Chapter 4 When you have finished studying this

Chapter 4 When you have finished studying this chapter, you should be able to: • Explain the purpose of budgeting • Discuss each step of the budgeting cycle • Define and describe the various types of budgets. • Identify the steps in preparing a budget. • Discuss and give examples of how to forecast revenue. • Discuss and give examples of how to forecast costs and expenses • Explain the difference between static and flexible budgets. • Identify the advantages and disadvantages of budgeting. Budgeting: page 1

Budgeting is part of the planning function of management. Preparation of budgets forces management to plan ahead, forecast and set up contingency plans. TYPES OF BUDGETS There are different types of budgets that a hospitality establishment may prepared. Each of these budgets served a different purpose. The most common types of budgets are listed below: 1. Operation Budgets: the revenue and expense budget, includes management plan for generating revenues and incurring expenses for a given period. It is a detailed operating plan by profit centers and cost centers 2. Capital Budgets: pertains to the acquisition of equipment, land, buildings, and other fixed assets. 3. Cash Budgets: management's plan for cash receipts and disbursements. It includes the projection of cash to be received, usually by monthly periods. Budgeting: page 2

ADVANTANGES OF BUDGETING 1. Budgeting requires management to examine alternatives before selecting a particular course of action. - Pricing 2. - Marketing - Staffing Budgeting provides hospitality operations with a standard of comparison. - Variance Analysis - Actual Versus Budgeted 3. Budgeting enables management to look forward, especially where strategic planning is concerned. 4. When participative budgeting is practiced, the budget process involves all levels of management. 5. The budget process provides a channel of communication whereby the hospitality operation's objectives are communicated to the lowest managerial level. 6. The degree that prices are a function of costs, the budget process provides estimates of future expenses enabling managements to set their prices in relation to their expenses. Budgeting: page 3

DISADVANTAGES OF BUDGETING 1. The time and cost to prepare budgets can be considerable. Usually, the larger the organization, the more costly (in time and dollars) it is to prepare budgets. 2. Budgets are based on unknown and some known facts. If research are not done correctly, the budget is worthless and time may be wasted. 3. When an expense is overestimated, spending to the budget may create problem for the organization. THE BUDGET PREPARATION PROCESS The major elements in the budget preparation process are as follows: 1. Financial Objectives 2. Revenue Forecasts 3. Expense Forecasts 4. Determination of Forecasted Net Income Budgeting: page 4

FORECASTING REVENUE In order for managers to be able to forecast revenue, they must have both financial data (historical data) and non-financial information, such as economic environment. Economic environment includes such items as: • Inflation rate • Guest spending • Competition • Business and tourist travel • Local events • Political Climate Once information are gathered. Management must be able to put these information to usable numbers. For example, if there is an expected inflation rate of 5% next year, management might allow prices for next year to be increased by a maximum of 6%. Historical data are often used as the foundation for revenue forecasting. For example, if revenue has increased by 5% each year for the past 3 years, then the revenue forecast could be an increase of 5% (provided that future conditions appears to be similar). Exhibit 1 shows the historical data of ACME Hotel for the past 3 months. Budgeting: page 5

EXHIBIT 1 - ACME HOTEL HISTORICAL DATA - Revenue Increases Increase in $ Increase in % January $100, 000 February $105, 000 $5, 000 5% March $110, 250 $5, 250 5% Since each of the past 2 months revenue has been increased by 5%, it is conceivable that revenue will also increased by another 5% to $115, 763 for the month of April. Exhibit 2 shows the calculation of the increase. EXHIBIT 2 - ACME HOTEL Revenue Forecasting for the month of April March Revenue = $110, 250 5% of $110, 250 = $5, 513 Therefore, Forecast Revenue for April = $110, 250 + $5, 513 = $115, 763 Budgeting: page 6

FORECASTING EXPENSES Since expenses are often pre-categorized as direct, indirect, and fixed or variable, the process of estimating expenses are similar to forecasting revenue. However, management must be aware of possibilities of prices or cost increases and changes in labor costs (benefits, taxes, etc. ). • Fixed costs generally will not be affected by volume of sales. • Variable costs projection can be calculated as a percentage of revenue. For example, if food costs has been in between 25% to 28% for the past several years, then management can estimate next year's food costs to be about 28% (using conservatism concept). DETERMINATION OF FORECASTED NET INCOME After budgeted revenues and expenses are completed. A comparison of both will reveal the forecasted net income. • Revenues can be budgeted using historical data or previous revenues records. • Expenses can be budgeted based on percentage of sales. Budgeting: page 7

EXHIBIT 3 ACME HOTEL - INCOME STATEMENT January February March $100, 000 $105, 000 $110, 250 $ 6, 000 $6, 400 $7, 000 TOTAL REVENUE $106, 000 $111, 400 $117, 250 EXPENSES PAYROLL $14, 500 LAUNDRY $4, 500 LINEN $6, 200 MAINTENANCE $3, 500 ENERGY COSTS $7, 560 DEPRECIATION $10, 000 INTEREST EXP $8, 500 PROPERTY TAXES $4, 500 OTHER EXPENSES $2, 400 INSURANCE $ 6, 000 TOTAL EXPENSES $67, 660 NET INCOME $ 38, 340 $15, 400 $5, 100 $6, 400 $4, 700 $7, 780 $10, 000 $8, 500 $5, 000 $2, 560 $6, 000 $71, 440 $ 39, 960 $16, 100 $5, 400 $7, 200 $4, 950 $8, 420 $10, 000 $8, 500 $5, 500 $3, 000 $6, 000 $75, 070 $ 42, 180 REVENUE: ROOMS TELEPHONE Budgeting: page 8

EXHIBIT 4 ACME HOTEL - INCOME STATEMENT ANALYSIS January February March ROOMS AVAILABLE 70 TOTAL ROOMS NIGHT* 2100 ROOM SOLD 1512 OCCUPANCY % 72. 00% AVERAGE RATE $66. 14 ROOMS REVENUE $100, 000 TELEPHONE [% of sales] 6. 00% 70 2100 1575 75. 00% $66. 67 $105, 000 6. 10% 70 2100 1638 78. 00% $67. 31 $110, 250 6. 35% 14. 67% 4. 86% 6. 10% 4. 48% 7. 41% 9. 52% 8. 10% 4. 76% 2. 44% 5. 71% 14. 60% 4. 90% 6. 53% 4. 49% 7. 64% 9. 07% 7. 71% 4. 99% 2. 72% 5. 44% EXPENSES: PAYROLL LAUNDRY LINEN MAINTENANCE ENERGY COSTS DEPRECIATION INTEREST EXPENSE PROPERTY TAXES OTHER EXPENSES INSURANCE 14. 50% 6. 20% 3. 50% 7. 56% 10. 00% 8. 50% 4. 50% 2. 40% 6. 00% * Average number of days in each month is 30 days. Budgeting: page 9

EXHIBIT 5 - ACME HOTEL OPERATING BUDGET FOR THE MONTH OF APRIL ROOMS AVAILABLE TOTAL ROOMS ROOM SOLD OCCUPANCY % AVERAGE RATE REVENUE ROOMS TELEPHONE EXPENSES PAYROLL LAUNDRY LINEN MAINTENANCE ENERGY COSTS DEPRECIATION INTEREST EXPENSE PROPERTY TAXES OTHER EXPENSES INSURANCE TOTAL EXPENSES NET INCOME 70 2100 1701 81. 00% $68. 10 % of Room Sales $115, 763 $ 7, 500 $123, 263 6. 48% $ 17, 364 $ 5, 788 $ 7, 525 $ 5, 210 $ 8, 682 $ 10, 000 $ 8, 500 $ 6, 000 $ 3, 470 $ 6, 000 $ 78, 539 15. 00% 6. 50% 4. 50% 7. 50% 8. 64% 7. 34% 5. 18% 3. 00% 5. 18% 67. 84% $ 44, 724 38. 63% Budgeting: page 10

EXHIBIT 6 - ACME HOTEL FLEXIBLE BUDGET BASED ON OCCUPANCY % Occupancy % at 81% at 85% at 88% Room Revenue $115, 763 $121, 560 $125, 850 $44, 724 $48, 114 $50, 626 Net Income as % 38. 63% of Room Sales 41. 56% 43. 73% Net Income Budgeting: page 11

IN-CLASS EXERICSE ACME Restaurant recorded the following operating information from the past two years. The management forecasted a 30% increase in revenue for year 3. Using these information, prepare a budgeted income statement for Year 3. Year 1 Revenue Year 2 $100, 000. 00 $120, 000. 00 Less Cost Of Sales $32, 000. 00 $38, 400. 00 Gross Profit $81, 600. 00 $68, 000. 00 Less Operating Expenses $40, 000. 00 $48, 000. 00 Net Profit $28, 000. 00 $33, 600. 00 Budgeting: page 12

YEAR 1 YEAR 2 YEAR 3 REVENUE $100, 000. 00 $120, 000. 00 $156, 000. 00 LESS COST OF SALES $32, 000. 00 $38, 400. 00 GROSS PROFIT $68, 000. 00 $81, 600. 00 $106, 080. 00 $49, 920. 00 LESS OPERATING EXPENSES $40, 000. 00 $48, 000. 00 $62, 400. 00 NET PROFIT $28, 000. 00 $33, 600. 00 $43, 680. 00 Cost of Sales = 32% of Revenue Operating Expenses = 40% of Revenue Budgeting: page 13

4. 1 Forecast the annual revenue for each of the following situation. a) A 300 -room hotel with a 70 percent occupancy and an average rate of $75. Assuming the hotel open 365 days a year. b) A seasonal resort hotel of 150 rooms that is closed for the months of November, December, January, and February. During the months in which it is open, it has occupancy of 90% and an average rate of $95. (Average number of days each month is 30 days) c) A cocktail lounge that is closed on Sundays and on four statutory holidays each year. Assume 52 -week year. Average revenue is $17 per seat per day open. There are 72 seats. d) A 125 seat coffee shop that is open for all three meals every day of the year (assume 365 days). Seat turnover and average check figures are as follows: Breakfast Lunch Turnover 1. 50 1. 75 Average Check $ 5. 05 $Budgeting: 8. 10 page 14

4. 2 Forecast the annual revenue for each of the following situation. a) A 200 -room hotel with a 65 percent occupancy and an average rate of $45. Assuming the hotel open 365 days a year. b) A seasonal resort hotel of 50 rooms that is closed for the months of November, December, and January. During the months in which it is open, it has occupancy of 80% and an average rate of $115. (Average number of days each month is 30 days) c) An 80 -seat restaurant that is closed on Sundays has average revenue of $12 per seat per day open. Assume 52 -week year. d) A 75 seat coffee shop that is open for lunch and dinner every day of the year (assume 365 days). Seat turnover and average check figures are as follows: Turnover Average Check Lunch 1. 50 $ 7. 45 Dinner 1. 25 $12. 00 Budgeting: page 15

4. 3 ACME Hotel has the following information based on historical data: Operating Days Rooms Available Average Daily Rate = 30 days = 120 rooms per day = $85. 00 Using the above information, ACME would like to forecast the Rooms revenue based on flexible on occupancy percentage of 70%, 80% and 85%. Compute the room revenues at each of the above occupancy percentage. Budgeting: page 16