financial overview and budgets. today’s learning understanding generic finance budgets and...

FINANCIAL OVERVIEW AND

BUDGETS

TODAY’S LEARNING

UNDERSTANDING GENERIC FINANCE

BUDGETS AND BUDGETING

PREPARATION OF BUDGETS

MANAGING FISCAL RESPONSIBILITIES

UNDERSTANDING GENERIC FINANCE

Interpretation of Financial Statements

The objective of financial statements is to provide information about the financial position, performance and capability of a business that is useful to a wide range of users in making economic decisions.

The Balance Sheet

• Gives a picture of where the company is at a particular time, usually a year end.

• Is also a financial statement that shows the value of assets and liabilities of a company at a point in time.

Statements of Standard Accounting Practice (SSAPs)

• Balance Sheets are prepared on the basis of historical costs as opposed to estimated current values.

• Subjective valuation is allowed in certain cases, such as the value of outstanding receivables (monies owed to the firm from sales on credit terms) which normally reflects a monetary, but ultimately subjective, element of bad debts.

Statements of Standard Accounting Practice

• Asset appreciation is ignored, but depreciation of assets, along schedules agreed with the taxation authorities is allowed.

• Some assets (intangible) might not be included due to the highly complex and subjective nature of their valuation. Typically these include the embedded value of human capital, the valuation of brands, and the goodwill of the business.

Depreciation

• Is an amount usually expressed as a

proportion of the initial cost of a fixed asset

that is offset against tax, on an annual basis.

• There are some guidelines for period of

depreciation, usually expressed in a number of years.

5-10 years on heavy equipment 2-3 years on operating equipment

Current Liabilities

These are liabilities which the company

expects to have to honour within the year.

The main elements of this portion of the

liabilities side of the balance sheet are:• short-term financing• overdrafts• accounts payable

Long-Term Liabilities

These are the remainder of the liabilities of the company such as long-term financing.

A possible additional element of liabilities is contingent liabilities, such as guarantees provided or provision for legal costs.

The Profit and Loss Statement

The profit and loss account of a company is a statement of the operating activities of a company over a certain period.

Generally, the profit and loss account is not on a cash basis but on an actual accrual basis.

The Accrual System

Accruals are submitted by each department based on items or services ordered in a period and not received.

The accounts department then allocate these amounts to the department so the money will be available from that financial period to pay for the goods or services.

Cash Flow Statement (CFS)

Is the financial statement that shows the cash generated and used over a specified period of time. Cash flows are classified into:

• Operating activities• Investing activities• Financing

.

The cash flow of a company is really like the blood circulating in a body – it stops moving then the body dies.

Solvency

Solvency is a money or cash phenomenon. A solvent company is one with adequate cash to pay its debts; an insolvent company is one with inadequate cash.

Any information that provides insight into the amounts, timings and certainty of a company’s future cash receipts and payments is useful in evaluating solvency, such as, statements of past cash receipts and payments .

Direct Method of Cash Flow from Operating Activities

Cash Received from Customers– Less cash payments to suppliers– Less cash paid to and on behalf of

Employees– Less other cash payments

= Net Cash Into (Out Of) Operating Activities

Indirect Method of Cash Flow from Operating Activities

• Operating Profit• Depreciation Charge• Profit/(Loss) from sale of fixed assets• Increase in Stocks• Decrease in Debtors• Increase in Creditors

= Net Cash Into (Out Of) Operating Activities

Measuring Financial Performance

How may the information available be used rapidly to get an insight into the health of a company?

How may we compare the information from a number of companies of different size?

Ratios are frequently used to standardise financial information.

Financial Ratios

Ratios are useful indicators of a firms performance and financial situation, the expertise lies in knowing which ratios provide useful information.

They can be used to analyze trends and to compare the firm’s financials to other companies.

Using Ratios

If they are applied incorrectly, they may be completely useless or, perhaps even worse, misleading.

If they are used correctly, they are a powerful tool for understanding and interpreting company accounts.

Some basic rules for financial ratio analysis are as follows:

Compare like with like, the performance of a company can be gauged by comparing that company’s financial ratios with:

financial ratios for a preceding period;budgeted financial ratios for the current

period;financial ratios for other profit centres within

the company;financial ratios for other companies within

the same sector.

Some Common Ratios

Typically ratios are used for a number of purposes:

• Measuring short-term solvency (liquidity ratios)

• Measuring long-term solvency (gearing ratios)

• Measuring profitability and turnover• Assessing market value

Liquidity Ratios

These ratios focus on the short term and are used as an indication of how easily the company could service its obligation over the short term.

These are of greater interest to short-term creditors.

Current Ratio = Current Assets

Current Liabilities

Gearing Ratios

A measure of financial leverage, shows the degree a firm's activities are funded by owner's funds versus borrowed funds.

• the debt-to-equity ratio (total debt / total equity)

• debt ratio (total debt / total assets)

Gearing Ratios

A company with high gearing (leverage) is more vulnerable to downturns in the business cycle because the company must continue to service its debt regardless of how bad sales are.

A greater proportion of equity provides a cushion and is seen as a measure of financial strength.

Profitability Ratios (1)

Profitability ratios measure how well a company is performing by analyzing how profit was earned relative to sales, total assets and net worth. Example:Return on Sales Ratio = Net Profit ÷ Net Sales

This ratio measures the profits after taxes on the year's sales. The higher this ratio, the better prepared the business is to handle downtrends brought on by adverse conditions.


Return on Assets (ROA) Ratio shows the after tax earnings of assets and is the key indicator of the profitability of a company.


Return on Net Worth Ratio measures the ability of a company's management to realize an adequate return on the capital invested by the owners in the company.

Budgets and Budgeting

What is a Budget?

A budget is the financial blueprint or action plan for an organization.

It translates strategic plans into measurable expenditures and anticipated returns (estimates the probable income and expenditures) over a certain period of time.

A budget acts as a control mechanism by pointing out soft spots in the planning process and/or in the execution of the plans.

It augments a company's ability to more quickly react and make necessary alterations.

Financial Forecasts

A financial forecast

quantifies future sales,

expenses, and earnings

according to certain

assumptions adopted by

the company.

A financial forecast

projects where the

company wants to

be in three, five, or

ten years.

Budgets should be

1.Realistic and quantifiable2.Historical 3.Period specific 4.Standardized 5. Inclusive 6.Successively reviewed 7.Formally adopted and disseminated8.Frequently evaluated

Realistic and Quantifiable

A company needs to

• Ration its own resources by setting goals and objectives which are attainable.

• Evaluate each potential activity to determine those that will result in the most appropriate resource allocation.

• Accomplish this through the quantification of the costs and benefits of the activities.

Historical

• The budget reflects a clear understanding of past results and a keen sense of expected future changes.

• Past results cannot be a perfect predictor but they flag important events and benchmarks.

Period Specific

• The budget period must be of reasonable length, hotels usually formulate each of its budgets on a 12-month basis.

• The length of the budget period dictates the time limitations for introducing effective modifications.

Standardized

• To facilitate the budget process, managers should use standardized forms, formulas, and research techniques.

• Increases the efficiency and consistency of the input and the quality of the planning.

• Assists the financial director when formulating the master budget.

Inclusive

Those responsible for the results take part in the development of their budgets and learn how their activities are interrelated with the other segments of the company.

Reviewed

• A thorough review of budget proposals at successive management level.

•This management review assures a proper fit within the overall “master budget”.

Adopt and Disseminate

Top management need to

• Formally adopt the (department)budgets. • Assemble the master budget. • Accept it as the operating plan for the

company.• Distribute it in a timely manner to the

responsible personnel.

Evaluated

• Responsible parties use the master budget and their own department budgets for information and guidance.

• On a regular basis they compare actual results with their budgets.

What is Budgeting?

• Budgeting describes the overall process of creating and fine-tuning budgets.

• Budgeting has two primary functions: planning and control (the utilization of assets in business activities).

• Budgeting lies at the foundation of every financial plan.

Budgeting Activities

• Forecasting future business results, such as sales volume, revenue and expenses.

• Reconciling those forecasts to organizational goals and financial constraints.

• Obtaining organizational support for the proposed budget.

• Managing subsequent business activities to achieve budgeted results.

What and Why?

• It is a formal process which covers every detail of sales, operations, and finance, thereby providing management with performance guidelines.

• It is sequential in nature, i.e., each budget hinges on a previous budget, so that no budget can be constructed without the data from the preceding budget.

What and Why?

• Through budgeting, management determines the most profitable use of limited resources.

• The process increases management's ability to more efficiently and effectively deploy resources, and to introduce modifications to the plan in a timely manner.

Planning and Control

• The planning process expresses all the ideas and plans in quantifiable terms.

• Careful planning in the initial stages creates the framework for control, when it

includes each department in the budgeting process standardizes procedures defines lines of responsibility establishes performance criteria sets up timetables

Benefits of Budgeting

• Enhances management perspective• Flags potential problems • Coordinates activities • Evaluates performance • Refines the historical view

Purpose of Budgeting

• Provide a forecast of revenues and expenditures i.e. construct a model of how our business might perform financially speaking if certain strategies, events and plans are carried out.

• Enable the actual financial operation of the business to be measured against the forecast.

Failure in the Budgeting Process

• Lack of top management support • Organizational conformity • Responsibility accounting • Wrong internal or external information • Time schedules • Flexibility • Evaluation of actual results • Reflecting evaluation results back to

business

PREPARATION OF BUDGETS

Introducing Budgets

There are different types of budgets for different purposes and a hotel cannot use only one type of budget to accommodate all its operations.

Types of Budgets

Main Budgets

• Operating budgets• Capital budgets• Cash budgets

Other Types of Budgets

• Fixed or static• Flexible or variable• Combination• Continuous

Operating Budgets

The operating budget is a detailed projection of all estimated income and expenses (and depreciation) based on forecasted sales revenue during a one year period.

It presents a projected income statement (pro forma) which displays how much money the company expects to make.

Capital Budgets

Capital budgets (CAPEX) outline planned outlays for investments in Large equipment, and product development.

Capital budgets may cover periods of three, five, or ten years.

Cash Budgets

Cash budgets plot the expected cash balances the organization will experience during the forecast period, based on information provided in operating and capital budgets.

Cash budgets are prepared by the finance department and are critical to ensuring that the company has sufficient liquidity (cash and credit) available to meet expected cash disbursements. It is a very useful tool for effective management.

Traditional Budgeting

Many organizations use a "traditional" budget—a budget that covers a one year period and presents forecasts that do not change during the life of the budget cycle.

Companies use traditional budgets because they are easy to put together and simplify coordination of budget assumptions across different departments.

The Fixed Budget

The fixed or static budget is not subject to change or alteration during the budget period.

A company “fixes” budgets when the cost of a budgeted activity shows little or no change when the volume of production fluctuates within an expected range of values.

The Flexible Budget

The flexible or variable budget

• Projects revenue and expenditure based on various levels of production.

• It distinguishes between fixed and variable costs, thus allowing for a budget that can be automatically adjusted

• Provides accurate measure of performance by comparing actual costs for a given output with the budgeted costs for the same level of output.

The Combination Budget

Recognizes that most production activities combine both fixed and variable budgets within its master budget.

For example, an increase in the volume of sales may have no impact on sales expenses while it will increase production costs.

The Continuous Budget

Is a budget that rolls ahead each month or period without regard to the fiscal year so that a twelve-month or other periodic forecast is always available.

Managers can review and assess the budget estimates for a never-ending 12-month cycle.

Fixed Budgets and Rolling Budgets

Budget

Parameter

Approach Description

Time period of the budget

Fixed

budget

(traditional)

The budget period is a specific time period, usually the company's fiscal year.

Rolling budget

The budget is continuously updated so that the time frame remains stable while the actual period covered by the budget changes. For example, as each month passes, a one-year rolling budget would be extended by one month so that there would always be a one-year budget in place.

Static Budgets and Flexible Budgets

Budget

Parameter


Forecast values

Static budget(traditional)

Presents one forecast for a given time period and is not changed during the life of the budget.

Flexible budget

Budgeted revenues and costs are adjusted during the budget period according to pre-determined variances between the budgeted and actual output and revenue.

Incremental and Zero-based

Budget

Parameter


Forecasting process

Incremental budgeting

(traditional)

The previous period's budget and actual results, as well as expectations for the future, are used in determining the budget for the next period.

Zero-based budgeting

The budgeting process begins from the ground up, as though the budget was being prepared for the first time.

Top-down and Participatory

Budget

Parameter


Setting goals

Top-down (traditional)

Senior management sets budget goals—such as revenue and profit—and imposes these goals on the rest of the organization.

Participatory Those responsible for achieving the budget goals are included in setting those goals.

Master Budget

The master budget is a consolidation of the operating budget and the financial budget.

The financial budget consists of the• capital expenditure budget • cash budget • budgeted balance sheet

Budgeted Statement of Cash Flows

The budgeted statement of cash flows

anticipates the timing of• the flow of cash revenues into the business

from all resources, and • the outflow of cash in the form of payables,

interest expense, tax liabilities, dividends, capital expenditures etc.

Statement of Cash Flows

The statement of cash flows will include• The amount of cash the company will receive

from all sources. • Credit sales for which it expects to receive at

least partial payment. • The amount of cash the company will pay out

for all activities. • The amount of cash the company will net

from its operating activities and investments.

Management Functions and the Hotel Budget

Planning Organizing Leading Controlling

Feedback

Summary Profit & Loss Schedule in the Multi-Property Operation

Revenues• Rooms• F & B• Outlet rental• Laundry

Cumulative profit & loss figures

Expenses• Cost of Sales• Departmental

Expenses• Payroll and

related expenses• Undistributed

expenses Cumulative profit &

loss figures

Ratios in the Multi-Property Operation

Operational ratios •Occupancy rate•Double occupancy rate•Average stay•Average room rate•Rev Par

Total cost per occupied room

Operational ratios •F&B spending•Cost of sales ratio for F&B outlets•Payroll and related expenses ratio

Profitability ratios

Cost Drivers and Department Budgets

Housekeeping department Cost Driver Budgeted Unit Cost

Departmental Expenses

Computers & computer supplies # of rooms sold $1.00

China/glass # of rooms sold $0.50

Cleaning Material # of guests $0.50

Amenities # of guests $1.00

Flowers & decoration # of rooms sold $2.00

Customer supplies # of guests $0.50

Room supplies # of rooms sold $2.00

Laundry # of guests $1.00

Linen # of guests $0.20

Printed materials and office supplies # of rooms sold $0.30

Total Departmental Expenses

Budgeting Tools

• Spreadsheets – For small sized hotels with minimum outlets

• Specialized budgeting software– Large scale hotels– Hotel Chains

MANAGING FISCAL RESPONSIBILITIES

Fiscal Management

• Varied and complex role of management responsible for finance.

• Linked to size of hotel, ownership (independent, chain).

• Technology has impacted on financial management role, especially in larger chains within flat management structure.

Role and Responsibilities

• Involves maintaining available resources, making resource decisions based on need and availability, and developing and implementing strategies to make rational and well thought-out decisions related to organizational resources.

• Includes the ability to provide guidance, formulate a budget plan, defend a budget plan, assess budget performance, advocate budget and alternative scenarios and execute a budget plan.

Main Activities

Capital Budgeting:

Process of planning and managing a firm’s investment in fixed assets.

Key concerns of the financial managers are the size, timing, and risk of the investment project's cash flows.

Main Activities

Capital Structure Choice:

Mix of debt and equity used by a firm.

Too many hotels have a very high debt mix with low equity volume.

Main Activities

Working Capital Management:

Managing short-term operating cash flows.

Managing assets and current liabilities.

THE END