Being able to measure organizational performance is key to obtaining and maintaining success for any business. Within the hotel industry, understanding which financial ratios to analyze is not only essential to determining whether a business is achieving its revenue performance goals but also if it is capable of meeting its various financial obligations.
For financial executives, performing an accurate ratio analysis is central to empowering general managers as well as divisional and departmental heads with the ability to make informed decisions reflecting the best interests of a business. Financial ratios are further what outside stakeholders look to in order to determine if a property or brand remains a good investment.
There are several financial ratios that can be utilized, however, some are more important than others when it comes to running a successful hotel business. In an industry featuring a high level of fixed and tangible assets, hoteliers must be able to identify, calculate and understand the trends uncovered by key financial ratios that point to current and future business health.
In today’s industry, solvency, operating and profitability ratios are the most commonly used financial analytics that hoteliers utilize to gauge current and projected business performance. However, each ratio consists of multiple types of analysis, with varying formulas to be used depending on specific business needs.
From understanding a hotel’s short-term liabilities to determining what the average daily rate should be, what follows is an in-depth review of the leading financial ratios for hotel businesses, what formulas are used for each type of analysis and why they are so essential to maintaining profitable operations.
No.1: Solvency Ratios
Complex hotel operations require a significant amount of investment in order to run on a daily basis. Chief among stakeholder concerns is a hotel’s ability to successfully manage its various debts without risking a default on payment. To alleviate such potential fears, hoteliers can turn to solvency ratios that analyze their various financial commitments.
The first ratio to address covers a hotel’s short-term debts. Known as a liquidity ratio, this analytic includes current or upcoming expenses such as F&B inventory, employee wages and the lease of rented assets.
To maintain hotel business viability, a property must have sufficient assets on hand to cover short-term liabilities should market conditions take a downturn. This can include cash, accounts receivable and available inventories that are reflected on a property’s balance sheet.
How to calculate the liquidity ratio?
To calculate a hotel’s liquidity ratio, financial executives sum up the total value of current assets and divide it by the total amount of short-term liabilities. Using this number, hoteliers can readily determine if their business is in line with or above the industry average, or alternatively, if they are at heightened risk of generating insufficient income to cover upcoming expenses.
Financial leverage ratio
The next key analytic for hoteliers is the financial leverage ratio, which seeks to identify a property’s long-term solvency. This metric specifically addresses whether a hotel business is able to meet debt commitments for long-term assets including building rental fees, taxes, and maintenance fees for equipment upkeep.
Financial leverage ratios can also prove valuable in determining how much an organization relies on borrowing and how much generated revenue originates from loans and debt. Identifying a property’s leverage ratio is ultimately key to understanding whether a business is able to sustain itself for the foreseeable future or if some level of debt financing is required.
How to calculate the financial leverage ratio?
To perform a financial leverage ratio analysis, hoteliers must first add together both short-term and long-term debt to arrive at their total debt sum. Total debt is then divided by the amount of shareholder’s equity in order to reveal a property’s financial leverage ratio.a
No.2: Operating Ratios
While knowing a property’s precise debt is crucial to preventing a business from experiencing bankruptcy, it is likewise essential for hotels to be able to determine their level of income generation in order to pay off those debts while still achieving profitability. The key to identifying revenue performance is utilizing a hotel’s income statement to calculate operating ratios.
With the vast majority of hotel revenue coming from guestroom reservations, the first operating ratio to be calculated is a property’s occupancy percentage. This analytic reflects the number of rooms sold per night, allowing hoteliers to determine if they are reaching their maximum revenue-earning potential or if unsold rooms are leaving profits behind.
How to calculate occupancy percentage
To calculate occupancy percentage, a property divides the number of rooms sold by the total number of rooms available and multiplies the sum by 100. Using a 200-room hotel as an example, assume that a property sold 165 rooms for one night. By dividing the number sold by total rooms available and multiplying by 100, the occupancy percentage would be 83 percent.
Average Daily Rate (ADR)
The next operating ratio that is vital to understanding if a hotel is truly maximizing room income generation is the Average Daily Rate (ADR). This will notably demonstrate if a hotel has been able to obtain the full rate for guestrooms rather than reserving at discounted prices.
How to calculate ADR
Using the same previous example of a 200-room hotel that sold 165 rooms for a specific night, let’s assume that rooms were sold at the following rates:
- 100 rooms at $200 each (full rate) = $20,000
- 50 rooms at $150 each = $7,500
- 15 rooms at $100 each = $1,500
After adding total sales ($29,000), the number is then divided by the total number of occupied rooms (165). This shows that the ADR for this hotel example is $175.80. Had the hotel sold each room at the full $200 rate, the property could have made an additional $4,000. This further reinforces why an effective upselling strategy is critical in avoiding potential revenue loss.
Revenue per Available Room (RevPar)
The operating ratio most often top of mind for many hoteliers is Revenue per Available Room (RevPar). This key analytic is what most businesses look to for an accurate reflection of financial performance. It is further what allows hoteliers to identify their most profitable periods and determine which rooms experience the most demand.
How to calculate RevPAR
To calculate a hotel’s RevPar, financial executives multiply ADR by their occupancy percentage. With the example hotel having an ADR of $175.80 and an occupancy of 80 percent, this means that the property’s RevPar is $140.64.
Using RevPar, hoteliers can importantly conduct a comparative analysis in order to determine how they can expect to perform from month-to-month and what level of occupancy they should strive to reach. If a hotel can meet its occupancy goals, it can avoid the need to increase its rates in order to stay in line with revenue-earning expectations.
No.3: Profitability Ratios
As with any business, hoteliers need to be able to determine their level of profitability in order to satisfy stakeholders and identify what revenue is left for further property investment. Key tools for conducting an accurate analysis of financial statements, and profitability ratios consist of Return on Investment (ROI), Return on Equity (ROE) and Return on Sales (ROS).
With ROI, hoteliers can identify the level of profitability from invested capital. Consisting of net working capital and fixed assets, this analytic is vital for understanding how much a business is earning from both owned and borrowed investments.
How to calculate ROI
The formula for calculating ROI is to divide a business’s operating income by its invested capital, then multiply by 100 which ultimately indicates the percentage of profit achieved.
Using ROE, hoteliers can identify the profitability of their assets which have been invested in by either hotel owners or shareholders in the form of risk capital.
This index is not only crucial to alieving any concerns of current investors and stakeholders but is also what will attract future investors depending on the level of performance.
How to calculate ROE
To determine a hotel’s ROE, a business’s annual net income is divided by its net equity, with the sum multiplied by 100.
The third profitability ratio, ROS, is used to identify average profitability in contrast to sales revenue. This formula simply consists of dividing a hotel’s operating profit by its net sales and multiplying by 100.
How to calculate ROS
Using ROS, hoteliers can not only measure average profitability relative to sales revenue, but can also vitally perform a comparative analysis with the performance of competitors. Say, for example, if a hotel’s ROS ratio is at 8 percent while the market average is 15 percent, this could uncover critical issues such as rate pricing or operating costs that need to be addressed.
Putting Your Best Financial Foot Forward
Hotels are undoubtedly complex operations requiring substantial performance analysis to ensure that profits aren’t replaced by income unpredictability and uncontrollable debt. Yet by leveraging the availability of financial ratios, hoteliers can maintain a consistent and accurate pulse on business health in order to ensure sustainable success and business growth.
Maína is the Head of Business Development Americas at UpStay. She graduated in Hotel Management and in German language and completed an MBA in Digital Marketing and E-commerce. She is a professional from the hospitality industry with experience as Distribution Director of a Brazilian group of 30 hotels and the Americas Director of an international Sales & Marketing representation company.
Maína considers herself an excellent communicator. She is a native speaker of Portuguese and speaks 4 other languages: English, Spanish, French, and German.