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Chapter 6 - Ratio analysis. Ratio analysis is used to analyze profitability and it is also used to examine, in detail, the asset, liability, and owners’ equity positions of a business. In this chapter you will learn how to compute and analyze the ratios used to evaluate each of these three major components of the basic Accounting Formula.
Chapter Ratio Analysis © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Chapter Outline Purpose and Value of Ratios Types of Ratios Comparative Analysis of Ratios Ratio Analysis Limitations © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Learning Outcomes State the purpose and value of calculating and using ratios to analyze the health of a hospitality business Distinguish between liquidity, solvency, activity, profitability, investor, and hospitality-specific ratios Compute and analyze the most common ratios used in the hospitality industry © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Percentages A ratio is created when you divide one number by another A special relationship (a percentage) results when the numerator (top number) used in your division is a part of the denominator (bottom number) To convert from common form to decimal form, move the decimal two places to the left, that is, 50.00% = 0.50 To convert from decimal form to common form, move the decimal two places to the right, that is, 0.50 = 50.00% © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Value of Ratios to Stakeholders All stakeholders who are affected by a business’s profitability will care greatly about the effective operation of a hospitality business These stakeholders may include: Owners Investors Lenders Creditors Managers © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Value of Ratios to Stakeholders Each of these stakeholders may have different points of view of the relative value of each of the ratios calculated for a hospitality business Owners and investors are primarily interested in their return on investment (ROI), while lenders and creditors are mostly concerned with their debt being repaid At times these differing goals of stakeholders can be especially troublesome to managers who have to please their constituencies One of the main reasons for this conflict lies within the concept of financial leverage © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Financial Leverage Financial leverage is most easily defined as the use of debt to be reinvested to generate a higher return on investment (ROI) than the cost of debt (interest) g o fig u re! To illustrate, assume a hospitality manager: Borrows $10,000 to be repaid at 10% interest Reinvests the same $10,000 in an investment that gains 12% ROI And thus, creates a surplus of 2% gain In this case, borrowing $10,000 and reinvesting the same $10,000 at a higher rate of return earns a net gain of 2% after the debt is repaid The manager, in this case, has leveraged debt to secure a gain © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Financial Leverage Because of financial leverage, owners and investors generally like to see debt on a company’s balance sheet because if it is reinvested well, it will provide more of a return on the money they have invested Conversely, lenders and creditors generally not like to see too much debt on a company’s balance sheet because the more debt a company has, the less likely it will be able to generate enough money to pay off its debt © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Ratio Comparisons Ratios are most useful when they compare a company’s actual performance to a previous time period, competitor company results, industry averages, or budgeted (planned for) results When a ratio is compared to a standard or goal, the resulting differences (if differences exist) can tell you much about the financial performance (health) of the company you are evaluating © 2009 John Wiley & Sons Hoboken, NJ 07030 Managerial Accounting for the Hospitality Industry Dopson & Hayes Types of Ratios Managerial accountants working in the hospitality industry use: Liquidity Ratios Solvency Ratios Activity Ratios Profitability Ratios Investor Ratios Hospitality Specific Ratios Most numbers for these ratios can be found on a company’s income statement, balance sheet, and statement of cash flows © 2009 John Wiley & Sons Hoboken, NJ 07030 10 Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! For Joshua’s Restaurant, the Cost of Food Sold (Cost of Sales: Food) would be calculated as follows: Beginning Inventory + Purchases = Food Available for Sale 51,400 771,000 822,400 - Ending Inventory = Cost of Food Consumed 53,750 768,650 - Value of Transfers Out + Value of Transfers In - Employee Meals = Cost of Food Sold 11,992 25,785 15,000 767,443 Thus, the cost of food sold for Joshua’s is $767,443 © 2009 John Wiley & Sons Hoboken, NJ 07030 50 Managerial Accounting for the Hospitality Industry Dopson & Hayes Cost of Beverage Sold (Cost of Sales: Beverage) Cost of beverage sold (cost of sales: beverage) is the dollar amount of all beverage expenses incurred during the accounting period The cost of beverage sold is calculated in the same way as cost of food sold except that the products are alcoholic beverages (beer, wine, and spirits) Employee meals are not subtracted because employees are not drinking alcoholic beverages © 2009 John Wiley & Sons Hoboken, NJ 07030 51 Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! For Joshua’s Restaurant, the Cost of Beverage Sold (Cost of Sales: Beverage) would be calculated as follows: Beginning Inventory + Purchases = Beverage Available for Sale - Ending Inventory - Value of Transfers Out + Value of Transfers In = Cost of Beverage Sold 11,520 112,589 124,109 13,750 25,785 11,992 96,566 Thus, the cost of beverage sold for Joshua’s is $96,566 © 2009 John Wiley & Sons Hoboken, NJ 07030 52 Managerial Accounting for the Hospitality Industry Dopson & Hayes Food Cost Percentage A restaurant’s food cost percentage is the ratio of the restaurant’s cost of food sold (cost of sales: food) and its food revenue (sales) g o fig u re! Using Joshua’s Restaurant in Figure 6.6, the calculation for food cost percentage is: Cost of Food Sold Food Sales = Food Cost % or $767,443 $2,058,376 =37.3% Thus, the food cost % for Joshua’s is 37.3% © 2009 John Wiley & Sons Hoboken, NJ 07030 53 Managerial Accounting for the Hospitality Industry Dopson & Hayes Beverage Cost Percentage A restaurant’s beverage cost percentage is the ratio of the restaurant’s cost of beverage sold (cost of sales: beverage) and its beverage revenue (sales) g o fig u re! Using Joshua’s Restaurant in Figure 6.6, the calculation for beverage cost percentage is: Cost of Beverages Sold Beverage Sales = Beverage Cost % or $96,566 $482,830 = 20.0% Thus, the beverage cost % for Joshua’s is 20.0% © 2009 John Wiley & Sons Hoboken, NJ 07030 54 Managerial Accounting for the Hospitality Industry Dopson & Hayes Labor Cost Percentage Restaurateurs are very interested in the labor cost percentage, which is the portion of total sales that was spent on labor expenses It is typically not in the best interest of restaurant operators to reduce the total amount they spend on labor In most foodservice situations, managers want to serve more guests, and that typically requires additional staff Many managers feel it is more important to control labor costs than product costs because, for many of them, labor and labor-related costs comprise a larger portion of their operating budgets than the food and beverage products they sell © 2009 John Wiley & Sons Hoboken, NJ 07030 55 Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! Using Joshua’s Restaurant in Figure 6.6, the calculation for labor cost percentage is: Cost of Labor Total Sales = Labor Cost % or $825,892* $2,541,206 = 32.5% *Cost of labor is calculated by adding salaries and wages to employee benefits or $714,079 + $111,813 = $825,892 Thus, the labor cost % for Joshua’s is 32.5% © 2009 John Wiley & Sons Hoboken, NJ 07030 56 Managerial Accounting for the Hospitality Industry Dopson & Hayes Average Sales per Guest (Check Average) Average sales per guest (check average) is the average amount of money spent per customer during a given accounting period This measure of “sales per guest” is important because it carries information needed to monitor menu item popularity, estimate staffing requirements, and even determine purchasing procedures It also allows a financial analyst to measure a chain’s effectiveness in increasing sales to its current guests, rather than increasing sales simply by opening additional restaurants © 2009 John Wiley & Sons Hoboken, NJ 07030 57 Managerial Accounting for the Hospitality Industry Dopson & Hayes Average Sales per Guest (Check Average) The check average ratio can be used to compare a restaurant’s performance to previous accounting periods, to forecasted or budgeted results, to similar restaurants, and to published industry averages or standards Industry averages and other restaurant statistics are readily available through publications such as the Restaurant Industry Operations Report published by the National Restaurant Association © 2009 John Wiley & Sons Hoboken, NJ 07030 58 Managerial Accounting for the Hospitality Industry Dopson & Hayes g o fig u re! Assuming Joshua’s Restaurant in Figure 6.6 served 203,300 guests during the year, the calculation for average sales per guest is: Total Sales Number of Guests Served = Average Sales per Guest (Check Average) or $2,541,206 203,300 = $12.50 Thus, the average sales per guest for Joshua’s is $12.50, meaning that each guest spent, on average, $12.50 when dining at his restaurant © 2009 John Wiley & Sons Hoboken, NJ 07030 59 Managerial Accounting for the Hospitality Industry Dopson & Hayes Seat Turnover Seat turnover measures the number of times seats change from the current diner to the next diner in a given accounting period g o fig u re! Assuming Joshua’s Restaurant in Figure 6.6 had 260 seats and served 203,300 guests (covers) during the year, the calculation for seat turnover is: Covers Served Number of Seats X Number of Operating Days in Period = Seat Turnover or 203,300 260 X 365 = 203,300 94,900 = 2.14 turns Thus, the seat turnover for Joshua’s is 2.14 times, meaning that each seat changed from the current diner to the next diner, on average, 2.14 times per day © 2009 John Wiley & Sons Hoboken, NJ 07030 60 Managerial Accounting for the Hospitality Industry Dopson & Hayes Restaurant Ratios Ratio Name Definition Source of Data Formula Food Cost Percentage Food Cost Percentage represents the portion of food sales spent on food expenses Numerator: Operating Reports Cost of Food Sold Food Sales Beverage Cost Percentage represents the portion of Beverage sales spent on Beverage expenses Numerator: Operating Reports Labor Cost Percentage represents portion of total sales spent on labor expenses Numerator: Operating Reports Beverage Cost Percentage Labor Cost Percentage Denominator: Operating Reports Cost of Beverage Sold Beverage Sales Denominator: Operating Reports Cost of Labor* Total Sales Denominator: Operating Reports *Cost of labor = salaries + wages + employee benefits Average Sales Per Guest (Check Average) Average sales per guest is average amount of money spent per customer during a given accounting period Numerator: Operating Reports Seat Turnover Seat turnover shows the number of times seats change from a current diner to another diner in given accounting period Numerator: Operating Reports © 2009 John Wiley & Sons Hoboken, NJ 07030 61 Denominator: Operating Reports Denominator: Operating Reports Total Sales Number of Guests Served Covers Served Number of Seats x Number of Operating Days in Period Managerial Accounting for the Hospitality Industry Dopson & Hayes Comparative Analysis of Ratios Like many other types of financial data, a company’s financial ratios are often compared to previous accounting periods, to forecasted or budgeted results, or to published industry averages or standards Figure 6.9 City-Wide and The Blue Lagoon Occupancy Percentage City-Wide Blue Lagoon © 2009 John Wiley & Sons Hoboken, NJ 07030 2008 81.0% 82.0% 62 Occupancy Percentage 2009 79.1% 80.4% 2010 77.0% 80.0% Managerial Accounting for the Hospitality Industry Dopson & Hayes Ratio Analysis Limitations One weakness inherent in an over-dependency on financial ratios is that ratios, by themselves, may be less meaningful unless compared to those of previous accounting periods, budgeted results, industry averages, or similar properties Another limitation is that financial ratios not measure a company’s intellectual capital assets such as brand name, potential for growth, and intellectual or human capital when assessing a company’s true worth © 2009 John Wiley & Sons Hoboken, NJ 07030 63 Managerial Accounting for the Hospitality Industry Dopson & Hayes Review of Learning Outcomes State the purpose and value of calculating and using ratios to analyze the health of a hospitality business Distinguish between liquidity, solvency, activity, profitability, investor, and hospitality-specific ratios Compute and analyze the most common ratios used in the hospitality industry © 2009 John Wiley & Sons Hoboken, NJ 07030 64 Managerial Accounting for the Hospitality Industry Dopson & Hayes ... 2,854,080 8,877 ,60 0 5,934,240 7,535,880 1, 760 ,400 1, 260 ,000 4,515,480 1,272,000 3,243,480 1,297,390 1,9 46, 090 Managerial Accounting for the Hospitality Industry Dopson & Hayes Figure 6. 2 Balance... Hoboken, NJ 07030 12 14,577,400 18 ,60 0,000 3,000,000 18,775,100 6, 1 16, 850 27,891,950 46, 491,950 Managerial Accounting for the Hospitality Industry Dopson & Hayes Figure 6. 3 Statement of Cash Flows Blue... 532,800 2,721 ,60 0 2,340,000 534, 960 201 ,60 0 7 36, 560 1 ,69 2,000 * *The discussion of cost of goods sold and cost of goods consumed will be explained later in this chapter in the Hospitality- Specific