solvency Ratios

• Debt to Asset ratio
• Total debt / total assets
• Debt to equity ratio
• Total debt / total equity
• Hotel industry often has high debt
• Times interest earned
• EBIT / interest expense
• Gives lender a measure of cushion (how much
  earnings are available to pay interest)

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Profitability Ratios

• Profit margin
• Net Income / Total Revenue
• Return on assets
• Measure amount of profit for every 1 in assets
• Net Income / Average Total Assets
• DuPont Ratio
• ( Net Income / Total Revenue ) x
  ( Total Revenue / Average Total
  Assets )
• Return on equity
• Net Income / Average Stockholders Equity

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Activity Ratios

• Occupancy percentage
• Rooms Occupied / Rooms Available
• Average Daily Rate (ADR)
• Rooms Revenue / Rooms Sold
• REVPAR
• Occupancy Percentage x ADR
• Rooms Revenue / Rooms Available
• Food Cost Percentage
• Cost of food sold / food revenue
• Beverage Cost Percentage
• Cost of beverage sold / beverage revenue

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Investor Ratios

• P/E Ratioprice to earnings (net income)
• Market Price / Earnings Per Share
• Dividend payout ratio
• Dividend Per Common Share / Earning Per Share
• Dividend yield
• Annual Dividend / Market Price Per Share

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Limitations of Ratio Analysis

• Be careful not to label ratios by themselves as
  good or bad.
• Different users of ratios have different
  perspectives.
• Example Lenders vs. owners regarding the
  current ratio
• Ratios may tell you there is a problem, but they
  dont tell you what the problem is.
• Example high food cost
• Why?

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HomeworkProblems 1,2,3 5