HFT 4464 Chapter 3 Review of Financial Statements

HFT 4464 Chapter 3 Review of Financial Statements & Selected Ratios 2/6/2022 1

Chapter 3 Introduction n n This chapter will provide a review of the major financial statements and selected key ratios used in the industry. Financial statements reviewed: u Income statements u Balance sheet u Statement of retained earnings u Statement of cash flows 3 -2

Income Statement n n Details revenues and expenses for a period of time Income statements can be as detailed as necessary for use by managers and investors: u Summary for outside users u Detailed departmental statements for insiders 3 -3

Uniform System of Accounts n n n Widely used format for income statements in the hospitality industry Focuses primarily on departmental performance u Revenues and expenses specifically attributable to that department Undistributed operating expenses include items like marketing and maintenance 3 -4

Uniform System For Restaurants n n Restaurants also follow a specific format. First expense shown is cost of goods sold for both food and beverage. This is followed by other expenses Not completed on a departmental basis like hotels because the restaurant is really one department. 3 -5

Review of Balance Sheet n n Shows financial position of an organization at a particular point in time Assets, liabilities, and owner’s equity Current items listed first u “Current” meaning convertible to cash or paid in cash within a year Retained earnings are not the same as cash 3 -6

Relationship Between Balance Sheet and Income Statement n n n Assets used to generate revenue and cash flow: u For a hospitality business this is land, building, and equipment. Liabilities are related to expenses. u Accrued wages and accounts payable Retained earnings will increase with net income, less any dividends declared. u This is the link to the income statement. 3 -7

Statement of Retained Earnings n n Often consolidated into a consolidated statement of owner’s equity Basic calculation u Balance at beginning of period u Plus: net income u Less: dividends declared u Equals: ending balance There is no cash in retained earnings. It is simply accrued earnings less dividends declared to the shareholders. 3 -8

Statement of Cash Flows n n n Its purpose is to show where cash flow came from and where it went during a period of time. Three major sections of the statement: u Operating activities u Investing activities u Financing activities Recent accounting scandals have placed a premium on a company’s ability to earn cash flows. 3 -9

Statement of Cash Flows n Why has this become so important? u Balance sheet uses estimates. « Enron “hid” debt from its balance sheet. « Worldcom categorized expenses as “investments” (assets). u Income statement is completed on accrual basis (when do we recognize the revenue). u Cash flows represent the actual flows of cash and are more difficult to “invent. ” 3 -10

Validity of Financial Statements n n n Who is responsible? u Management is responsible for the accounting and financial reporting systems. Auditors are there to assess if the statements make a fair representation of firm position and performance. Investors learned a hard lesson in 2000– 01 about financial statements and are aware of the need for change. Some potential remedies include: u Rotating auditors regularly u CEOs taking responsibility for veracity of 3 -11 financial statements

Ratio Analysis n n n Ratio analysis is used to take existing financial accounting information and generate new information. Ratios on their own are not very meaningful. Various ratios of a hospitality organization can be compared to industry averages. However: u Which segment of the hospitality industry? u Which companies are included in the industry averages? u Are there enough firms in the average to make the ratios meaningful? u Do all the firms use the same accounting 3 -12 methods?

Classes of Ratios n n n Liquidity—ability to meet current debts Turnover—management’s effectiveness regarding the management of assets Solvency—ability to meet long-term debts or the extent of long-term financing Profitability—how profitable the operation is Activity—involves key measures of operating performance Investor—those ratios of special significance to outside investors 3 -13

Liquidity Ratios n n Current ratio u Current assets/current liabilities Quick ratio u Cash + marketable securities + accts. rec. current liabilities Working capital = current assets less current liabilities Does current ratio always have to be greater than 1? 3 -14

Turnover Ratios n n Inventory turnover u Cost of sales / average inventory « Appropriate range for this number Asset turnover « Revenue / Average Total Assets « Revenue per dollar of assets « Can management manipulate this figure? 3 -15

Solvency Ratios n n n Debt to Asset ratio u Total debt / total assets Debt to equity ratio u Total debt / total equity u Hotel industry often has high debt Times interest earned u EBIT / interest expense u Gives lender a measure of “cushion” (how much earnings are available to pay interest) 3 -16

Profitability Ratios n n n Profit margin u Net Income / Total Revenue Return on assets u Measure amount of profit for every $1 in assets u Net Income / Average Total Assets Du. Pont Ratio u n ( Net Income / Total Revenue ) x ( Total Revenue / Average Total Assets ) Return on equity u Net Income / Average Stockholder’s Equity 3 -17

Activity Ratios n Occupancy percentage u n Average Daily Rate (ADR) u n Rooms Occupied / Rooms Available Rooms Revenue / Rooms Sold REVPAR Occupancy Percentage x ADR u Rooms Revenue / Rooms Available u n Food Cost Percentage u n Cost of food sold / food revenue Beverage Cost Percentage u 3 -18 Cost of beverage sold / beverage revenue

Investor Ratios n P/E Ratio—price to earnings (net income) u n Dividend payout ratio u n Market Price / Earnings Per Share Dividend Per Common Share / Earning Per Share Dividend yield u Annual Dividend / Market Price Per Share 3 -19

Limitations of Ratio Analysis n n n Be careful not to label ratios by themselves as “good” or “bad. ” Different users of ratios have different perspectives. u Example: Lenders vs. owners regarding the current ratio Ratios may tell you there is a problem, but they don’t tell you what the problem is. u Example: high food cost u Why? 3 -20

Homework: Problems 1, 2, 3 & 5 2/6/2022 3 -21 21