Finance in the Hospitality Industry

Question: Discuss about Finance in the Hospitality Industry? Answer: Financial management is one of the major aspects of any business. However, managing finance related aspects are never easy and most of the financial managers should have adequate knowledge and information to manage such aspects (Jones, Hillier and Comfort 2016). Financial managers must have adequate information regarding the financial requirements of the business (Brotherton 2012). The managers must also have the information related to the sources of funding available to business. The managers also should have the ability to make effective decisions related to financial management. Such decisions largely depend on various factors such as the existing performance, future prospective and current capabilities of the companies (Sheffet et al. 2014). Various tools or techniques such as financial ratios are there to analyse such factors. The current study critically analyses various key aspects related to Finance. Main Body Sources of funding and income Sources of Funding Two key financial sources of funding available for the companies are equity and debt. Three major types of capital that help the businesses managing their business are fixed capital, working capital and growth capital. Fixed Capital: Fixed capital is useful for financing towards the purchase of any asset or equipment. Such assets are usually long-term. The building, machinery, and Vehicles are key examples of such assets (Brooks and Mukherjee 2013). Working Capital: Working capital involves short-term business expenditures and daily business operation such as paying wages or salaries, inventory etc (Bodnar et al. 2013). Growth Capital: Growth capital is mainly used for expanding or diversifying the business operations. For instance, growth capital is required for developing a new project (Molina and Preve 2012). Following are the key sources of these capitals. Equity: Equity is the capital, which is generated by the companies through issuing shares. The interest of the investors is the key factor. Not getting an adequate return, or even losing money are the key concerns of the equity capital. The investors having equity have the limited ownership right to the business (Ruan and Yan 2012). Various sources of Equity Financing are as follows: Friends and family members Personal savings Corporations Partners Public stock sale Venture capital companies (Ledgerwood 2014) Debt: Debt is another key source of funds, where the borrower has to repay funds with interest. Debt is recorded as the liability in the financial statements (balance sheet) of the company. Debt financing is relatively expensive than equity financing, in the case of small business companies (Rey 2015). Various key sources of debt capital are as follows: Trade credit Commercial banks Saving and loan associations Commercial finance companies Equipment suppliers (Claessens and Kose 2013) Such sources of funds can be considered by the companies based on their capital requirements and financial management structure. Selected sources of finance Selected sources of funding available to Ryanair are as follows: Marginally Positive Working Capital Inflows Funds from Operations (FFO) (800 Million) Cash and Cash Equivalents (2.8 Billion) Factor influencing the sources of finance for Ryanair Factors that may influence the sources of funds for Ryanair are as follows: 600 Million Extraordinary Shareholder Returns 500 Million as Capex 400 Million as Debt maturities Relevant cost Relevant costs involved by using various finance sources to fund are as follows: Average Cost Marginal Cost of Capital Future Cost Historic Cost Spot Cost Specific Cost Explicit Cost Opportunity Cost (Alcock et al. 2013) Principal (amount) and its accompanying cost(s) The principal and the accompanying cost on the main financial statements of Ryanair will be recorded on the income statement, balance sheet, statement of cash flows and statement of retained earnings (Dembiermont, Drehmann and Muksakunratana 2013). Contribution made by a range of methods of generating income within Ryanair Holdings PLC Various methods of generating income within Ryanair Holdings PLC are there. Such method may include the fees, charged against the core services offered by Ryanair Holdings PLC to their customers, in order to recover the cost for the provision of service. Manufacturing and sale, even resale are the most popular and core methods of generating income (ÄŒihk et al. 2012). Renting and leasing the tangible asset to other entities are also the most common methods of generating income. Various intangible assets such as methodology, proprietary, goodwill and brand can also be considered as the methods of generating income. In the case of the hospitality industry, offering services to the customers is the major method of generating income. Ryanair Holdings PLC is an Airline company that introduces the 'lowest fare / lowest cost' model for generating income through their core Airline services. Airport subsidies and website traffic monetization to partners are one of the key methods of g enerating income within Ryanair Holdings PLC, as almost 25% revenue of the company comes from such methods (Haldane 2013). Conclusion Cash and cash equivalents and working capital inflows are effective sources of a fund that Ryanair Holdings PLC was capitalising on. However, Funds from operations is the major sources of funding for the company and the management of Ryanair Holdings PLC considered offering share buyback, as their profit was more than double. The companies like Ryanair Holdings PLC that have both internal and external finance, usually tend to utilise the internal finance options. Most of such companies often make plans to evaluate the available money and to forecast the position of the company during any development. However, the companies may have to face various issues, while considering the internally generated income as the funding option. Lack of flexibility is one of the key issues. In addition, the capital of the company also decreases. As a result, the company may have to face various vulnerable situations, when they need cash, but they have nothing available at that moment. External finance implies either tending towards debt or losing major control. The company may consider obtaining external investments through venture capitalists and shares public. Such companies are vulnerable to takeover. Elements of cost Cost card Total direct material cost = 380 Total direct labour cost = 280 Standard direct cost = 660 Standard variable costs of production = 700 Standard full production cost = 880 Standard cost of sales = 233 (Refer to Appendix 1) Actual and Estimated total Profits Standard sales price = 1163 Units produced and sold = 2000 (Refer to Appendix 1) Methods of Controlling Stock and Cash Various methods are there to control the stock and cash for the hospitality industry. The key aim of managing the stock is to avoid the trouble of deploying asset and to minimise the material holding cost for protecting the material (Reinhart, Reinhart and Rogoff 2012). Various key methods of controlling stock are as follows: Economic Order Quantity (EOQ): EOQ is one of the effective procedures to evaluate the adequate economic quantity for material, which is needed within a particular period of time. The below-mentioned formula evaluates the economic quantity, which is essential for maintaining balance the holdings too much or too little stock (Backer 2015). (Fernandes, Lynch Jr and Netemeyer 2014) Just in Time (JIT): The method, just in time or JIT is useful for minimising the stock, as the companies usually purchase materials as per their requirements and for avoiding the maintenance cost (Kapan and Minoiu 2015). However, there are various issues with the JIT method. For instance, the business operations can be delayed, in case, the material is not delivered on time due to any reason. First in First out (FIFO): FIFO is one of the sophisticated methods to ensure that perishable material will be utilised effectively. In the case of utilising highly perishable material and the situation, where the cost of holding is greater, FIFO is typically implemented (Reinhart, Reinhart and Rogoff 2012). SEC PLC - Economic Order Quantity (EOQ) - Maximise Profit EOQ Holding cost 25 Demand 32000 Ordering costs 10 Step 1 640000 Step 2 12 ECONOMIC ORDER QUANTITY: 230.94 Evaluating business accounts Trial balance A trial balance is organized during an accounting cycle. It is essential to record all the journal entries, before preparing the trial balance. The key rationale of preparing the trial balance is to maintain a balance between both debits and credits. All of the ledger, accounts, debit or credit balances and both general journal and special, listed for justifying whether debits equal credits in the trail balance recording process (Nikulina et al. 2015). The structure of the Trial Balance (Refer to Appendix 2). Financial Statements of Label Consultancy PLC Income Statement Revenue 2012 Sales revenue 4,500 Inventory 2,00,000 Total Revenues 2,04,500 Expenses Administration 700 Investments 2,500 Dividends 60 Distribution 30 Purchases 2,020 Total Expenses 5,310 Net Income Before Taxes 1,99,190 Income tax expense 90,000 Income from Continuing Operations 1,09,190 Net Income 1,09,190 Balance Sheet Assets Current Assets: Cash $3,50,000 Accounts Receivable $8,50,000 Less: Reserve for Bad Debts 0 8,50,000 Merchandise Inventory 2,00,000 Total Current Assets $14,00,000 Fixed Assets: Equipment 50,000 Less: Accumulated Depreciation 7,000 43,000 Buildings 1,50,000 Less: Accumulated Depreciation 1,20,000 30,000 73,000 Other Assets: Goodwill 3,00,000 Total Other Assets 3,00,000 Total Assets $17,73,000 Liabilities and Capital Current Liabilities: Accounts Payable $5,00,000 Sales Taxes Payable 90,000 Total Current Liabilities $5,90,000 Long-Term Liabilities: Long-Term Notes Payable 0 Mortgage Payable 0 Total Long-Term Liabilities 0 Total Liabilities 5,90,000 Capital: Owner's Equity 10,00,000 Net Profit 1,83,000 Total Capital 11,83,000 Total Liabilities and Capital $17,73,000 The process and purpose of budgetary control to Label Consultancy LTD Budgetary objectives: It is essential for the finance personnel to understand the objectives and policies of the companies regarding the execution of the budget (Reddy 2015). Budgetary organisation: the Appropriate organisation is essential for preparing, maintaining and administrating budgets successfully. Departmental heads and managers have the authority to develop functional budgets (Bugg-Levine, Kogut and Kulatilaka 2012). Budget centres: It implies the part of the organisation, regarding which the budget is prepared. The budget centres are useful for cost control purposes. Budget manual: The duties and the responsibilities of the financial executives are recorded as a budget manual (McKinney 2015). Budget controller: Budget controller is selected for the administration of budgets. The key roles and responsibilities of the budget controller include implementation, construction, coordination and revision of business budgets. In other words, the controller is responsible for managing budgetary performance (Greenbaum, Thakor and Boot 2015). Budget committee: The key aim of the budget committee is for assisting the budget controller (Brigham and Ehrhardt 2013). Budget period: The budget period indicates the time when the budget is prepared and employed. The period depends on various circumstances (Adrian and Shin 2014). Variances from budgeted and actual figures Variance Variance (%) Sales and Production (units) 300 42.86% Sales 5800 40.85% Variable cost of sales: Direct Materials Direct Labour Variable Overheads 84000 -85.71% Contribution 1600 36.36% Fixed Costs 400 -7.41% Profit/(Loss) 2000 -200.00% Analysing business performance through financial ratios Financial Ratios Gross profit margin 2015 2014 Sales revenue 2000 1000 Cost of sales 1300 700 Gross profit margin = (revenue cost of sales)/revenue 0.35 0.30 Gross profit margin is one of the key profitability ratios. The gross profit margin of KAlexaddo LTD increased in 2015, compare to 2014. Therefore, it can be inferred that the company is able to enhance their profitability and is also able to retain sales to service its other costs and obligations (Haas and Lelyveld 2014). Net profit markup 2015 2014 Sales revenue 2000 1000 Cost of sales 1300 700 Gross profit margin = (revenue cost of sales)/cost of sales 53.85% 42.86% The Net profit markup of KAlexaddo LTD largely increased in 2015 and such increment indicates that the company has added product costs to cover the cost of goods. Return on capital employed 2015 2014 Earnings before interest and taxes 240 90 Current Liabilities 500 800 Total Assets 5110 4720 Return on capital employed = EBIT /(Total Assets Current Liabilities) 5.21% 2.30% Current liabilities Loans and other borrowings (overdrafts) 200 400 Trade payables 200 100 Other creditors (taxation) 100 300 Total current liabilities 500 800 The ROCE of KAlexaddo LTD on 2015 is relatively higher than 2014. Therefore, it is confirmed that the management has been able to enhance their return on capital for the shareholders. However, as per the industry scenario, the Return on capital employed is 15%, which is largely greater than the current ROCE of KAlexaddo LTD. Current ratio 2015 2014 Current Assets 1810 1110 Current Liabilities 500 800 Current Ratio 3.62 1.3875 The current ratio of KAlexaddo LTD is exceptionally well in 2015, even in terms of in terms of industry standards, which is 2.3:1. However, the current ratio was low in 2014. It can be inferred that the company has not only been able to increase their current assets, but also to decrease their current liabilities. The company has the ability to use their current assets for paying their current liabilities (Allen et al. 2016). Trade receivables collection days 2015 2014 Accounts receivables 400 800 Sales 2000 1000 Trade receivables collection days = Accounts receivables/( Sales/365) 73 146 The management is also able to minimise the Trade receivables collection days to 73 in 2015 while the Trade receivables collection days was 146 in 2014. Trade payables payment days 2015 2014 Average Accounts Payable 200 100 Cost of Sales 1300 700 Trade payables payment days = (Average Accounts Payable/ Cost of Sales)*365 56.15 52.14 The Trade payables payment days of KAlexaddo LTD slightly increased in 2015 and such increment signifies that the company is facing problems paying off their creditors. Gearing ratio 2015 2014 Long-term liabilities 1000 1200 Cost of Sales 1300 700 Trade payables payment days = (Average Accounts Payable/ Cost of Sales)*365 56.15 52.14 Share Capital 2000 1800 Retained Earnings 1010 820 Capital employed = Retained earnings + Share capital + long-term liabilities 4010 3820 Gearing ratio = Long-term liabilities/ Capital employed 24.94% 31.41% The gearing ratios of KAlexaddo LTD are normal in both 2015 and 2014. It indicates that the company is interested in financing their activities using debt. Interest cover 2015 2014 EBIT 240 90 Interest Expenses 100 60 Interest cover = EBIT/Interest Expenses 2.4 1.5 The interest cover ratios of the company for the year 2014 and 2015 were 2.4 and 1.5 respectively. Therefore, the company has been able to maintain acceptable ratio and the company is able to pay off their interest payments accordingly (Law and Singh 2014). Future competitive business strategies for KAlexaddo PLC The company KAlexaddo LTD is able to enhance their revenue and the management of KAlexaddo LTD should implement new strategies to minimise their cost of sales in the future to enhance their profitability further. Increasing the product costs to recover the cost of sales is reasonable to some extent (Gray et al. 2015). However, the management must find some other effective ways or strategies to cover the cost of sales. The company must concentrate enhancing their ROCE by minimising their current liabilities. The company has good perspective, in terms of getting loans from banks or other FIs. The company must concentrate collecting payments from the customers more effectively. The company must consider utilising their capital effectively to pay off their creditors (Adrian, Covitz and Liang 2013). Applying the model of the marginal costing Categorise costs Fixed Cost: The cost is a preset cost that does not tend to change while the amount of produced goods or services is changing. There is no relation between fixed cost and any business activity. Salaries, tax, rent, heating, insurance and lighting are key examples of fixed cost. Fixed cost is also known as the indirect cost. Such costs are not associated with any business activities directly (Kindleberger 2015). The companies have to pay fixed cost, even if they are not producing any services or products. Variable Cost: Variable cost is one of the key corporate costs that changes in accordance with the changes in production. Such cost largely depends on production volume. Variable costs are completely different than the fixed cost. Advertising, materials, electricity, rent, office supplies and insurance etc are the key examples of variable costs. Total costs include both costs. Variable cost is also recognized as the direct cost (Al-Najjar 2013). Semi-variable costs: The semi-variable cost is the grouping of both fixed and variable cost components. To certain extent or level of production, the cost remains fixed. However, after reaching or crossing the level, the cost becomes variable. Therefore, these costs have both fixed and variable in nature. The total cost can be calculated by adding fixed, variable and semi-variable costs together. Employment benefits or incentives are the perfect examples of semi-variable cost (Huang, Zhou and Zhu 2012). Contribution per product Contribution per unit = (Total revenues - Total variable costs) / Total units (Nagurney and Siokos 2012) = (1163 - 700)/2000 = 0.2315 P = 1163/2000= 0.58 V = variable cost per unit = 700/2000 = 0.35 X = Total number of units produced and sold = 2000 FC = Total fixed cost = 660 Contribution Margin = (Sales variable cost) = 1163 700 = 463 Contribution Margin ratio = 463/1163= 0.40 = 40% Break Even Point = Total fixed cost/ Contribution Margin ratio = 660/40% = 264 Break-even points in units Quarter 1: Break-even point in units = Total fixed cost/Contribution margin per unit (Stagars 2014) 2000 = 660/ Contribution margin per unit Therefore, Contribution margin per unit = 0.33 Quarter 2: Break-even point in units = Total fixed cost/Contribution margin per unit 5500 = 660/ Contribution margin per unit Therefore, Contribution margin per unit = 0.12 Quarter 3: Break-even point in units = Total fixed cost/Contribution margin per unit 4000 = 660+1300/ Contribution margin per unit Therefore, Contribution margin per unit = 0.49 Conclusion The current study concludes that the finance in the hospitality industry is comparatively different than any other industry. 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