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Diploma in Hospitality Management
Unit Number and Title
Unit 2 Finance in Hospitality Industry
A business can be analysed to arrive at its component of expenses, which keep the activity going. It represents the monetary value in the books of the company, spent to manufacture a product or provide a service and encompasses all the time, money and labour expended.
The costs in a retail sales entity such as M&S would be slightly different from a manufacturing business strategy, wherein they would fall into any one of the following categories, namely:
All the above examples may not be always identifiable in M&S. For e.g. Materials, normally are substances which are key products of manufacture held at various stages of processing. However, in retail environment such as in M&S, where there is no factory like production process and products are procured from supplier’s world-over, and this category would be made up of purely inventory or stock ready for sale.
A direct cost is one which is directly identifiable with the product or service e.g. Materials, labour etc.
Indirect costs are however not immediately identifiable with the product sold to customers e.g. Stationery, insurance, taxes etc.
Costs are also distinguished as Fixed and Variable costs.
Fixed costs are those that remain at the same level, no matter how much the volume of output changes e.g. Rent, taxes etc.
Variable costs vary with changes in output levels e.g. Fuel, labour etc.
Some types of cost may also be semi-variable with a fixed portion and a variable portion e.g. Vehicle running costs which has a fixed element like tax and variable element such as fuel.
A third variety of cost is called the discretionary cost and is one whose level depends upon the discretion of the management e.g. advertising, training costs
Analysis of the financial statements of a company is enabled by the use of various types of ratios and as profits are key targets of any commercial venture, Profitability ratios are the starting point.
These ratios help in 2 ways – a) in reflecting the performance and b) efficiency of operations of the entity.
The Gross Profit Percentage (GPP) sometimes also referred to as the Gross Profit Ratio or the Gross Profit Margin shows the relationship of the company’s profits as a percentage of its Sales. In a sense, it is the key indicator of business efficiency and the higher the number, the healthier the business. The ratio permits one to compare the profits made by companies of differing sizes within an industry, as it is expressed as a percentage and not in absolute terms. We can also infer from the ratio as to what percentage of earnings are available to cover overheads and tax on profits.
GPP = (Gross profit*/Total Sales) x 100
(Where *Gross profit = Total Sales-Cost of Goods sold)
The cost of goods sold (COGS) is the sum total value of all components that went into producing the goods sold. To arrive at the selling price, the seller has to add the mark up or the profit component, which constitutes the Gross Profit (GP).
Selling price = COGS + Mark up (GP)
Net Profit (NP) is derived from the GP after deducting all overheads, such as rent, salaries and taxes and it constitutes the actual amount earned.
Initially the Trading/Manufacturing account is prepares ascertain the GP and thereafter the Profit & Loss account is prepared to determine the NP.
The concept of Net Sales is the amount after discount or other ‘markdowns’ are priced in and is the amount paid in by the ultimate customer.
Cash and stock (inventory) make up 2 key components of working capital, the others being receivables and payables. But between a business and a service, there may be differing levels of the two assets, depending upon the nature of industry.
For example, M&S being retail intensive may be looking to convert cash quickly back into stock but this process would be entirely dictated by demand for consumer goods, seasonality and supply from quality vendors. In case of a service organization, the value of inventory may be close to nil even.
Further, a manufacturer may trade on cash and credit terms and may enjoy credit from his suppliers. On the other hand, a retailer may be completely cash driven
Better working capital management is desired to ensure there is no idle cash, save unnecessary costs (e.g. Interest payments), earn interest where possible etc.
Most commonly used methods to control stock and cash are:
The best method for a business would entirely depend on the nature of business / service. For e.g. Businesses which are dependent on materials which need procurement in large quantities may be required to build up stock at competitive prices and hence may not have much choice like JIT.
Ultimately, an efficient inventory control system must come up with the answers to 2 basic questions ie. (a) How much to order ? and (b) When to order?
A useful method for addressing both these questions would be the EOQ or the Economic Order Quantity model, which is particularly effective in case of businesses with large variable costs, like within the retail sector. This model is based on the formula =
where A = Demand for the year; Cp = Cost to place a single order and Ch = Cost of holding one unit inventory for a year.
Retail sector entities like M & S may incur costs in disposal of cash through banking and other channels in cash driven economies like in a developing country unlike in the UK where card payments are almost the rule. This can be mitigated to a large extent by encouraging payment through direct Bank transfers through a variety of incentives such as preferential/discounted prices, quicker supply etc. Thus cash handling costs can be done away with. Frequent routing of payments via bank transfers would definitely increase the need for a close watch over the bank account by means of daily Bank account reconciliation process in order to ensure that every sale is recovered without fail. This definitely augurs well for a better credit management system.
Figure.1 Budgetary control system
Now a days all the organizations across the globe have a system of budgetary control installed within the organization. A budget helps the organization to plan in advance and to efficiently allocate the resources. The system of budget is more effective with the comparison of the actual performance of the organization. This helps the organization to understand the areas where more funds were expended and the reasons there of. The process of budgetary system depends on the location of key factor. A key factor is an important element that can impact the levels of production. The budgets are prepared keeping the past results in mind with the future expectations. The budgetary process can not solely rely on the past results. The objectives which impel the preparation of a budget have been outlined below:
Material Price Variance: The budgeted material price was 0.15 whereas the actual price was 0.30 which was double the estimated amount. An adverse material price variance suggests the following:
Material Usage Variance: The usage variance has also exceeded the budget quantity. Adverse material usage variance points towards the following facts:
Labour Rate Variance: The Labour rate also decreased as a consequence there is a favourable variance of 3750. A positive or favourable variance indicates the following:
Labour Efficiency Variance:The labour efficiency has deteriorated. An adverse ratio is an indication of:
It can be clearly understood that the above variances are due to change in prices of the material and the labour and also the quantity of usage. The budgeted material price was 0.15 whereas the actual price was 0.30 which was double the estimated amount. The Labour rate also increased by almost 50%. As the labour working hours have not been given no analysis of the efficiency can be done.
It is evident from the above that the budget making decision process has not been efficiently implemented within the organization. The organization needs to fine tune the same so as to reduce the variance with the actual performance.
“A trial balance is a list of all the balances contained against each Nominal, as they are sometimes referred to or General ledger account numbers. These consist of both Balance sheet and Profit and Loss accounts.” (E-conomic.co.uk, 2014)
A trial balance is a statement which is prepared with the closing balances of all the accounts. It checks if the debits equal the credits.
After a transaction has taken place the same is recorded in the books of accounts. The journal is the fist book of entry. From the journal the records are posted to the respective ledgers. At the close of the accounting year the ledgers are balanced and the balance is posted to the trial balance.
A trial balance is a report which checks the arithmetical accuracy of the accounts prepared however it is not able to detect the following errors:
Figure.2 Format of trial balance
Profit and Loss
Less Cost of goods sold:
Wages and salaries
Van running costs
Doubtful debt provision
Office furniture & Van
Less provision for doubtful debts
Cash at bank & hand
Add net profit
Accounts Receivable Turnover
Accounts Receivable Turn-Days
Accts. Rec. Turnover
Accounts Payable Turnover
Cost of Goods Sold
Average Payment Period
Accts. Pay. Turnover
Key Ratios - Ratio Analysis
Accounts receivable, net
Total current assets
Total long-term assets
Total current liabilities
Total long-term liabilities
Total shareholders' equity
Total operating expenses
Income (loss) before taxes
Net income (loss)
Return on equity
Return on assets
Return on sales
Gross profit margin
Asset turnover ratio
Leverage and Liquidity Ratios
Quick or acid test ratio
Long-term debt ratio
Debt to equity ratio
Total Fixed cost=$30000, Budgeted no. Of units=10000, Sales=$100000, so S.P/unit=100000/10000=10, Total V.C. =$80000, so v.c/unit=80000/10000=8
BEP and Profitability Analysis
BEP in units=F.C/Contr per unit
BEP in sales=BEP units*SP/unit
b) Reqd. Profit=$20000, So reqd.contr. =F.C. +Profit=30000+20000=$50000
No. Of units=Contr/Contr. Per unit
Total Contr.=Contr/unit*No. of units
Fixed costs are those costs which remain unchanged with the level of production for example the rent of factory. Variable costs are costs that change with the level of production and can be said to be directly proportional to the change in the level of production. Semi Variable costs are those costs which are fixed to a certain level of production. No cost is fixed in the long run. The proposition 3 is a better proposition as the consumers are getting a better product for the same price. As the consumers are sensitive to rise in price of a product the organization has to plan its pricing business strategy very carefully. An organization has to consider the price elasticity before the prices can be raised. Proposition 1 offers the same product for a lower price, hence the quality remains the same. Proposition 2 on the other hand is not good for the consumers as the price of the product will move upward. Hence the proposition is the best.
McKenzie, W, 2003, 3rd edn, The Financial Times Guide to Using and Interpreting Company Accounts, FT Prentice Hall, Harlow.
Palat, R R, 2006, How to read Annual Reports & Balance Sheets, Jaico Publishing House, Mumbai
Ernst & Young, (2013) Working Capital Optimization, [Online], Available at: http://www.ey.com/Publication/vwLUAssets/Working-Capital-Optimization/$FILE/Working-Capital-Optimization.pdf [Accessed on 23rd February 2014].
Pew Research Centre, (2014) Fast Food Statistics, [Online] Available at : http://www.statisticbrain.com/fast-food-statistics/ [Accessed on 21st February 2014].
Big Hospitality, (2012) Fast Food, Trends and Reports, [Online] Available at : http://www.bighospitality.co.uk/Trends-Reports/Quick-service-and-fast-food-sites-make-up-half-of-all-restaurant-meals-eaten [Accessed on 21st February 2014].
Datamonitor Research Store, (2012) United Kingdom, Fast Food Industry profile, [Online], Available at : http://www.datamonitor.com/store/Product/united_kingdom_fast_food?productid=MLIP0123-0015, [Accessed on 22nd February 2014].