May 25, 2013
McCaysville GA – May 25, 2013 – (hospitalitybusinessnews.com – by Eric Hertha) Usually, when revenues increase, profit goes up. The opposite is also the norm. Revenues decrease and profit goes down. But how much should profit go up and how much should it go down? The analysis of this is most often called “Flow-Through” and sometimes “revenue conversion”.
My feeling is that if you do not know generally what something should be then you cannot tell if there is a problem. Let’s say that you introduce a new menu into your restaurant and all items are cost out with a 30% food cost. If, at the end of the first month, you show a food cost of 40% then you would know that something is not right and a further investigation would need to be done in order to determine why the discrepancy exists. The same can be done for the overall revenue and profit of the hotel or restaurant. We can come up with formulas that will compare the variance between budget (for example) and actual and then pinpoint potential problem areas.
When performing the Flow-Through analysis you can create formulas that analyze your business down to the penny, or, you can take a “30,000 foot” perspective and simply make good estimates of costs and profitability and then go from there. Logic would tell you that the more precise you are the better the result will be. Actual results may show that good estimates will give you the results that you are looking for. And what are these results? The whole purpose of this exercise is to guide you, it is to make you aware, it is to point you down the right road; it is to show you where there are potential problems within your organization. For the purpose of our discussion we will try to give examples of what you should look at. This being said I am sure that many people reading this document will come up with alternative options that add value to their situation and ultimately make this analysis more beneficial to them.
So, how do we do this?
Well, in a nut shell, we have two areas to look at; first revenues and next costs. This is probably fairly obvious so let’s look further. Depending on the type of revenue, different costs will change. Some of these costs are accounted for within the department and others are accounted for in overhead departments. For example if room revenues increase and the guest pays with a credit card, the commission expense will not affect rooms’ department profit, it will increase G&A costs.
A point should be made here; simply because revenues increase you should not always expect that profit should too. Take rooms revenue as an example. Let’s say that we have the following situation:
In the above example we would expect that the Rooms’ Department profit and GOP would decrease even though revenues have gone up. This is due to the difference in profit margins on a $1 increase in room rate (95%) vs. the profit on one additional room occupied (70%).
So, what should your Flow-Through be?
The answer to this is that there is no answer. Some people seem to think that a Flow-Through at GOP vs. budget of 65% is the target number. Its fine to have a target, but on a month-to-month basis the target will change. If you simply say we want a 65% Flow-Through, then perhaps you will lose some upside profit. What happens in a month where the increase in revenue is all attributable to room rate? In this case, depending on your variables costs wouldn’t you expect a Flow-Through in the vicinity of 80%-90%? So, on a monthly basis you need to calculate what your target GOP is and then compare this to the actual and go from there.
Let’s start with the rooms department and put together the basic worksheet for our Flow-Through analysis.
To begin with, we need to determine what profit we can expect from each of our room segments if the rate increases or if occupancy increases. Additionally, we need to know which costs reside in the rooms department and which costs reside elsewhere. For example, if our room rate increases by $1, there could be an increase in travel agent commissions, which is recorded in the Rooms Department. There could also be an increase in Credit Card Commissions and this cost resides in G&A.
In our example, we will use a limited number of market segments. This should give the reader a good idea of how to adapt this to their situation. The segments that we will use are Transient (B.A.R.), Corporate and Wholesaler. We have put together a table that shows some of the variable costs associated with a change in occupancy. This is presented to give the reader an idea of how to go about this calculation. In order to do a comprehensive analysis, you will need to identify each expense as either fixed or variable and then calculate the associated cost, for the variable costs, for either a change in occupancy or rate. To be clear, in this example we have not included energy costs. These will have to be added in order to come up with your final report.
Additionally there are some “fuzzy” areas, for example linen expense. The cost of towels and sheets are a variable cost. But is it accounted for as such? By this I mean, how many hotels have come up with a “wear and tear” cost per room occupied for towels and sheets and then accrue this amount on a monthly basis? To my knowledge most hotels budget a monthly amount, perhaps based on occupancy and then expense what is put into circulation. Then on an annual basis an inventory is done then circulating stock is trued up. So these costs may very well be treated as fixed for this analysis. There is absolutely no reason why your fixed costs cannot change on a monthly basis. For example, window washing: maybe this is done on a quarterly basis and budgeted as such.
Finally, should we take into account the number of guests in a room? In our example Corporate rooms would be 95% single occupancy while Wholesaler rooms would be 95% double. So shouldn’t there be a difference in Guest Supplies? The answer is maybe. If Corporate stays average one day, then you will most likely throw out a lot of product where the Wholesaler room (with an average stay between 3-7 days) uses it. So the cost is the same. If your corporate average stay is longer maybe there is a reason to look at this. Also, what about suites and “Executive Floor” rooms? But, I will get back to our original premise. The purpose here is to point someone in the right direction so that potential cost issues will be investigated. There are a lot of exceptions to look at. In a lot of cases they will not matter. You will need to look at your own situation to determine whether these variances need to be accounted for in this analysis.
In connection with rate , we have one variable in Rooms and one in G&A. In our example here the reservation fee is a fixed amount.
So we now have our variable profitability calculated for both occupancy and rate, by market segment. Now we can perform our Flow-Through analysis for the rooms department by comparing our actual figures against these budgeted ones. This comparison can be done by market segment or in total. A suggestion would be to prepare an excel sheet so that on a monthly basis the actual and budget figures could be input and then the analysis would be performed automatically.
One final point here is that you will need to determine if your fixed costs come into play. For example, if your revenues do not cover your fixed costs, this will change the Flow-Through calculation. Also, if your hotel has “other revenue” in the rooms department, then this will need to be included in the analysis too.
Food and Beverage Department
Food revenue is somewhat similar to rooms in that you have both volume and price variances in your revenue and you can have different market segments. How you analyze this is up to you. I have normally looked at total food revenues and calculated the Flow-Through. If you have a situation where there are, for example, three outlets with very different costs, then perhaps you will need to split them out. For our discussion here we will look at this department on an overall basis.
Food volume variance
When the number of covers served changes, what does this effect? This depends on your situation to some degree, but in general the following will be affected. For our examples I have added estimated costs to each one:
– Food Cost – 30%
– Payroll – 20% (You may want to put this in $ terms)
– Expenses – 5% (For this example we have a percentage for our variable costs associated with each additional cover).
Based on the above we have calculated that our profit, within the department, on each additional cover is 45%. In order to calculate the payroll cost you will need to know how many covers are being served per hour by the wait staff, how many are cooked by the kitchen staff, and how many are cleaned by the stewards.
In addition to these costs, we will have increased utility costs and an increase in credit card commissions. Additionally, if your hotel participates in a loyalty program, there may be an additional cost for that as well. In some cases the loyalty program is a percentage of “qualifying revenue”. Therefore our net, variable profit, on a volume increase will be somewhere between 40% and 45%.
Average Cover dollar increase
It should be made clear that an increase in menu pricing is different from an average cover increase. In the context here an increase in the average cover is due to a change in the market mix. If the cover increase came as a result of a menu price increase, then the profitability would be higher as food cost would not increase.
If the average cover increases, the following costs need to be calculated. For our examples, I have added estimated costs to each one:
– Food Cost – 30%
– Expenses – 5% (I have put in 5% but perhaps this will not change at all. You need to be careful and look at all of your costs.
Based on the above, we would look for a profit of 65% on each $1 increase in the average cover within the F&B department. As with other areas of this analysis, you need to be careful. When you do your analysis, perhaps you find that you are not achieving the profit levels than you projected. Maybe the 65% isn’t right. The idea then is that you may need to adjust your figures based on the analysis. For example, maybe you introduced a special “appetizer” program in the restaurant. This has increased sales dramatically, the average cover has gone up, but because the average cover increase is due to additional food items being served, you need additional kitchen staff and thus payroll has increased more than our initial estimate.
In addition to these costs, we may have increased utility costs, there will be an increase in credit card commissions and, if your hotel participates in a loyalty program, there may be an additional cost for that as well. In some cases the loyalty program is a percentage of “qualifying revenue”. Therefore our net, variable profit, on a volume increase will be somewhere between 60% and 65%.
As beverage sales are not normally broken out by average covers, the Flow-Through analysis must be based simply on the change in total sales.
The major issue here will be to estimate the increase or decrease in payroll. If I sell one more dollar, how much does my payroll increase? The answer to one dollar is most likely that no increase exists in payroll costs. At some point the increase in sales is going to require an additional bartender or server. What I have normally done is to take my variable payroll percentage for the beverage department and then take 30% – 50% of that amount and come up with a percentage for it compared to total sales. For example, if my variable beverage payroll is 30% the I would use a percentage between 9%-15% for the incremental sales. Of course, if you find that this does not give the proper results then you may need to make an adjustment.
So here are some cost estimates for the beverage department:
– Cost of Sales – 25%
– Payroll – 15%
– Expenses – 5% (as with food you will need to break out the variable expenses and come up with an accurate percentage)
Based on the above, we can expect that for every additional dollar in sales we will see a profit of 55% within the Beverage department. Additional overhead costs will consist of credit card commissions, loyalty program, and utilities. Again we would probably expect that at the GOP level, we would have a Flow-Through of between 50% and 55%
Other F&B income
If you derive any income from room rental, audio visual rentals, etc you will need to determine the incremental profit on each source of income.
Minor Operating Departments / Other Income
Depending on what other departments you operate, you will need to come up with the formulas to calculate Flow-Through for each of them. You simply need to go line by line and determine what costs are affected by each change in revenue just as we have done above.
Calculating the Flow-Through Percentage
Flow-Through is defined as the amount of money that you keep for every dollar that sales increase. Revenues go up $1. GOP goes up $0.60. You have a 60% Flow-Through. When revenues go down Flow-Through represents your savings. So if revenues go down by $1 and GOP goes down by $0.40 then you saved $0.60 and your Flow-Through is 60%.
Positive Flow-Through is good. Negative Flow-Through is bad.
So let’s take a look at the different scenarios
1. Revenue up $100. GOP up $60 Flow-Through 60%
2. Revenue down $100. GOP down $40 Flow-through 60%
3. Revenue Up $100. GOP down $60 Flow-Through (60%)
4. Revenue Down $100. GOP up $60 Flow Through 160%
By using the information above, you should be able to set up a monthly report that will calculate the Flow-Through for your property and thus give you a better understanding of where potential areas of concern exist. Remember that Flow-Through is based on the revenue mix so a Flow-Through percentage of 10% one month may be a better performance than one of 60% a month later. Never accept a number or percentage until you understand what it means.
For more information contact Eric Hertha (Eric.Hertha@hfcgllc.com)