Managing Financial Systems in the Hospitality Industry - Essay Example

1. What is meant by finance? Finance is the science of management of money and other assets (Steen, VanderVeen & Voskuil, 2006). Finance is the process of raising funds or capital to manage expenditure. Any new venture in the hospitality industry requires finance to launch itself. This finance is raised through own contribution, loans or through selling equity. Finance can be obtained through intermediaries like banks, financial institutions or investment companies. Raising finance for hotels require planning, analysis and control operations, which is the responsibility of the financial manager. Financial decisions are taken based on certain factors. While an increase in cash holdings reduces risk, converting other types of assets to cash reduces the firm’s profitability. Raising the firm’s debt may increase profitability but it also increases the risk that goes with it. Finance ensures a balance between risk and profitability. Today finance focuses on the analysis of risk and the return on investment and the investor’s time. Finance redefines what is real and what is quantifiable. The goal of financial management is to increase shareholder’s wealth. 2. What is the purpose of a financial statement? Financial statement appraises the company’s owners of the financial standing of the firm. Based on this the organization takes decisions, which affect both the profitability and the risk of the firm’s operations. In the hospitality industry, management accounting system (MAS) gives an evaluation of the performance. Financial statements help to monitor business performance and analyze statement relevant to investment decisions. There is more emphasis now on risk assessment and non-financial performance measures. Everything that happens to a company has some consequence for the future. Finance theory suggests that share prices take into account of wide information set when pricing shares. This makes it important to display performance in total. Financial statements demonstrate firms’ fundamental values (Ou & Penman, 1989). Analysis of published financial statements helps determine the values that are not reflected in stock prices. These intrinsic vales serve as benchmarks with which prices are compared to identify overpriced and under priced stocks. Every change in the shareholders’ funds has to be reported. Financial statements give the true picture of the organization. 3. What analytical techniques are applied to various financial problems? (Provide answers from your class notes and readings) Selected ratios are applied to various financial problems, especially in medium and large asset size firms. Rations can be computed from funds’ statement data. Failure of a firm is defined as business defaulting on interest payment on its debt, overdrawing bank limits, or declaring bankruptcy. The operating and financial difficulties can be detected through financial ratios. Before the development of quantitative measure of company performance, only qualitative information of the credit-worthiness of the firm could be established. Beaver’s univariate analysis of a number of bankruptcy predictors set the stage for multivariate attempts (Altman, 2000). Research suggests that ratios are definite predictors of financial problems. Rations measure liquidity, solvency and profitability but univariate analysis has some short comings. Ratio analysis may demonstrate poor profitability or solvency but above average liquidity, the situation may not be that serious. The clear mission in the hospitality industry is satisfying the customer. The industry is moving towards a knowledge-based era driven by technological advancements. This increases the significance of examining the key factors related to marketing, product, organization, capital and technology. It is critical to understand how to deal with the shareholder wealth in a capital-constrained competitive environment. REVPAR (revenue per available room) focuses on the physical asset will be replaced by REVPAC (revenue per available customer). This concept focuses on increasing the yield from the guest. The management needs to interpret, analyze and evaluate the trends and operating standards. It has to make optimum decisions concerning food, labor, overheads and inventory. Projections of demand, estimated sales and profits have to be made to allocate budgets. A simple business ratio report helps to benchmark the company’s performance. They have to assess against the overall industry average performance. These help to et realistic profit targets. 4. What is meant by a market analysis, feasibility study, and financial analysis? (Provide examples of each). The pace of change in the external business environment indicates that a regular systematic analysis is essential for every unit in the hospitality industry (Teare, 1995). This helps in decision making and strategy formulation. Market analysis can be done through a study of the macro-economic factors and an assessment of competitive forces. For instance, Chon and Singh state that market analysis highlights that overbuilding, economic recession, the Gulf War and the slump in the real estate market would adversely affect the hospitality industry. Market analysis would help to understand and adopt the strategies that would respond to the prevailing market situation. The analysis further helps to determine the impact on organizational strategy, structure and performance. In the case of US restaurant chain, market analysis would help to determine that effects of recession, increased competition in maturing markets and need to cut costs would require change in organizational thinking. Feasibility study would indicate how feasible or practical or profitable it is for a unit to function under the existing circumstances. Financial analysis helps to understand the performance and decide on the feasibility. Financial analysis can be done through statistical techniques and ratios which give a clear picture of the financial standing. 5. Provide explanations regarding Franchising, Management Contracts and Leasing. (Provide examples of each). Franchising, management contracts and leasing are different modes of entry or expansion which hotels for business expansion (Connell, 1997). The circumstances and objectives to a large extent determine the mode of entry but generally hotels use multiple modes. This flexibility provides greater opportunities to meet the needs of property owners, developers, investors and regulators and leads to greater market network. Holiday Inn for example is largely franchise driven but they also have company-owned properties, leased units as well as joint ventures or management contracts. Foreign entry mode through high equity and control modes is not always feasible or desirable for large global operations (Panvisavas & Taylor, 2006). They rely more on non-equity partnerships and franchises. This enables global chains to capture the vital economies necessary for competitive international operations. For instance, the local government regulations do not allow a majority stake in hotels in Thailand by foreign firms. The only mode of entry in Thailand is as minority stakeholders in joint venture or a non-equity mode such as franchising or management contracts. Foreign firms contract with local Thai hotel owners to trade under the name of a foreign hotel chain through a franchisee agreement. A combination of management contract and franchisee allows a higher level of contract and also alleviates concern regarding maintenance of service and quality. Franchising is a business relationship in which the franchisor permits the franchisee to use their brand name, logo or product in am ongoing manner in exchange for a fee (Felstead 1993, cited by Connell, 1997). Franchising leads to rapid international expansion and helps to overcome many of the cultural, linguistic, technical, legal and employment problems associated with internationalization. Direct franchising involves extending a domestic or established foreign regional system into new markets but the market penetration may be slow. In master franchising, the franchisor grants the authority to an intermediary to appoint franchisees within a specified territory. In this case the franchisor does not have direct contacts with the individual outlets and also loses a significant portion of the franchisee fee to the intermediary. In the food sector, franchising is very common as in the case of McDonald’s. Leasing arrangements and management contracts reduce the investment risk associated with the internationalization of highly capital-intensive luxury hotels. These arrangements have another advantage over franchising. The hotels have direct managerial control in countries with lower levels of management and staff expertise. In the new tourism markets the hotel property owners may have little knowledge about running hotels and prefer management contracts where a long-term contract is created between the owner and contractor. 6. What is meant by Capital Markets and supply examples? Capital market refers to market from which capital can be raised for an organization. In the hospitality industry firms have to decide on the capital structure and how this needs to be met. This would also depend on the type of unit and the term for which the debt is required. For instance, in the restaurant business, raising short term capital is not advisable due to the risky nature of the business (Upneja & Dalbor, 2001). Older firms use long-term debts. Research suggests that firms with high cash flows use more debts since firms with high cash flows have high opportunities for growth. The capital market also is willing to lend to those firms that are established for long and have significant cash flow. Before investing, lenders wish to be assured that they will receive an adequate risk-adjusted return on their investment. This prompts them to look at the firm size and financial stability. While hotel firms change their capital structure depending upon the changes in value, the restaurant firms do not do so. The availability of capital and the interest of private equity firms in the lodging sector have led to several public-to-private transactions. Capital is also raised through merger and acquisitions in the hospitality industry. Starwood Hotels & Resorts and Host Marriott announced a $4.0 billion transaction for 38 hotels (Ernst&Young, 2006). This is one way of raising capital. Since the lodging industry looks lucrative and the interest rates may increase, it would not be feasible to directly invest in hotels. Equity participation through mergers is a good form of supply of capital to the industry. The REVPAR is an important consideration for an investor and in USA the hotel performance is positive. Hospitality ventures like convention centers and leisure resorts lead to public/private partnership to raise capital (Magarity, 2003). For the developer, this partnership provides low-cost financing, negotiate favorable land lease terms, claim redevelopment incentives, and secure site improvements. Since such ventures lead to creation of new jobs and is a source of tax revenues, the government is interested since they have a wide array of financial vehicles to fund these projects. 7. What is meant by a Business Plan and how do Market, Financial, and Valuation analyses relate to this plan? To start a new venture or to expand an existing unit, funds need to be raised. To attract potential investors and raise fund through the capital markets, a business plan has to be presented. This business plan carries details of market analysis and customer expectations based on this analysis. It describes the competitive forces and how the business expects to combat these forces. The business plan details the capital that the owner would invest and the amount required from external sources. Financial projections including the expected sales and profitability have to be realistic depending on market forces. Market analysis gives details of competition, and expected business based on macro and micro factors. It takes into account the country’s economy, the reasons for recessions and downslide and the resultant impact on the business proposed. The projections of sales and profitability can only be made once the revenue per customer is estimated. Market segmentation further helps to get a realistic picture. The value of the company is determined by the analysts and the capital market by discounting the present value of the future cash flows that will be generated by the company’s operations (Damant, 2003). The assets and liabilities also change in value over time. The revaluations are fixed with reference to either the stock market or the real estate market. In the case of the hospitality industry it is related to the real estate market. The financial analysts also deal separately with the assets and liabilities. Thus the valuation of the company depends upon the discounted present value of the operational cash flows plus the valuation of certain assets and liabilities in the balance sheet. The business plan carries all these projections which help determine whether the business is worth investing in. It gives projections through extrapolation and modification. References: Altman, E. I., (2000), Predicting Financial distress of companies: revisting the z-score and zeta models, 28 Feb 2007 Connell, J., (1997), International hotel franchise relationships – UK franchisee perspectives, International Journal of Contemporary Hospitality Management 9/5/6 [1997] 215–220 Damant, D., (2003), The revolution ahead in financial reporting: a new world - what the income statement means to financial reporting, Balance Sheet, Vol. 11 No. 4, pp. 10-18 Ernst&Young (2006), Hospitality Industry Top 10 Thoughts for 2006, 28 Feb 2007 Finance. (2007). In Encyclopædia Britannica. Retrieved February 28, 2007, from Encyclopædia Britannica Online: http://search.eb.com/eb/article-9034277 Kogen, M. D., (n.d.), Executive Talent in a Changing Environment, 28 Feb 2007 Magaritry, M., (2003), Marking Public/Private Partnerships Work for the Hospitality Industry and Community Economic Development, 28 Feb 2007 Ou, J. A., & Penman, S. H., (1989), Financial Statement Analysis and the prediction of stock returns, 28 Feb 2007 Panvisavas, V., & Taylor, J. S., (2006), The use of management contracts by international hotel firms in Thailand, International Journal of Contemporary Hospitality Management Vol. 18 No. 3, 2006 pp. 231-245 Steen, T. P., VanderVeen, S., & Voskuil, J., (2006), Finance: on earth as it is in heaven? Managerial Finance Vol. 32 No. 10, 2006 pp. 802-811 Teare, R., (1995), The international hospitality business: a thematic perspective, International Journal of Contemporary Hospitality Management, Vol. 7 No. 7 1995, pp. 55-73 Upneja, A., & Dalbor, M. C., (2001), An examination of Capital Structure in the restaurant industry, International Journal of Contemporary Hospitality Management Vol. 13 No. 2, 2001 pp. 54-59 Read More