CHA FinancialManagement

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FINANCIAL MANAGEMENT
TABLE OF CONTENTS
CHAPTER 1
The Balance Sheet....................................................................................1
CHAPTER 2
The Income Statement...........................................................................15
CHAPTER 3
Operations Budgeting............................................................................31
CHAPTER 4
Capital Budgeting..................................................................................47
CHAPTER 5
Lease Accounting...................................................................................63
CHAPTER 6
System Selection.....................................................................................75
CHAPTER 7
Basic Cost Concepts...............................................................................91
CHAPTER 8
Cost-Volume-Profit Analysis...............................................................101
CHAPTER 9
Cost Approaches to Pricing................................................................. 113
CHAPTER 10
Managing Productivity and Controlling Labor Costs......................123
CHAPTER 11
Managing Inventories..........................................................................143
2016 American Hotel & Lodging Educational Institute

FINANCIAL MANAGEMENT 1
CHAPTER 1
THE BALANCE SHEET
CONTENTS & COMPETENCIES
Purposes of the Balance Sheet.................................................................2
1
Explain the purposes
Limitations of the Balance Sheet...................................................3 of the balance sheet.
Balance Sheet Formats.................................................................4
2
Identify the limitations
Content of the Balance Sheet ..................................................................5 of the balance sheet.
Current Accounts...........................................................................5
3
Define the various
Property & Equipment...................................................................7 elements of assets,
liabilities, and owners’
Long-Term Liabilities......................................................................7 equity as presented
on the balance sheet.
Balance Sheet Analysis.............................................................................8
4
Horizontal Analysis........................................................................8 Interpret balance
sheets using
Vertical Analysis.............................................................................9
horizontal and vertical
Base-Year Comparisons..............................................................13 analysis as well as
base-year
Wrap Up..................................................................................................14 comparisons.
Review Questions........................................................................14

CHAPTER 1 FINANCIAL MANAGEMENT 2
PURPOSES OF THE
BALANCE SHEET
Other major financial statements—the income statement, the statement
of owners’ equity, and the statement of cash flows—pertain to a period
of time. The balance sheet reflects the financial position of the hospitality
operation—its assets, liabilities, and owners’ equity—at a given date. It is
the financial statement that reflects, or tests and proves, the fundamental
accounting equation (assets equal liabilities plus owners’ equity).
Balance sheet—statement of the financial position of the hospitality

establishment at a given date, giving the account balances for assets, liabilities,
and owners’ equity.
Management, although generally more interested in the income statement

and related department operations statements, will find balance sheets
useful for conveying financial information to creditors and investors. In
addition, management must determine if the balance sheet reflects to
the best extent possible the financial position of the hospitality operation.
For example, many long-term loans specify a required current ratio
(which is current assets divided by current liabilities). Failure to meet the
requirement may result in all long-term debt being reclassified as current
and thus due immediately. Since few operations could raise large sums
of cash quickly, bankruptcy could result. Therefore, management must
carefully review the balance sheet to determine that the operation is in
compliance. For example, assume that at December 31, 20X1 (year-
end), a hotel has $500,000 of current assets and $260,000 of current
liabilities. Further assume that the current ratio requirement in a bank’s
loan agreement with the hotel is 2 to 1. The required current ratio can
be attained simply by taking the appropriate action. In this case, the
payment of $20,000 of current liabilities with cash of $20,000 results in
current assets of $480,000 and current liabilities of $240,000, resulting
in a current ratio of 2 to 1.
Current ratio—ratio of total current assets to total current liabilities

expressed as a coverage of so many times; calculated by dividing current
assets by current liabilities.
Creditors are interested in the hospitality operation’s ability to pay its

current and future obligations. The ability to pay its current obligations is
shown, in part, by a comparison of current assets and current liabilities.
The ability to pay its future obligations depends, in part, on the relative
amounts of long-term financing by owners and creditors. Everything else
being the same, the greater the financing from investors, the higher the
probability that long-term creditors will be paid and the lower the risk that
these creditors take in “investing” in the enterprise.
Investors are most often interested in earnings that lead to dividends. To

maximize earnings, an organization should have financial flexibility, which
is the operation’s ability to change its cash flows to meet unexpected needs

and take advantage of opportunities. Everything else hospitality operations whose assets are appreciating
being the same, the greater the financial flexibility of rather than depreciating, this difference may be
the hospitality operation, the greater its opportunities significant. Hilton Hotels Corporation may be a fair
to take advantage of new profitable investments, thus reflection of this difference. In an annual report that
increasing net income and, ultimately, cash dividends disclosed market values, Hilton revealed the current
for investors. value of its assets (footnote disclosure only) to be
$4.03 billion, while its balance sheet showed the book
In addition, the balance sheet reveals the liquidity value of its assets to be $1.89 billion. The difference
of the hospitality operation. Liquidity measures the between current value and book value was $2.14
operation’s ability to convert assets to cash. Even when billion. The assets reflected in the balance sheet for
a property’s past earnings have been substantial, this Hilton were only 47 percent of their current value.
does not in itself guarantee that the operation will be This “understatement,” if unknown or ignored by
able to meet its obligations as they become due. The management, investors, and creditors, could lead to
hospitality operation should have sufficient liquidity less than optimal use of Hilton’s assets.
not only to pay its bills, but also to provide its owners
with adequate dividends. Another limitation of balance sheets is that they fail to
reflect many elements of value to hospitality operations.
Most important to hotels, motels, restaurants, clubs,
Liquidity—the ability of an operation to meet its short- and other sectors of the hospitality industry are people.
term (current) obligations by maintaining sufficient cash Nowhere in the balance sheet is there a reflection of
and/or investments easily convertible to cash. the human resource investment. Millions of dollars are
spent in recruiting and training to achieve an efficient
Analysis of several balance sheets for several periods and highly motivated work force, yet this essential
will yield trend information that is more valuable than ingredient for successful hospitality operations is not
single-period figures. In addition, comparison of shown as an asset.
balance sheet information with projected balance sheet
numbers (when available) will reveal management’s Balance sheets are limited by their static nature; that
ability to meet various financial goals. is, they reflect the financial position for only a moment.
Thereafter, they are less useful because they become
outdated. Thus, the user of the balance sheet must be
aware that the financial position reflected at year-end
may be quite different one month later. For example,
a hospitality operation with $1,000,000 of cash may
seem financially strong at year-end, but if it invests
most of this cash in fixed assets two weeks later, its
financial flexibility and liquidity are greatly reduced.
This situation would generally only be known to the
user of financial documents if a balance sheet and/or
other financial statements were available for a date
after this investment had occurred.
Limitations of the Balance Sheet Finally, the balance sheet, like much of accounting, is
As useful as the balance sheet is, it is generally based on judgments; that is, it is not exact. Certainly,
considered less useful than the income statement assets equal liabilities plus owners’ equity. However,
to investors, long-term creditors, and especially to several balance sheet items are based on estimates.
management. Since the balance sheet is based on the The amounts shown as accounts receivable (net)
cost principle, it often does not reflect current values reflect the estimated amounts to be collected. The
of some assets, such as property and equipment. For amounts shown as inventory reflect the lower of the
cost or market (that is, the lower of original cost and
current replacement cost) of the items expected to be
sold, and the amount shown as property and equipment
reflects the cost less estimated depreciation. In each

case, accountants use estimates to Exhibit 1.1 Balance Sheet Account Format
arrive at values. To the degree that
these estimates are in error, the MASON MOTEL
balance sheet items will be wrong. BALANCE SHEET
DECEMBER 31, 20X1
Report format—a possible
arrangement of a balance sheet
that lists assets first, followed by
liabilities and owners’ equity.
Account format—a possible

arrangement of a balance sheet that
lists the asset accounts on the left
side of the page and the liability
and owners’ equity accounts on the
right side.
Balance Sheet
Formats
The balance sheet can be arranged
in either the account or report
format. The account format lists
the asset accounts on the left side
of the page and the liability and
owners’ equity accounts on the
right side. Exhibit 1.1 illustrates
this arrangement. The report format
shows assets first, followed by
liabilities and owners’ equity.
The group totals on the report

form can show either that assets
equal liabilities and owners’ equity
or that assets minus liabilities
equal owners’ equity. Exhibit 1.2
illustrates the report format.
The daily report of

operations provides a
means of reconciling
cash, bank accounts,
revenue, and accounts
receivable.

Exhibit 1.2 Balance Sheet Account Format CONTENT OF

MASON MOTEL
THE BALANCE
BALANCE SHEET
DECEMBER 31, 20X1
SHEET
The balance sheet consists of
ASSETS assets, liabilities, and owners’
equity. Simply stated, assets are
Current Assets: things owned by the firm, liabilities
Cash $ 2,500 are claims of outsiders to assets,
and owners’ equity is claims of
Accounts Receivable 5,000 owners to assets. Thus, assets
Cleaning Supplies 2,500 must equal (balance) liabilities
and owners’ equity. Assets include
Total Current Assets 10,000 various accounts such as cash,
Property and Equipment: inventory for resale, buildings, and
accounts receivable. Liabilities
Land $ 20,000 include accounts such as accounts
Building 300,000 payable, wages payable, and
mortgage payable. Owners’
Furnishings and Equipment 50,000 equity includes capital stock and
retained earnings. These major
Less: Accumulated Depreciation 125,000
elements are generally divided
Net Property and Equipment 245,000 into various classes as shown in
Exhibit 1.3. While balance sheets
Total Assets $ 255,000
may be organized differently, most
LIABILITIES AND OWNER’S hospitality operations follow the
EQUITY order shown in Exhibit 1.3.
Current Liabilities:
Notes Payable $ 23,700
Accounts Payable 8,000
Wages Payable 300 $ 32,000
Long-Term Liabilities:
Balance sheets are
Mortgage Payable 120,000
limited by their static
Total Liabilities 152,000 nature; that is, they
Owner’s Equity: reflect the financial
Melvin Mason, Capital at January 64,500
position for only a
1, 20X1 moment. Thereafter,
they are less useful
Net Income for 20X1 38,500
because they become
Melvin Mason, Capital at 103,000 outdated.
December 31, 20X1
Total Liabilities and Owner’s $ 255,000
Equity

Exhibit 1.3 Major Elements of a Balance Sheet Exhibit 1.4 Normal Operating Cycle
LIABILITIES AND
ASSETS OWNERS’ EQUITY
Cash
Purc
Current Assets Current Liabilities has
s ing
on ,
Noncurrent Assets: Long-Term Liabilities
cti
Pa
lle
yro
Noncurrent Owners’ Equity
Co
ll
Ca
Receivables
sh
Sa
le s
Investments
Accounts Inventory,
Property and Receivable Labor, etc.
Equipment
Other Assets
C r e d it S a l e s
Current Assets. Current assets, listed in the order

Current Accounts of liquidity, generally consist of cash, short-term
Under both “assets” and “liabilities and owners’ equity” investments, receivables, inventories, operating
is a “current” classification. Current assets normally equipment, and prepaid expenses Cash consists of
refer to items to be converted to cash or used in cash in house banks, cash in checking and savings
operations within one year or in a normal operating accounts, and certificates of deposit. The exception
cycle. Current liabilities are obligations that are is cash restricted for retiring long-term debt, which
expected to be satisfied either by using current assets should be shown under other assets. Cash is shown
or by creating other current liabilities within one year on the balance sheet at its face value.
or a normal operating cycle.
Short-term investments (also known as marketable
securities) are shown as current assets when they
Current assets—resources of cash and items that will are available for conversion to cash. Investments
be converted to cash or used in generating income within that are not available for conversion to cash are
a year through normal business operations. considered Investments (noncurrent). Generally,
the critical factor in making this current/noncurrent
decision is management’s intent. Short-term
Current liabilities—obligations that are due within a investments should be shown on the balance sheet
year. at market value.
Exhibit 1.4 reflects a normal operating cycle, which The current asset category of receivables consists
includes (1) the purchase of inventory for resale and of accounts receivable—trade and notes receivable.
labor to produce goods and services, (2) the sale of Accounts receivable—trade are open accounts
goods and services, and (3) the collection of accounts carried by a hotel or motel on the guest, city, or
receivable from the sale of goods and services. rent ledgers. Notes receivable due within one year
are also listed, except for notes from affiliated
A normal operating cycle may be as short as a few days, companies, which should be shown under “Due
as is common for many quick-service restaurants, or it from Owner, Management Company, or Related
may extend over several months for some hospitality Party.” Receivables should be stated at the amount
operations. It is common in the hospitality industry estimated to be collectible. An allowance for doubtful
to classify assets as current/noncurrent on the basis accounts, the amount of receivables estimated
of one year rather than on the basis of the normal to be uncollectible, should be subtracted from
operating cycle. receivables to provide a net receivables amount.

Inventories of a hospitality operation primarily consist sheet date that are not due until after the balance
of merchandise held for resale, such as food and sheet date. Advance deposits include amounts
beverage inventory. The cost of unused supplies to received for services that have not been provided as
be used in operating the property, if significant, should of the balance sheet date. Due to owner, management
also be reported as part of the inventories. Examples company, or related party includes amounts due the
of supplies include cleaning and guest supplies. owner, a management company, and/or other related
Inventories are generally an insignificant percentage entities for loans, advances for capital improvements,
of the total assets of a hospitality operation and management fees, and other expenses or advances
may be valued at cost. If the amount of inventory is provided to a property. These accounts are classified
material and the difference between cost and market as either current or long-term based on their payment
is significant, then the inventory should be stated at terms.
the lower of cost or market.
Obligations to be paid with restricted cash within 12
Current Liabilities. Current liabilities are obligations months of the balance sheet date (that is, cash that
at the balance sheet date that are expected to be has been deposited in separate accounts, often for the
paid by converting current assets or by creating other purpose of retiring long-term debt) should be classified
current liabilities within one year. They generally as current.
consist of one of the four following types:
Current liabilities are often compared with current
1. Payables resulting from the purchase of goods, assets. The difference between the two is commonly
services, and labor and from the applicable called net working capital. The current ratio results
payroll taxes from dividing current assets by current liabilities.
Many hospitality properties operate successfully with
2. Amounts received in advance of the delivery of a current ratio approximating 1 to 1, compared with a
goods and services, such as advance deposits reasonable current ratio for many other industries of
on rooms and banquet deposits 2 to 1. The major reason for this difference lies with
the relatively low amount of inventories required and
3. Obligations to be paid in the current period relating relatively high turnover of receivables by hospitality
to fixed asset purchases or to reclassification of operations as compared with many other industries.
long-term debt as current
4. Dividends payable and income taxes payable Restricted cash—cash that has been deposited in
separate accounts, often for the purpose of retiring long-
The major classifications of current liabilities according term debt.
to the USALI are notes payable, current maturities
of long-term debt, income taxes payable, deferred
income taxes, accrued expenses, advance deposits, Working capital—current assets minus current
accounts payable, and due to owner, management liabilities.
company, or related party. Notes payable include
short-term notes that are due within 12 months.
Current maturities of long-term debt include the
Property & Equipment
principal payments of long-term debt such as notes Property and equipment consists of fixed assets
and similar liabilities, sinking fund obligations, and including land, buildings, furnishings and equipment,
the principal portion of capitalized leases due within construction in progress, and leasehold improvements.
12 months. Accounts payable include amounts due Property and equipment under capital leases should
to creditors for merchandise, services, equipment, also be shown in this section of the balance sheet.
or other purchases. Deferred income taxes—current With the exception of land, the cost of all property
include amounts that represent the tax effects of and equipment is written off to expense (depreciation
timing differences attributable to current assets and expense) over time due to the matching principle.
current liabilities that are accounted for differently for Depreciation methods used should be disclosed in
financial and income tax reporting purposes. Accrued a footnote to the balance sheet. The depreciation
expenses are expenses incurred before the balance method used for financial reporting to outsiders and

that used for tax purposes may the most significant timing difference for hotels and motels relates to
differ, resulting in deferred income depreciation, since many operations use the straight-line method for
taxes. Deferred income taxes financial reporting purposes and an accelerated method for income tax
resulting from the use of different purposes. For example, suppose a hotel decides to depreciate a fixed
depreciation methods for tax and asset on a straight-line basis at $15,000 a year for reporting purposes,
financial purposes are generally a and depreciate the same asset.
noncurrent liability. On the balance
sheet, property and equipment are $25,000 for the year using an accelerated method for tax purposes. If the
shown at cost and are reduced firm’s marginal tax rate is 25 percent, then the difference in depreciation
by the related accumulated expense of $10,000 ($25,000 - $15,000) times 25 percent results in
depreciation and amortization. $2,500 cash saved and reported as a noncurrent liability. The book entry
to record this savings is as follows:
Long-Term Liabilities
Long-term liabilities are obligations Income Tax Expense
$2,500
at the balance sheet date that are
expected to be paid beyond the next Deferred Income Taxes $2,500
12 months. Common long-term
liabilities consist of notes payable,
mortgages payable, bonds payable,
capitalized lease obligations, and
deferred income taxes. Any long-
term debt to be paid with current
assets within the next year is
reclassified as current liabilities.
Still, long-term debt per the USALI
is reported on the balance sheet
in total with the amount due within
12 months subtracted as “Less
Current Maturities.”
Long-term liabilities—obligations
at the balance sheet date that are
expected to be paid beyond the
next 12 months, or if paid in
the next year, they will be paid
from restricted funds; also called
BALANCE SHEET ANALYSIS
The information shown on the balance sheet is most useful when it is
noncurrent liabilities.
properly analyzed. The analysis of a balance sheet may include the
following:
Lease obligations reported as
long-term liabilities generally
1. Horizontal analysis (comparative statements)
cover several years, while short-
term leases are usually expensed
2. Vertical analysis (common-size statements)
when paid. Deferred income taxes
result from timing differences
3. Base-year comparisons
in reporting for financial and
income tax purposes—that is, the 4. Ratio analysis
accounting treatment of an item
for financial reporting purposes In the remainder of this chapter, the first three techniques will be discussed.
results in a different amount of
expense (or revenue) than that
used for tax purposes. Generally,

1. Are the marketable securities readily convertible
Comparative statements—the horizontal analysis
to cash?
of financial statements from the current and previous
periods in terms of both absolute and relative variances 2. Is the amount invested in marketable securities
for each line item. adequate for cash needs in the next few months?
3. Should some of the dollars invested in marketable

Common-size statements—financial statements used securities be moved to less liquid, but higher
in vertical analysis whose information has been reduced rate-of-return investments?
to percentages to facilitate comparisons.
Significant changes in other accounts should be
Horizontal Analysis similarly investigated.
Horizontal analysis compares two balance sheets—
To explain the drastic change in some balance sheet
the current balance sheet and the balance sheet of
items, a fluctuation explanation may be prepared.
the previous period. In this analysis, the two balance
This explanation provides detail not available on the
sheets are often referred to as comparative balance
balance sheet. Exhibit 1.6 illustrates a fluctuation
sheets. This represents the simplest approach to explanation for the Stratford Hotel’s marketable
analysis and is essential to the fair reporting of the securities.
financial information. Often included for management’s
analysis are the two sets of figures with the changes
from one period to the next expressed both in absolute Fluctuation explanation—a document providing detail
and relative terms. Absolute changes show the change not available on the balance sheet that explains drastic
in dollars between two periods. For example, assume changes in balance sheet items.
that cash was $10,000 at the end of year 20X1 and
$15,000 at the end of year 20X2. The absolute change
is the difference of $5,000.
Horizontal analysis—comparing financial statements

for two or more accounting periods in terms of both
absolute and relative variances for each line item.
Comparative balance sheets—balance sheets from two

or more successive periods used in horizontal analysis.
The relative change (also called the percentage Vertical Analysis

change) is found by dividing the absolute change
Another approach to analyzing balance sheets
by the amount for the previous period. The relative
is to reduce them to percentages. This vertical
change, using the cash example above, is 50 percent
analysis, often referred to as common-size statement
($5,000 ÷ $10,000). The $5,000 absolute change may
analysis, is accomplished by having total assets
not seem significant by itself, but viewed as a relative
equal 100 percent and individual asset categories
change, it is a 50 percent increase over the previous
equal percentages of the total 100 percent. Likewise,
year.
total liabilities and owners’ equity equal 100 percent
Examine the comparative balance sheets for the and individual categories equal percentages of 100
Stratford Hotel found in Exhibit 1.5. Comparative percent.
analysis shows that marketable securities increased
by $629,222 in absolute terms and 404.7 percent in
relative terms. The increase is substantial. In light of
these figures, a manager would desire answers to
several questions, including the following:

Vertical analysis—analyzing individual financial statements by reducing financial information to percentages of a

whole; that is, income statement line items are expressed as percentages of total revenue; balance sheet assets are
expressed as percentages of total assets; and so forth.
Exhibit 1.5 Comparative Balance Sheets
COMPARATIVE BALANCE SHEETS - STRATFORD HOTEL

December 31 Change from 20X1 to 20X2
ASSETS 20X2 20X1 Amount Percentage
Current Assets:
Cash $ 104,625 $ 85,600 $ 19,025 22.2%
Marketable Securities 784,687 155,465 629,222 404.7
Accounts Receivable (net) 1,615,488 1,336,750 278,738 20.9
Inventories 98,350 92,540 5,810 6.3
Other 12,475 11,300 1,175 10.4
Total 2,615,625 1,681,655 933,970 55.5
Property and Equipment:
Land 905,700 905,700 0 0
Buildings 5,434,200 5,434,200 0 0
Furnishings and Equipment 2,617,125 2,650,500 (33,375) (1.3)
Less: Accumulated Depreciation 1,221,490 749,915 471,575 62.9
Total 7,735,535 8,240,485 (504,950) (6.1)
Other Assets 58,350 65,360 (7,010) (10.7)
Total Assets $ 10,409,510 $ 9,987,500 422,010 4.2%
LIABILITIES
Accounts Payable $ 1,145,000 $ 838,000 $ 307,000 36.6%
Current Maturities of Long-Term Debt 275,000 275,000 0 0
Income Taxes Payable 273,750 356,000 (82,250) (23.1)
Total 1,693,750 1,469,000 224,750 15.3
Long-Term Debt
Notes Payable 50,000 0 50,000 N.M.
Mortgage Payable 1,500,000 1,775,000 (275,000) (15.5)
Less: Current Maturities 275,000 275,000 0 0
Total 1,275,000 1,500,000 (225,000) (15.0)
Total Liabilities 2,968,750 2,969,000 (250) 0
OWNERS’ EQUITY
Common Stock 1,750,000 1,750,000 0 0
Additional Paid-In Capital 250,000 250,000 0 0
Retained Earnings 5,440,760 5,018,500 422,260 8.4
Total 7,440,760 7,018,500 422,260 6.0
Total Liabilities and Owners’ Equity $ 10,409,510 $ 9,987,500 $ 422,010 4.2%
N.M. = not meaningful

Exhibit 1.6 Fluctuation Explanation ($5,000) may not be excessive

since cash is 10 percent of total
assets in both cases. However,
FLUCTUATION EXPLANATION—MARKETABLE SECURITIES only a detailed investigation would
STRATFORD HOTEL resolve whether cash equal to 10
Balance at Dec. 31 percent of total assets is required
Increase in each case.
20X2 20X1 (Decrease)
Marketable Securities Common-size balance sheets—

balance sheets used in vertical
Commercial Paper $240,000 $ 90,000 $150,000 analysis whose information has
been reduced to percentages to
Bank Repurchase 44,687 15,465 29,222
facilitate comparisons.
Agreements
Treasury Bills 150,000 25,000 125,000 Examine the Stratford Hotel’s

common-size balance sheets
Treasury Bonds 150,000 25,000 125,000 (Exhibit 1.7). Notable changes
include marketable securities
Corporate Stocks & 200,000 –0– 200,000 (1.6 percent to 7.5 percent), total
Bonds current assets (16.9 percent to 25.1
$784,687 155,465 $629,222 percent), accumulated depreciation
(-7.5 percent to -11.7 percent), and
accounts payable (8.4 percent to
Common-size balance sheets permit a comparison of amounts relative to
11.0 percent). Management should
a base within each period. For example, assume that cash at the end
investigate significant changes
of year 20X1 is $10,000 and total assets are $100,000. At the end of
such as these to determine if they
year 20X2, assume that cash is $15,000 and total assets are $150,000.
are reasonable. If the changes
Horizontal analysis shows a $5,000/50 percent increase. But cash at
are found to be unreasonable,
the end of each year is 10 percent of the total assets ($10,000 divided
management should attempt to
by $100,000 equals 10 percent; $15,000 divided by $150,000 equals 10
remedy the situation.
percent). What first appears to be excessive cash at the end of year 20X2
Exhibit 1.7 Fluctuation

Explanation
COMMON-SIZE BALANCE SHEETS - STRATFORD HOTEL

December 31 Common Size
ASSETS 20X2 20X1 20X2 20X1
Current Assets:
Cash $ 104,625 $ 85,600 1.0% 0.9%
Marketable Securities 784,687 155,465 7.5 1.6

Accounts Receivable (net) 1,615,488 1,336,750 15.5 13.4
Inventories 98,350 92,540 1.0 0.9
Other 12,475 11,300 0.1 0.1
Total 2,615,625 1,681,655 25.1 16.9
Property and Equipment:
Land 905,700 905,700 8.7 9.1
Buildings 5,434,200 5,434,200 52.2 54.4
Furnishings and Equipment 2,617,125 2,650,500 25.1 26.5
Less: Accumulated Depreciation 1,221,490 749,915 (11.7) (7.5)
Total 7,735,535 8,240,485 74.3 82.5
Other Assets 58,350 65,360 0.6 0.6
Total Assets $ 10,409,510 $ 9,987,500 100.0% 100.0%
LIABILITIES
Accounts Payable $ 1,145,000 $ 838,000 11.0% 8.4%
Current Maturities of Long-Term Debt 275,000 275,000 2.6 2.8
Income Taxes Payable 273,750 356,000 2.6 3.6
Total 1,693,750 1,469,000 16.2 14.8
Long-Term Debt
Notes Payable 50,000 0 0.5 0
Mortgage Payable 1,500,000 1,775,000 14.4 17.8
Less: Current Maturities 275,000 275,000 (2.6) (2.8)
Total 1,275,000 1,500,000 12.3 15.0
Total Liabilities 2,968,750 2,969,000 28.5 29.8
OWNERS’ EQUITY
Common Stock 1,750,000 1,750,000 16.8 17.5
Additional Paid-In Capital 250,000 250,000 2.4 2.5
Retained Earnings 5,440,760 5,018,500 52.3 50.2
Total 7,440,760 7,018,500 71.5 70.2

Total Liabilities and Owners’ Equity $ 10,409,510 $ 9,987,500 100.0% 100.0%

Common-size statement comparisons are not limited strictly to internal use. Comparisons may also be made
against other operations’ financial statements and against industry averages. Common-size figures are helpful
in comparing hospitality operations that differ materially in size. For example, assume that a large hospitality
operation has current assets of $500,000, while a much smaller operation’s current assets are $50,000 and
that both figures are for the same period. If total assets equal $1,500,000 for the large operation and $150,000
for the small enterprise, then both operations have current assets equaling 33.3 percent of total assets.
These percentages provide a more meaningful comparison than the dollar amount of the current assets when
comparing financial statements of the two companies.
Base-Year Comparisons
A third approach to analyzing balance sheets is base-year comparisons. This approach allows a meaningful
comparison of the balance sheets for several periods. A base period is selected as a starting point, and all
subsequent periods are compared with the base. Exhibit 1.8 illustrates the base-year comparisons of the
Stratford Hotel’s current assets for the years 20X0-20X2.
Base-year comparison—an analytical tool that allows a meaningful comparison of financial statements for several
periods by using a base period as a starting point (set at 100 percent) and comparing all subsequent periods with the
base.
The base-year comparisons of the Stratford Hotel use 20X0 as the base. Total current assets for 20X2 are
152.71 percent of the total current assets for 20X0. The user of this analysis is quickly able to determine the
changes of current assets over a period of time. For example, cash increased only 26.30 percent from the
end of 20X0 to the end of 20X2, while marketable securities increased 239.32 percent.
Exhibit 1.8 Base-Year Comparison
BASE-YEAR COMPARISONS CURRENT ASSETS STRATFORD HOTEL
20X2 20X1 20X0
Cash 126.30% 103.33% 100.00%
Marketable Securities 339.32% 67.23% 100.00%
Accounts Receivable (net) 124.39% 102.92% 100.00%
Inventories 110.55% 104.02% 100.00%
Other 114.11% 103.37% 100.00%
Total Current Assets 152.71% 98.18% 100.00%

WRAP UP
CONCLUSION
Although the balance sheet may not play the vital role in management
decision-making that other financial statements play, it is still an
important tool. By examining it, managers, investors, and creditors
may determine the financial position of the hospitality operation at a
given point in time. It is used to help determine an operation’s ability
to pay its debts, offer dividends, and purchase fixed assets.
Review Questions
1
How do creditors and investors use the
balance sheet?
2
What are some of the limitations of the
balance sheet?
3
What are the differences and similarities between
the account and report formats
of the balance sheet?
4
What are assets, liabilities, and owners’ equity?
What is the relationship among the three?
5
What are the differences between a comparative
balance sheet and a common-size balance sheet?
6
What is the order of liquidity for the following
accounts (most liquid first): marketable securities,
prepaid expenses, cash, inventories,
and receivables?
7
How do the terms “current” and “long-term” relate
to the balance sheet?
8
How is the current ratio determined?
What does it reflect?

CHAPTER 2
THE INCOME STATEMENT
Major Elements of the Income Statement............................................16
1
Describe revenues,
Relationship with the Balance Sheet...........................................18 expenses, gains, and
losses as presented
Income Statements for Internal and External Users....................18 on the income
statement.
Contents of the Income Statement........................................................20
2
Analysis of Income Statements..............................................................23 Distinguish between
income statements
Wrap Up..................................................................................................29
prepared for internal
Review Questions........................................................................29 users and those
prepared for external
users.
3
Describe the contents
of an income
statement.
4
Interpret income
statements using
horizontal and vertical
analysis as well as
base-year
comparisons.

The income statement, also called the statement of earnings, the profit
and loss (or P & L) statement, the statement of operations, and various
other titles, reports the success of the hospitality property’s operations for
a period of time. This statement may be prepared on a weekly or monthly
basis for management’s use and quarterly or annually for outsiders such
as owners, creditors, and governmental agencies.
Users of financial statements examine an operation’s income statements

for answers to many questions, such as:
1. How profitable was the hospitality operation during the period?
2. What were the total sales for the period?
3. How much was paid for labor?
4. What is the relationship between sales and cost of sales?
5. How much have sales increased over last year?
6. What is the utilities expense for the year and how does it compare
with the expense of a year ago?
7. How much was spent to market the hospitality operation’s services?
8. How does net income compare with total sales for the period?
Income statement—a report on the profitability of operations, including

revenues earned and expenses incurred in generating the revenues for the
period of time covered by the statement.
MAJOR ELEMENTS OF THE

INCOME STATEMENT
The income statement for a single property reflects the revenues,
expenses, gains, and losses for a period of time. Revenues represent the
inflow of assets, reduction of liabilities, or a combination of both resulting
from the sale of goods or services. For a hospitality operation, revenues
generally include food sales, beverage sales, room sales, interest and
dividends from investments, and rents received from lessees of retail
space.
Revenue—the amount charged to customers in exchange for goods and

services.
Expenses are defined as the outflow of assets, increase in liabilities, or

a combination of both in the production and rendering of goods and
services. Expenses of a hospitality operation generally include cost of
goods sold (for example, food and beverages), labor, utilities, advertising,
depreciation, and taxes, to list a few.

gains and losses are shown near the bottom of the
Expenses—costs incurred in providing the goods and
income statement before income taxes.
services offered.
The income statements of large, multi-unit hospitality
Gains are defined as increases in assets, reductions
businesses may also be affected by items such
in liabilities, or a combination of both resulting from a
as discontinued operations, extraordinary gains
hospitality operation’s incidental transactions and from
and losses, and changes in accounting principles.
all other transactions and events affecting the operation
Discontinued operations refers to operations of a
during the period, except those that count as revenues
segment of business that has been disposed of or,
or investments by owners. For example, there may be
though still operating, will be disposed of in the future
a gain on the sale of equipment. Equipment is used
based on a formal plan of disposal. Extraordinary
by the business to provide goods and services and,
gains and losses are classified as extraordinary by
when sold, only the excess proceeds over its net book
their unusual nature and infrequency of occurrence.
value (purchase price less accumulated depreciation)
An extraordinary item is unusual in nature when the
is recognized as gain.
underlying event is highly abnormal and is clearly
unrelated to the ordinary and typical activities of the
Gain—an increase in assets, a reduction in liabilities, hospitality company. The infrequency of occurrence of
or a combination of both resulting from incidental an extraordinary item is determined by judging that the
transactions and from all other transactions and events underlying event would not reasonably be expected to
affecting the operation during the period, except those recur in the foreseeable future. For example, a flood
that count as revenues or investments by owners. loss for a hotel near the Mississippi River may not be
unusual, while casualty loss from a flood to a hotel
located several miles from any river may meet the
Loss—a decrease in assets, an increase in liabilities, definition of extraordinary. The cumulative effect of
or a combination of both resulting from incidental a change in one method of accounting to another
transactions and from other transactions and events (such as from a straight-line method of depreciation
affecting the operation during a period, except those to an accelerated method of depreciation) must be
that count as expenses or distributions to owners. reported. Generally accepted accounting principles
require that these additional items be reported on
Finally, losses are defined as decreases in assets, income statements as follows:
increases in liabilities, or a combination of both
resulting from a hospitality operation’s incidental
Income from continuing operations $XXX
transactions and from other transactions and events
before taxes
affecting the operation during a period, except those
that count as expenses or distributions to owners. In Income tax expense (XX)
the equipment example above, if the proceeds were
less than the net book value, a loss would occur and Income from continuing operations XXX
would be recorded as “loss on sale of equipment.”
Another example would be a loss from an act of Discontinued operations (net of tax) XX
nature, such as a tornado or hurricane. The loss
reported is the reduction of assets less insurance Extraordinary gains and losses (net of XX
proceeds received. tax)
Cumulative effect of change in XX

In the income statement for hospitality operations,
accounting principle (net of tax)
revenues are reported separately from gains,
and expenses are distinguished from losses. Net income $XXX
These distinctions are important in determining
management’s success in operating the hospitality
Since 1997, the Financial Accounting Standards Board
property. Management is held accountable primarily
has required businesses to report comprehensive
for operations (revenues and expenses) and only
income in addition to net income. This requirement
secondarily (if at all) for gains and losses. Generally,
relates primarily to the corporate level of large lodging

firms. Comprehensive income includes net income Income statements for external users are often called
plus other comprehensive income, as follows: summary income statements, even though the word
“summary” does not usually appear on the form.
Exhibit 2.1 is the income statement presentation of
Net income $XXX Starwood Hotels & Resorts Worldwide, Inc. and its
subsidiaries from a recent annual report. Starwood’s
Other comprehensive income (net of consolidated statement of income shows the following
tax): items:
Foreign currency translation $XX •• Revenues
adjustments
•• Costs and expenses
Unrealized gains in securities XX
•• Operating income
Pension liability adjustments XX
•• Equity earnings
Other comprehensive income XX •• Interest expense
Comprehensive income $XXX •• Loss on early extinguishment of debt
•• Gain (loss) on asset dispositions and impairment
Relationship with the
Balance Sheet •• Discontinued operations
The income statement covers a period of time, while •• Net income
the balance sheet is prepared as of the last day of
the accounting period. Thus, the income statement •• Earnings per share
reflects operations of the hospitality property for the
period between balance sheet dates. The result of Summary income statement—an income statement
operations—net income or loss for the period—is intended for external users that lacks the detail of
added to the proper equity account and shown on supporting schedules.
the balance sheet at the end of the accounting period
We have already stated that notes, which generally
appear after the financial statements in the financial
report, are critical to interpreting the numbers reported
on the income statement. Note that Starwood notifies
readers of the importance of notes on the same page
as the income statement.
Although the amount of operating information shown

in the income statement and accompanying footnotes
may be adequate for external users to evaluate
the hospitality property’s operations, management
requires considerably more information. Management
also needs this information more frequently than
Income Statements for outsiders. In general, the more frequent the need
to make decisions, the more frequent the need for
Internal and External Users financial information. Management’s information
Hospitality properties prepare income statements for needs are met, in part, by detailed monthly income
both internal users (managers) and external users statements that reflect budget numbers and report
(creditors, owners, and so forth). These statements performance for the most recent period, the same
differ substantially. The income statements provided period a year ago, and year-to-date numbers for both
to external users are relatively brief, providing only the current and past year.
summary detail about the results of operations.

Exhibit 2.1 Consolidated Statement of Income for Starwood Hotels & Resorts Worldwide, Inc.
STARWOOD HOTELS & RESORTS WORLDWIDE, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In millions, except per share data) Year Ended December 31,
2009 2008 2007
(In millions, except per share data)
Revenues
Owned, leased and consolidated joint venture hotels. . . . . . . . . . . . . . . . . . . . . . . $1,584 $2,212 $2,384
Vacation ownership and residential sales and services . . . . . . . . . . . . . . . . . . . . . . 523 749 1,025
Management fees, franchise fees and other income. . . . . . . . . . . . . . . . . . . . . . . . 658 751 730
Other revenues from managed and franchised properties . . . . . . . . . . . . . . . . . . . . 1,947 2,042 1,860
4,712 5,754 5,999
Costs and Expenses
Owned, leased and consolidated joint venture hotels. . . . . . . . . . . . . . . . . . . . . . . 1,315 1,688 1,774
Vacation ownership and residential . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 422 583 758
Selling, general, administrative and other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 314 377 416
Restructuring, goodwill impairment and other special charges, net . . . . . . . . . . . . 379 141 53
Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274 281 271
Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 32 26
Other expenses from managed and franchised properties . . . . . . . . . . . . . . . . . . . 1,947 2,042 1,860
4,686 5,144 5,158
Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 610 841
Equity (losses) earnings and gains and losses from unconsolidated ventures, net . . (4) 16 66
Interest expense, net of interest income of $3, $3 and $21 . . . . . . . . . . . . . . . . . . (227) (207) (147)
Loss on asset dispositions and impairments, net . . . . . . . . . . . . . . . . . . . . . . . . . . (91) (98) (44)
Income (loss) from continuing operations before taxes and noncontrolling
interests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (296) 321 716
Income tax (expense) benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 293 (72) (183)
Income (loss) from continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3) 249 533
Discontinued operations:
Income (loss) from operations, net of tax (benefit) expense of $(2), $4 and $6. . (2) 5 11
Gain (loss) on dispositions, net of tax (benefit) expense of $(35), $54 and $1 . . 76 75 (1)
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 329 543
Net loss (income) attributable to noncontrolling interests . . . . . . . . . . . . . . . . . . . 2 — (1)
Net income attributable to Starwood . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 73 $ 329 $ 542
Earnings (Losses) Per Share — Basic
Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.00 $ 1.37 $ 2.62
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.41 0.44 0.05
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.41 $ 1.81 $ 2.67
Earnings (Losses) Per Share — Diluted
Continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.00 $ 1.34 $ 2.52
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.41 0.43 0.05
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.41 $ 1.77 $ 2.57
Amounts attributable to Starwood’s Common Shareholders
Income (loss) from continuing operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (1) $ 249 $ 532
Discontinued operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74 80 10
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 73 $ 329 $ 542
Weighted average number of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180 181 203
Weighted average number of shares assuming dilution . . . . . . . . . . . . . . . . . . . . . 180 185 211
Dividends declared per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 0.20 $ 0.90 $ 0.90
The accompanying notes to financial statements are an integral part of the above statements

CONTENTS OF THE small, category of direct expense

is “goods used internally.” For
INCOME STATEMENT example, food may be provided
free of charge to employees
The summary income statement (see Exhibit 2.2) is divided into three major
(employee meals), to entertainers
sections—operated departments, undistributed operating expenses, and
(entertainers—complimentary
the final section that includes management fees, fixed charges, interest
food), to guests for promotional
expense, gain or loss on sale of property, and income tax.
purposes (promotion—food), or
to other departments (transfers
The first section, operated departments, reports net revenue by
to the beverage department).
department for every major revenue-producing department. Net revenue
In each case, the cost of food
is the result of subtracting allowances from related revenues. Allowances
transferred must be charged to
include adjustments for service problems. That is, when the hotel reduces
the proper account of the benefiting
the price of a guestroom because the guest encountered some problem
department and subtracted in the
with the room, the reduction is treated as an allowance. (Allowances
calculation of cost of food sold.
do not include posting errors. For example, if a hotel charges guests
For example, cost of employee
$100 for their rooms when it should have charged a group rate of $80,
meals for the rooms department is
the subsequent $20 correction of this posting error is treated as a direct
subtracted to determine cost of food
reduction of revenue rather than as an allowance.) Revenues earned
sold. The cost of employee meals
from non-operating activities such as investments are shown with rentals.
for rooms department employees is
If these amounts are significant, they should be reported separately.
shown as an expense in the rooms
For each department generating revenues, direct expenses are reported. department.
These expenses relate directly to the department incurring them and
The second major direct expense
consist of three major categories: cost of sales, payroll and related
category of operated departments
expenses, and other expenses. Cost of sales is normally determined
is “payroll and related expenses.”
as follows:
This category includes the salaries
and wages of employees working
BEGINNING INVENTORY in the designated operated
departments (for example, servers
PLUS: Inventory purchases in the food department). Salaries,
wages, and related expenses
EQUALS: Goods available for sale of departments not generating
revenues but providing service,
LESS: Ending inventory such as marketing, are recorded by
service departments. The category
EQUALS: Cost of goods consumed of “related expenses” includes all
payroll taxes and benefits relating
LESS: Goods used internally to employees of each operated
department. For example, in the
EQUALS: Cost of goods sold rooms department, the front office
manager’s salary and related
Cost of sales is determined by starting first with beginning inventory. payroll taxes and benefits would
The beginning inventory is the value of the inventory at the start of the be included in the “payroll and
accounting period. Inventory purchases include the purchase cost of related expenses” of the rooms
goods for sale plus the related shipping cost. An important, but relatively department.

Exhibit 2.2 Summary Income Statement
PAYROLL
AND
NET COST OF RELATED OTHER INCOME
REVENUE SALES EXPENSES EXPENSE (LOSS)
Operated Departments $ $ $ $ $
Rooms
Food
Beverage
Telecommunications
Garage and Parking
Golf Course
Golf Pro Shop
Guest Laundry
Health Center
Swimming Pool
Tennis
Tennis Pro Shop
Other Operated Departments
Rentals and Other Income
Total Operated Departments
Undistributed Operating
Expenses
Administrative and General
Sales and Marketing
Property Operation and
Maintenance
Utilities
Total Undistributed Expenses
Totals
Gross Operating Profit
Management Fees
Income Before Fixed Charges
Rent, Property Taxes, and
Insurance
Depreciation and Amortization
Net Operating Income
Interest Expense
Income Before Gain or Loss on
Sale of Property
Gain or Loss on Sale of
Property
Income Before Income Taxes
Income Taxes
Net Income
The final major expense category for the operated departments is “other expenses.” This category includes
only other direct expenses. For example, the 26 major other expense categories for the rooms department
(per the USALI) include, but are not limited to, cable/satellite television, cleaning supplies, commissions,

complimentary services and gifts, contract services, electricity, gas, oil, steam, sewer, and water. Taxes
guest relocation, guest transportation, laundry and assessed by utilities are included in this category.
dry cleaning, linen, operating supplies, reservations,
telecommunications, training, and uniforms. Expenses Subtracting the total undistributed operating expenses
such as marketing, administration, and general from the total operated departments income results
transportation are recorded as expenses of service in gross operating profit (GOP).
departments. They benefit the rooms department and
other profit centers, but only on an indirect basis. Operating management is considered fully responsible
for all revenues and expenses reported to this point
Net revenue less the sum of cost of sales, payroll on the income statement, as they generally have the
and related expenses, and other expenses results authority to exercise their judgment to affect all these
in departmental income or loss. The departmental items. However, the management fees and the fixed
income or loss is shown on the income statement for charges that follow in the next major section of the
each operated department. income statement are the responsibility primarily
of the hospitality property’s board of directors. The
The second major section of the income statement expenses listed on this part of the statement generally
is undistributed operating expenses. This section relate directly to decisions by the board, rather than
includes four general categories: administrative and to management decisions.
general expenses, sales and marketing, property
operation and maintenance, and utilities. These Management fees are the cost of using an independent
expense categories are related to the various service management company to operate the hotel or motel.
departments. In the income statement, two of the Management fees often consist of a basic fee
expense elements—payroll and related expenses, calculated as a percentage of sales and an incentive
and other expenses—are shown for each category. fee calculated as a percentage of GOP.
The administrative and general expense category
includes service departments such as the general Fixed charges are also referred to as capacity costs,
manager’s office and the accounting office. In addition as they relate to the physical plant or the capacity
to salaries, wages, and related expenses of service to provide goods and services to guests. Fixed
department personnel covered by administrative and charges include rent, property taxes, insurance, and
general, other expenses include, but are not limited to, depreciation and amortization. Rent includes the
information services, professional fees, and provision cost of renting real estate, computer equipment, and
for doubtful accounts. other major items that, if they had been purchased,
would have been recorded as fixed assets. Rental of
Sales and marketing expenses include costs relating miscellaneous equipment for specific functions such
to personnel working in the areas of sales and as banquets is to be shown as a direct expense of the
marketing. In addition, other expenses are divided food and beverage departments.
between sales expenses and marketing expenses.
The sales and marketing schedule in the chapter.
Capacity costs—fixed charges relating to the physical
Franchise fees are also included in this schedule for
plant or the capacity to provide goods and services to
lodging operations that are franchised.
guests.
The third major category of undistributed operating
Property taxes include real estate taxes, personal
expenses is property operation and maintenance.
property taxes, and other taxes (but not income and
Included in property operation and maintenance are
payroll taxes) that cannot be charged to guests.
payroll and related costs of the property operation and
Insurance expense is the cost of insuring the facilities,
maintenance personnel and the various supplies used
including contents, for damage caused by fire or other
to maintain the buildings, grounds, furniture, fixtures,
catastrophes and the cost of liability insurance.
and equipment.
Depreciation of fixed assets and amortization of other
The final category of undistributed operating expenses
assets are shown on the income statement as fixed
is utilities. The recommended schedule includes
charges. The depreciation methods and useful lives
separate listings of the various utilities, such as
of fixed assets are normally disclosed in footnotes.

GOP less management fees and fixed charges equals
net operating income (NOI). Interest expense is then
ANALYSIS OF INCOME
subtracted from NOI to equal income before gain or
loss on sale of property.
STATEMENTS
The analysis of income statements enhances the user’s
knowledge of the hospitality property’s operations.
Interest expense is the cost of borrowing money and is
This can be accomplished by horizontal analysis,
based on the amounts borrowed, the interest rate, and
vertical analysis, base-year comparisons, and ratio
the length of time for which the funds are borrowed.
analysis. Since much less financial information is
Generally, loans are approved by the operation’s
available to owners (stockholders and partners who
board of directors, as most relate to the physical plant.
are not active in the operation) and creditors than is
The income statement then shows gains or losses available to management, their analytical approaches
on the sale of property and equipment. A gain or loss will generally differ.
on sale of property results from a difference between
Horizontal analysis compares income statements for
the proceeds from the sale and the carrying value
two accounting periods in terms of both absolute and
(net book value) of the fixed asset. For example,
relative variances for each line item in a way similar
suppose that a 15-unit motel that cost $600,000 and
to the analysis of comparative balance sheets. The
was depreciated by $450,000 was sold for $200,000.
user should investigate any significant differences.
The gain in this case is determined as follows:
Another common comparative analysis approach is to
compare the most recent period’s operating results
NetBook = Cost – Accumulated Depreciation with the budget by determining absolute and relative
Value variances.
= $600,000 - $450,000
Exhibit 2.3 illustrates the horizontal analysis of
= $150,000 operating results of the Vacation Inn for years 20X1
and 20X2. In this comparative analysis, 20X1 is
Gain = Proceeds – NetBook Value considered the base. Because the revenues for 20X2
exceed revenues for 20X1, the dollar difference is
= $200,000 - $150,000 shown as positive. If 20X2 revenues had been less
= $50,000 than 20X1 revenues, the difference would have been
shown as negative. Actual 20X2 expenses increased
In the income statement, gains are added while losses compared with 20X1, resulting in a positive difference.
are subtracted in determining income before income This should be expected, since as revenues increase,
taxes. expenses should also increase. If actual 20X2
expenses had decreased compared with 20X1, the
Finally, income taxes are subtracted from income differences would have been shown as negative.
before income taxes to determine net income. The percentage differences in this statement are
determined by dividing the dollar difference by the
base (that is, the 20X1 numbers).
Comparative income statements—horizontal analysis

of income statements for two accounting periods in
terms of both absolute and relative variances for each
line item.
Another approach in analyzing income statements

is vertical analysis. The product of this analysis
is also referred to as common-size statements.
These statements result from reducing all amounts
to percentages using total sales as a common

denominator. Exhibit 2.4 illustrates two common-size income statements
for the Vacation Inn.
Common-size income statements—income statements used in vertical

analysis whose information has been reduced to percentages to facilitate
comparisons.
Vertical analysis allows for more reasonable comparisons of two or more

periods when the activity for the two periods was at different levels. For
example, assume the following:
20X1 20X2
Food sales $500,000 $750,000
Cost of food sales $150,000 $225,000
A $75,000 increase in cost of sales may at first appear to be excessive.

However, vertical analysis reveals the following:
20X1 20X2
Food sales 100% 100%
Cost of food sales 30% 30%
In this example, vertical analysis suggests that despite the absolute

increase in cost of sales from 20X1 to 20X2, the cost of food sales has
remained constant at 30 percent of sales for both years. The relatively
large dollar increase from 20X1 to 20X2 can be attributed to the higher
level of activity during the 20X2 period rather than to unreasonable
increases in the cost of sales.

Exhibit 2.3 Comparative Income Statements
VACATION INN – COMPARATIVE INCOME STATEMENTS

DIFFERENCE
20X1 20X2 $ %
Total Revenue $ 1,719,393 1,883,482 $ 164,089 9.54%

Rooms—Revenue 1,041,200 1,124,300 83,100 7.98
Payroll & Related Expenses 185,334 192,428 7,094 3.83
Other Expenses 79,080 84,624 5,544 7.01
Department Income 776,786 847,248 70,462 9.07
Food—Revenue 420,100 460,115 40,015 9.53
Cost of Sales 160,048 173,359 13,311 8.32
Other Expenses 44,013 50,178 6,165 14.01
Department Income 55,539 54,859 (680) (1.22)
Beverage—Revenue 206,065 237,126 31,061 15.07
Cost of Sales 48,400 62,072 13,672 28.25
Other Expenses 22,500 26,497 3,997 17.76
Department Income 77,133 80,656 3,523 4.57
Telecommunications—Revenue 52,028 61,941 9,913 19.05
Cost of Sales 46,505 50,321 3,816 8.21
Other Expenses 6,816 7,561 745 10.93
Department Income (15,610) (12,230) 3,380 21.65
Total Operated Department Income 893,848 970,533 76,685 8.58
Undistributed Operating Expenses
Administrative and General 152,453 165,131 12,768 8.32
Sales and Marketing 66,816 79,760 12,944 19.37
Property Operation and Maintenance 80,964 84,465 3,501 4.32
Utilities 88,752 96,911 8,159 9.19
Total Undistributed Operating Expenses 388,985 426,267 37,282 9.58
Gross Operating Profit 504,863 544,266 39,403 7.80
Rent, Property Taxes, and Insurance 200,861 210,932 10,071 5.01
Depreciation and Amortization 115,860 118,942 3,082 2.66
Net Operating Income 188,142 214,392 26,250 13.95
Interest 52,148 61,841 9,693 18.59
Income Before Income Taxes 135,994 152,551 16,557 12.17
Income Taxes 48,707 57,969 9,262 19.02
Net Income $87,287 $ 94,582 $ 7,295 8.36%

Exhibit 2.4 Common-Size Income Statements
VACATION INN – COMMON-SIZE INCOME STATEMENTS
DIFFERENCE
20X1 20X2 $ %
Total Revenue $ 1,719,393 1,883,482 100.0% 100.0%

Rooms—Revenue 1,041,200 1,124,300 60.6 59.7
Payroll & Related Expenses 185,334 192,428 10.8 10.2
Other Expenses 79,080 84,624 4.6 4.5
Department Income 776,786 847,248 45.2 45.0
Food—Revenue 420,100 460,115 24.4 24.4
Cost of Sales 160,048 173,359 9.3 9.2
Other Expenses 44,013 50,178 2.6 2.7
Beverage—Revenue 206,065 237,126 12.0 12.6
Cost of Sales 48,400 62,072 2.8 3.3
Other Expenses 22,500 26,497 1.3 1.4
Telecommunications—Revenue 52,028 61,941 3.0 3.3
Cost of Sales 46,505 50,321 2.7 2.7
Other Expenses 6,816 7,561 0.4 0.4
Department Income (15,610) (12,230) 0.9 (0.7)
Total Operated Department Income 893,848 970,533 52.0 51.5

Administrative and General 152,453 165,131 8.9 8.8

Sales and Marketing 66,816 79,760 3.9 4.2
Property Operation and Maintenance 80,964 84,465 4.7 4.5
Utilities 88,752 96,911 5.1 5.1
Total Undistributed Operating Expenses 388,985 426,267 22.6 22.6
Gross Operating Profit 504,863 544,266 29.4 28.9
Rent, Property Taxes, and Insurance 200,861 210,932 11.7 11.2
Depreciation and Amortization 115,860 118,942 6.7 6.3
Net Operating Income 188,142 214,392 11.0 11.4
Interest 52,148 61,841 3.0 3.3
Income Before Income Taxes 135,994 152,551 8.0 8.1
Income Taxes 48,707 57,969 2.8 3.1
Net Income $87,287 $ 94,582 5.1% 5.0%

Vertical analysis allows more meaningful comparisons starting point and its figures are assigned a value of
among hospitality operations in the same industry 100 percent. All subsequent periods are compared
segment but differing substantially in size. This with the base on a percentage basis. Exhibit 2.5
common-size analysis also allows comparisons is a comparative income statement that illustrates
to industry standards, as discussed previously. the base-year comparison of the Vacation Inn for
However, a note of caution is offered at this point. 20X0-20X2 (with 20X0 as the base). Note that some
Industry averages are simply that—averages. They percentages increase quite dramatically.
include firms of all sizes from vastly different locations
operating in entirely different markets. The industry A fourth approach to analyzing income statements
averages reflect neither any particular operation nor is ratio analysis. Ratio analysis gives mathematical
an average operation, and they certainly do not depict expression to a relationship between two figures and
an ideal operation. is computed by dividing one figure by the other figure.
Financial ratios are compared with standards in order
A third approach to analyzing income statements to evaluate the financial condition of a hospitality
is base-year comparisons. This approach allows operation. Since vertical analysis is a subset of ratio
a meaningful comparison of income statements analysis, there is considerable overlap between these
for several periods. A base period is selected as a two approaches.

Exhibit 2.5 Base-Year Comparison Income Statements
VACATION INN – BASE-YEAR COMPARISON INCOME STATEMENTS
20X0 20X1 20X2
Total Revenue 100.0% 107.5% 117.7%

Rooms—Revenue 100.0% 104.1% 112.4%
Payroll & Related Expenses 100.0% 103.1% 106.9%
Other Expenses 100.0% 105.4% 112.8%
Department Income 100.0% 104.3% 113.7%
Food—Revenue 100.0% 105.0% 115.0%
Cost of Sales 100.0% 101.3% 109.7%
Other Expenses 100.0% 110.0% 125.4%
Beverage—Revenue 100.0% 103.0% 118.6%
Cost of Sales 100.0% 105.2% 134.9%
Other Expenses 100.0% 107.1% 126.2%
Telecommunications—Revenue 100.0% 105.1% 113.9%
Cost of Sales 100.0% 103.3% 111.8%
Other Expenses 100.0% 113.6% 126.0%
Total Operated Department Income 100.0% 110.9% 120.4%

Administrative and General 100.0% 105.1% 113.9%

Sales and Marketing 100.0% 102.8% 122.7%
Property Operation and Maintenance 100.0% 101.2% 105.6%
Utilities 100.0% 103.2% 112.7%
Total Undistributed Operating Expenses 100.0% 103.2% 113.1%
Gross Operating Profit 100.0% 117.7% 126.9%
Rent, Property Taxes, and Insurance 100.0% 100.4% 105.5%
Depreciation and Amortization 100.0% 99.9% 102.5%
Net Operating Income 100.0% 104.7% 119.1%
Interest 100.0% 94.1% 111.6%
Income Before Income Taxes 100.0% 236.1% 264.8%
Income Taxes 100.0% 281.9% 335.5%
Net Income 100.0% 216.5% 234.6%

WRAP UP
CONCLUSION
The income statement, complete with all departmental statements,
is generally considered the most useful financial statement for
management. It highlights the important financial aspects of the
property’s operations over a period of time.
The income statement shows four major elements: revenues,

expenses, gains, and losses. Revenues (increases in assets or
decreases in liability accounts) and expenses (decreases in assets or
increases in liability accounts) are directly related to operations, while
gains and losses result from transactions incidental to the property’s
major operations.
Review Questions
1
What are the major differences between the balance
sheet and the income statement?
2
What does the income statement for a single
property reflect?
3
What are the major differences between a revenue
and a gain?
4
How are income statements for internal and external
users different?
5
How are the cost of sales normally
determined?
6
What are some items that might be found in the
“other expenses” category?
7
What are the three major sections
of the income statement?
8
List the four main ways an analysis of the income
statement can be competed.


CHAPTER 3
OPERATIONS BUDGETING
Types of Budgets.....................................................................................32
1
Describe the different
The Budget Preparation Process...........................................................32 types of budgets that
are prepared by a
Forecasting Revenue...............................................................................33 hospitality property.
Budgetary Control..................................................................................35
2
Explain the process
Determination of Significant Variances........................................37 of preparing an
operations budget.
Variance Analysis....................................................................................38
3
Revenue Variance Analysis.........................................................40 Describe the role of
forecasting in budget
Wrap Up..................................................................................................45
preparation.
4
Describe the
budgeting control
process and explain
how significant
variances are
determined.
5
Use information from
budget reports to
calculate and analyze
several kinds of
variances related to
revenue, cost,
volume, and labor.

TYPES OF BUDGETS
Hospitality operations prepare several types of budgets. The operations
budget, the topic of this chapter, is also referred to as the revenue and
expense budget, because it includes management’s plans for generating
revenues and incurring expenses for a given period. The operations
budget includes not only operated department budgets (budgets for
rooms, food, beverage, telecommunication, and other profit centers),
but also budgets for service centers such as marketing, accounting,
and human resources. In addition, the operations budget includes the
planned expenses for depreciation, interest expense, and other fixed
charges. Thus, the operations budget is a detailed operating plan by profit
centers, cost centers within profit centers (such as the housekeeping
department within the rooms department), and service centers. It includes
all revenues and all expenses that appear on the income statement and
related subsidiary schedules. Annual operating budgets are normally
subdivided into monthly periods. Certain information is reduced to a daily
basis for management’s use in controlling operations. The operations
budget enables management to accomplish two of its major functions:
planning and control.
Operations budget—management’s detailed plans for generating revenue

and incurring expenses for each department within the operation; also referred
to as the revenue and expense budget.
Two other types of budgets are the cash budget and the capital budget. The
cash budget is management’s plan for cash receipts and disbursements.
Capital budgeting pertains to planning for the acquisition of equipment,
land, and buildings.
THE BUDGET PREPARATION

PROCESS
The major elements in the budget preparation process are as follows:
asts Fina
orec nci
al
eF
Ob
m
co
jec
Net In
tives
Budget
Preparation
Process
Expe
a sts
re c
ns
eF
or
Fo
ec e
a sts nu
Reve

The operations budget process begins with the board
of directors establishing financial objectives. A major
financial objective set by many organizations, both
hospitality and business firms in general, is long-term
profit maximization. Long-term profit maximization
may mean that the operation does not maximize its
profits for the next year. For example, in the next year,
profits could be increased by reducing public relations
efforts and major maintenance projects; however, in
the long run, cuts in these programs may disturb the
financial well-being of the hospitality establishment. An
alternative objective set by institutional food service
FORECASTING
operations (for example, hospital food service) is cost
containment. Since many of these operations generate
REVENUE
Forecasting revenue is the next step in preparing the
limited food service revenues, cost containment is
operations budget. In order for profit center managers
critical to enable these operators to break even.
(for example, rooms department managers) to be able
Another objective may be to provide high quality to forecast revenue for their departments, they must
service, even if it means incurring higher labor costs be provided with information regarding the economic
than allowable to maximize profits. Other objectives environment, marketing plans, capital budgeting, and
set by hospitality organizations have been to be the detailed historical financial operating results of their
top establishment in one segment of the hospitality departments.
industry, to be the fastest growing establishment, and/
Information regarding the economic environment
or to be recognized as the hospitality operation with
includes such items as:
the best reputation. Many more objectives could be
listed. The critical point is that the board must establish
•• Expected inflation for the next year.
major objectives. These are then communicated to the
CEO and are the basis for formulating the operations •• Ability of the operation to pass on cost increases
budget. to guests.
When a management company operates a hotel for •• Changes in competitive conditions—for example,
independent owners, the owners’ expectations for the emergence of new competitors, the closing of
both the long and short term must be fully considered. former competitors, and so on.
Generally, the owners reserve the right to approve the •• Expected levels of guest spending for products/
operating budget. Therefore, failure to consider their services offered by the hospitality operation.
views will most likely result in their rejection of the
plan, as well as damaged relationships and the need •• Business travel trends.
to redo the budget. Several of the major hotel chains,
such as Hilton, Hyatt, and Marriott, manage many •• Tourist travel trends.
more hotels than they own. Thus, their management •• For international operations, other factors such
teams at the managed properties must work closely as expected wage/price controls and the political
with the owners of each hotel. environment may need to be considered.
In order for this information to be useful, it must be
expressed in usable numbers. For example, regarding
inflation and the ability of the operation to increase its
prices, the information received by department heads
may be phrased as follows: inflation is expected to be 4
percent for the next year and prices of all products and
services may be increased by an average maximum
of 5 percent, with a 2.5 percent increase effective
January 1 and July 1.

Marketing plans include, but are forecasts. This type of budgeting has been called incremental budgeting.
not limited to, advertising and For example, rooms revenue of a hotel for 20X1 through 20X4 is shown in
promotion plans. What advertising Exhibit 3.1. From year 20X1 to 20X4, the amount of revenue increased 10
is planned for the upcoming year, percent for each year. Therefore, if future conditions appear to be similar
and how does it compare with the to what they were in prior years, the rooms revenue for 20X5 would be
past? What results are expected budgeted at $1,464,100, which is a 10 percent increase over 20X4.
from the various advertising
campaigns? What promotion will
be used and when during the Incremental budgeting—forecasting budgets based on historical financial
budget year? What results can information.
be expected? Are reduced room
prices and complimentary meals Exhibit 3.1 Room Revenue Increases
part of the weekend promotion?
Answers to these questions and INCREASE OVER
many others must be provided in PRIOR YEAR
order for managers to be able to
prepare their budgets. AMOUNT AMOUNT %
20X1 $1,000,000 — —
Capital budgeting information
includes the time of the addition 20X2 1,100,000 100,000 10
of property and equipment. 20X3 1,210,000 110,000 10
For an existing property, the
20X4 1,331,000 121,000 10
completion date of guestroom
renovation must be projected in An alternative approach to budgeting revenue based on increasing the
order to effectively estimate room current year’s revenue by a percentage is to base the revenue projection
sales. The renovation of a hotel’s on unit sales and prices. This approach considers the two variables of unit
restaurant, the addition of rooms, sales and prices separately. For example, an analysis of the past financial
and so forth are areas that must information in Exhibit 3.2 shows that occupancy percentage increased 2
be covered before projecting sales percent from 20X1 to 20X2, 1 percent from 20X2 to 20X3, and 2 percent
and expenses for the upcoming from 20X3 to 20X4. The average room rates have increased by $2, $3,
year. and $4 over the past three years, respectively. Therefore, assuming
the future prospects appear similar, the forecaster may use a 1 percent
Historical financial information
increase in occupancy percentage and a $5 increase in average room
should be detailed by department.
rate as the basis for forecasting 20X5 rooms revenue. The formula for
The break-down should be on
forecasting rooms revenue is as follows:
at least a monthly basis, and in
some cases, on a daily basis.
Quantities and prices should both Forecasted
be provided. That is, the number Rooms Occupancy Average
X X X Rooms
of each type of room sold and the Available Percentage Rate
Revenue
average selling price by market
segment—business, group, tourist, 36,500 X .76 X $54 X $1,497,960
and contract—should be provided.
Generally, financial information
for at least the two prior years is
provided. The controller should be
prepared to provide additional prior
information as requested.
Historical financial information

often serves as the foundation on
which managers build their revenue

Exhibit 3.2 Room Revenue 20X1-20X4 to corporate management, also goes to

the next level of management below the
general manager and controller.
AVERAGE
ROOMS OCC. ROOM ROOMS In order for the reports to be useful,
YEAR SOLD % RATES REVENUES
they must be timely and relevant.
20X1 25,550 70 $40 $1,022,000 Budget reports issued weeks after the
end of the accounting period are too
20X2 26,280 72 42 1,103,760
late to allow managers to investigate
20X3 26,645 73 45 1,199,025 variances, determine causes, and
20X4 27,375 75 49 1,341,375 take timely action. Relevant financial
information includes only the revenues
and expenses for which the individual
This simplistic approach to forecasting rooms revenue is meant only department head is held responsible. For
to illustrate the process. A more detailed (and proper) approach example, including allocated overhead
would include further considerations, such as different types of rooms expenses such as administrative and
available and their rates, different room rates charged to different general salaries on a rooms department
guests (for example, convention groups, business travelers, and budget report is rather meaningless
tourists), different rates charged on weeknights versus weekends, from a control viewpoint, because the
and different rates charged based on seasonality (especially for hotels rooms department manager is unable
subject to seasonal changes), and so on. In addition, managers of to affect these costs. Further, they
other profit centers, such as food, beverage, telecommunications, detract from the expenses that the
and the gift shop, must forecast their revenue for the year. rooms department manager can take
action to control. Relevant reporting
Although sales forecasting is often used for short-term forecasts, also requires sufficient detail to allow
many of its concepts are relevant to forecasting revenue for the reasonable judgments regarding budget
annual budget. In addition to relying on historical information, many variances. Of course, information
hotels, especially convention hotels that have major conventions overload (which generally results in
booked a year or more in advance, are able to rely in part on room management’s failure to act properly)
reservations in forecasting both room and food and beverage sales. should be avoided.
Still, for activities not reserved so far in advance, forecasting must
be done. There are five steps in the budgetary
control process:
BUDGETARY CONTROL
In order for budgets to be used effectively for control purposes,
budget reports must be prepared periodically (generally on a monthly
1
Determination
basis) for each level of financial responsibility. In a hotel, this would of variances
normally require budget reports for profit, cost, and service centers. 5 2
Action to Determination
Budget reports may take many forms. Exhibit 3.3, a summary income correct
Budgetary
of significant
problems variances
statement used by The Sheraton Corporation, is prepared monthly Control
and is the summary of the entire hotel operations. It is used by the Process
hotel top management and is also made available to corporate

executives and financial analysts. In addition to variances from
budget, variances from last year’s actual are also shown in order
4 3
Determination Analysis of
to put the budget in perspective and to provide management with of problems significant
variances
trend information.
Exhibit 3.4 is a departmental budget report for the rooms department. It

provides a further breakdown of the elements that make up revenues,
wages, benefits, and other expenses. This report, which is available

Exhibit 3.3 Monthly Summary Income Statement

Exhibit 3.4 Monthly Income Statement–Rooms Department
Determination of revenue from the budgeted amount. Yet the $1,000

difference based on a budget of $1,000,000 results
Significant Variances in a percentage difference of only .1 percent. Most
Virtually all budgeted revenue and expense items on managers would agree this is insignificant. However, if
a budget report will differ from the actual amounts, the rooms revenue budget for the period was $10,000,
with the possible exception of fixed expenses. This is a $1,000 difference would result in a percentage
only to be expected, because no budgeting process, difference of 10 percent, which most managers
however sophisticated, is perfect. However, simply would consider significant. This seems to suggest that
because a variance exists does not mean that variances should be considered significant based on
management should analyze the variance and follow the percentage difference. However, the percentage
through with appropriate corrective actions. Only difference also fails at times. For example, assume that
significant variances require this kind of management the budget for an expense is $10. A dollar difference
analysis and action. of $2 results in a 20 percent percentage difference.
The percentage difference appears significant, but
Criteria used to determine which variances are generally, little (if any) managerial time should be
significant are called significance criteria. They are spent analyzing and investigating a $2 difference.
generally expressed in terms of both dollar and
percentage differences. Dollar and percentage
differences should be used jointly due to the weakness Significance criteria—criteria used to determine which
of each when used separately. Dollar differences fail variances are significant. Generally expressed in terms
to recognize the magnitude of the base. For example, of both dollar and percentage differences.
a large hotel may have a $1,000 difference in rooms
Therefore, the dollar and percentage differences 3. Several rooms expense variances such as
should be used jointly in determining which variances laundry, linen, and commissions exceed the
are significant. The size of the significance criteria will percentage difference criterion, but do not
differ among hospitality properties in relation to the exceed the dollar difference criterion, so they
size of the operation and the controllability of certain are not considered significant; therefore, they will
revenue or expense items. In general, the larger the not be subjected to variance analysis.
operation, the larger the dollar difference criteria. Also,
the greater the control exercised over the item, the
smaller the criteria.
For example, a large hospitality operation may set

significance criteria as follows:
Revenue $1,000 and 4 percent
Variable expense $500 and 2 percent
Fixed expense $50 and 1 percent
A smaller hospitality operation may set significance VARIANCE ANALYSIS

criteria as follows: Variance analysis is the process of analyzing variances
in order to give management more information
Revenue $200 and 4 percent about variances. With this additional information,
management is better prepared to identify the causes
Variable expense $100 and 2 percent of any variances.
Fixed expense $50 and 1 percent

Variance analysis—process of identifying and
Notice that the change in criteria, based on size of investigating causes of significant differences (variances)
operation, is generally the dollar difference. Both between budgeted plans and actual results.
significance criteria decrease as the item becomes
more controllable.
Revenue variances—a group of variances used to
To illustrate the determination of significant variances, examine differences between budgeted and actual prices
the significance criteria above for a small hospitality and volumes.
operation will be applied to the Sands Motel’s January
20X4 budget report (see Exhibit 3.5). The following We will look at variance analysis for two general
revenue and expense items have significant variances: areas—revenue and variable labor. The basic models
presented in these areas can be applied to other
1. The unfavorable $680 difference between the similar areas.
budgeted rooms revenue and the actual rooms
revenue exceeds the dollar difference criterion
of $200, and the unfavorable 4.35 percent
percentage difference exceeds the percentage
difference criterion of 4 percent.
2. The favorable $257 difference between the

budgeted rooms payroll expense and the actual
rooms payroll expense exceeds the dollar
difference criterion of $100, and the favorable
10.28 percent difference exceeds the percentage
difference criterion of 2 percent.

Exhibit 3.5 Summary Budget Report–Sands Motel
SUMMARY BUDGET REPORT SANDS MOTEL FOR JANUARY 20X4

VARIANCES
BUDGET ACTUAL $ %
Revenue:
Rooms $15,62 $14,94 $(680) (4.35)%
Telecommunications 429 414 (15) (3.50)
Total 16,049 15,354 (695) (4.33)
Departmental Expenses:
Rooms
Payroll 2,500 2,243 257 10.28
Laundry 156 150 6 3.85
Linen 313 300 13 4.15
Commissions 156150 63.85
All other expenses 234 200 341 4.53

Total 3,359 3,043 316 9.41
Telecommunications 422 380 42 9.95
Total 3,781 3,423 358 9.47
Departmental Income:
Rooms 12,268 11,911 (357) (2.91)
Telecommunications 0 20 20 NA
Total 12,2681 1,931 (337) (2.75)
Undistributed Operating Expenses:
Administration 3,052 2,961 91 2.98
Maintenance and Utility Costs 2,169 2,220 (51) (2.35)
Gross Operating Profit: 7,047 6,750 (297) (4.21)
Insurance 500 500 0 –
Property Taxes 550 550 0 –
Depreciation 1,308 1,308 0 –
Interest Expense 1,087 1,087 0 –
Income Before Income Taxes 3,602 3,305 (297) (8.25)
Income Taxes 1,081 992 89 8.23
Net Income $2,521 $2,313 $(208) (8.25)%

Revenue Variance Analysis

Revenue variances occur because of price and volume differences. Thus, the variances relating to revenue
are called price variance (PV) and volume variance (VV). The formulas for these variances are as follows:
Price Budgeted Actual Budgeted

= × −
Variance Volume Price Price
PV = BV(AP − BP)
Volume Budgeted Actual Budgeted

= × −
Variance Price Volume Volume
VV = BP(AV − BV)
A minor variance due to the interrelationship of the price and volume variance is the price-volume variance
(P-VV), calculated as follows:
Price-
Actual Budgeted Actual Budgeted
Volume = − × −
Price Price Volume Volume
Variance
P-VV = (AP − BP)(AV − BV)
These formulas are illustrated by using the Sample Motel, whose budget and actual monthly results for rooms
revenue appear in Exhibit 3.6.
Exhibit 3.6 Room Revenue: Budget and Actual–Sample Model
YEAR ROOM NIGHTS AVERAGE PRICE TOTAL
Budget 400 $ 20 $ 8,000

Actual 450 18 8,100
Difference 50 $ 2 $ 100 (F)
The budget variance of $500 is favorable. Variance analysis will be conducted to determine the general
cause(s) of this variance—that is, price, volume, or the interrelationship of the two. The price variance for the
Sample Motel is determined as follows:
PV = BV(AP − BP)
= 400($90 − $100)
= −$4,000 (U)
The price variance of $4,000 is unfavorable because the average price charged per room night of $90 was
$10 less than the budgeted average price of $100.

The volume variance is computed as follows: Exhibit 3.7 Analysis–Sample Motel
VV = BP(AV − BV) Price-Volume
Price Price Variance Variance
= $100(450 − 400)
E F G
$100
= $5,000 (F)
$90
A B H
The volume variance of $5,000 is favorable, because
50 more rooms per night were sold than planned.
Volume
The price-volume variance is determined as follows: Variance
P-VV = (AP − BP)(AV − BV)

= ($90 − $100)(450 − 400)
= −$500 (U)
D I
0 400 450
The price-volume variance is due to the interrelationship Quantity (Rooms Sold)
of the volume and price variances. Ten dollars per
room less than budgeted multiplied by the 50 excess Variable Labor Variance Analysis
rooms results in an unfavorable $500 price-volume
variance. Variable labor expense is labor expense that varies
directly with activity. Variable labor increases as sales
The sum of the three variances equals the budget increase and decreases as sales decrease. In a lodging
variance of $500 for room revenue as follows: operation, the use of room attendants to clean rooms
is a clear example of variable labor. Everything else
VV = $5,000 (F) being the same, the more rooms to be cleaned, the
more room attendants’ hours are necessary to clean
PV = −4,000 (U) the rooms; therefore, the greater the room attendants’
P-VV = −500 (U) wages. In a food service situation, servers’ wages are
generally treated as variable labor expense. Again, the
Total $500 (F) greater the number of guests to be served food, the
greater the number of servers; therefore, the greater
The price-volume variance in the analysis of revenue the server expense. The remainder of the discussion
variances will be unfavorable when the price and of labor in this section will pertain to variable labor,
volume variances are different—that is, when one is which we will simply call labor expense.
favorable and the other is unfavorable. When the price
and volume variances are the same—that is, either Labor expense variances result from three general
both are favorable or both are unfavorable—then the causes—volume, rate, and efficiency. All budget
price-volume variance will be favorable. variances for labor expense may be divided among
these three areas. Volume variances (VV) result when
Exhibit 3.7 is a graphic depiction of the revenue there is a different volume of work than forecasted.
variance analysis for the Sample Motel. The rectangle Rate variances (RV) result when the average wage
0EFD represents the budgeted amount. The rectangle rate is different than planned. Efficiency variances
0AHI represents the actual amount of rooms revenue. (EV) result when the amount of work performed by
The price variance is the rectangle AEFB. The volume the labor force on an hourly basis differs from the
variance is the rectangle DFGI. The price-volume forecast. Of course, as with revenue variance analysis
variance is the rectangle BFGH. and with cost of goods sold variance analysis, there is
a variance (called the rate-time variance) due to the

interrelationship of the major elements of the labor The calculation of these formulas is illustrated in
budget variance. The formulas for these variances Exhibit 3.8. The work standard for servers of the
are: Sample Restaurant is serving 15 meals per hour.
Therefore, on the average, a meal should be served
every four minutes (60 ÷ 15).
VV = BR(BT − ATAO)
RV = BT(BR − AR) The volume variance is determined as follows:
EV = BR(ATAO − AT)
VV = BR(BT − ATAO)
R-TV = (BT − AT)(BR − AR)
= $2.50(200 − 213.33*)
where the elements within these formulas are defined = −$33.33 (U)
as follows:
*The ATAO of 213.33 is determined by dividing the work
•• BR (Budgeted Rate)—the average wage rates standard of 15 covers per hour into the 3,200 covers served.
budgeted per hour for labor services.
The volume variance of $33.33 is unfavorable,
•• BT (Budgeted Time)—hours required to perform
because more covers were served than budgeted.
work according to the budget. For example, if the
Normally, the volume variance is beyond the control
work standard for serving meals is 15 customers
of the supervisor of personnel to which the labor
per hour per server, then servers would require 40
expense pertains. Therefore, this should be isolated
hours (600 ÷ 15) to serve 600 meals.
and generally not further pursued from an expense
•• ATAO (Allowable Time for Actual Output)— perspective. In addition, an unfavorable volume
hours allowable to perform work based on the variance should be more than offset by the favorable
actual output. This is determined in the same way volume variance for the related food sales.
as budgeted time, except that the work is actual
versus budget. For example, if 660 meals were
actually served, the allowable time given a work
standard of 15 meals per hour would be 44 hours
(660 ÷ 15).
•• AR (Actual Rate)—the actual average wage rate
paid per hour for labor services.
•• AT (Actual Time)—the number of hours actually
worked.
Labor expense
variances result
from three general
causes—volume,
rate, and efficiency.

Exhibit 3.8 Labor Expense: Budget and Actual–Sample Restaurant
TIME/ HOURLY
COVERS COVER TOTAL TIME WAGE TOTAL
Budget 3,000 4 min. 200 hrs. $2.50 $500

Actual 3,200 5 min. 266 2/3 hrs. 2.40 640
Difference 200 1 min. 66 2/3 hrs. .10 $140 (U)
The rate variance for the Sample Restaurant is determined as follows:
RV = BT(BR − AR)
= −200($2.50 − $2.40)
$20 (F)
The rate variance of $20 is favorable because the average pay rate per hour is $.10 per hour less than the
budgeted $2.50 per hour. The credit for this is normally given to the labor supervisor responsible for scheduling
and managing labor.
The efficiency variance for the Sample Restaurant is determined as follows:
EV = BR(ATAO − AT)
= $2.50(213.33 − 266.67)
−$133.35 (U)
The efficiency variance of $133.35 is unfavorable, because an average of one minute more was spent serving
a meal than was originally planned. The supervisor must determine why this occurred. It could have been due
to new employees who were inefficient because of work overload, or perhaps there were other factors. Once
the specific causes are determined, the manager can take corrective action to ensure a future recurrence is
avoided.
The rate-time variance is determined as follows:
R-TV = (BT − AT)(BR − AR)

= (200 − 266.67)($2.50 −$2.40)
−6.67 (F)
The rate-time variance of $6.67 is favorable, even though the negative sign seems to indicate otherwise. This
compound variance is favorable when the individual variances within it differ. In this case, the rate variance
was favorable; however, the time variance was unfavorable.

The sum of the four variances equals Exhibit 3.9 Labor Variance Analysis–Sample Restaurant
the budget variance of $140 (U) as
follows:
Rate Volume Rate-Time
Price Variance Variance Variance
Volume Variance $ 33.33 (U)
D E I G F
Rate Variance 20.00 (F) $2.50
Efficiency Variance 133.35 (U) $2.40 G

A B K H
Rate-Time Variance 6.67 (F)
Total $140.01 (U)
Effciency
Variance
The one-cent difference is due to
rounding.
Exhibit 3.9 is a graphic depiction of

the labor variance analysis of the
Sample Restaurant. The budget for
labor expense is represented by the
rectangle 0DEC, while the actual C J H
labor expense is represented by the 0 200 213 1/3 266 2/3
rectangle 0AGH. The rate variance is Quantity (Hours)
represented by the rectangle ADEB.
The volume variance is represented
by the rectangle CEIJ. The rectangle
JIFH represents the efficiency
variance. The rate-time variance is
represented by the rectangle BEFG.

WRAP UP
CONCLUSION
The budgetary process is valuable to the operation of a hospitality
establishment. In order to formulate a budget, the establishment’s goals
must be stated and each department must look ahead and estimate
future performance. As the actual period progresses, management can
compare operating results to the budget, and significant differences
can be studied. This process forces management to set future goals
and to strive to see that they become realized.
Review Questions
1
What are the four major elements discussed in the
budget preparation process?
2
Discuss some of the information that should be
considered when forecasting revenue.
3
List the five steps of the budgetary control
process.
4
What constitutes a “significant”
variance?
5
Discuss the relationship between variable labor and
sales when doing a variable labor variance analysis.
6
Why is an increase in volume
favorable in revenue analysis?
7
What does the formula EV = BR(ATAO − AT)
calculate?


CHAPTER 4
CAPITAL BUDGETING
Types of Capital Budgeting Decisions...................................................48
1
Identify the various
Time Value of Money..............................................................................49 types of capital
budgeting decisions
Cash Flow in Capital Budgeting............................................................54 that require
significant
Capital Budgeting Models......................................................................58
expenditures.
Accounting Rate of Return..........................................................58
2
Calculate the time
Net Present Value Model.............................................................59
value of money.
Capital Rationing.........................................................................61
3
Wrap Up..................................................................................................62
Describe the
Review Questions........................................................................62 relevance of cash
flow to capital
budgeting.
4
Describe and apply
three capital
budgeting models.

TYPES OF CAPITAL
BUDGETING DECISIONS
Capital budgeting decisions are made for a variety of reasons. Some
are the result of meeting government requirements. For example, in
the United States, the Occupational Safety & Health Administration
(OSHA) requires certain safety equipment and guards on meat-cutting
equipment. The hospitality operation may spend several hundreds or
even thousands of dollars in order to upgrade equipment and meet
OSHA’s requirements. Regardless of the potential profit or cost savings
(if any) from this upgrading of equipment, the government regulation
forces the hospitality operation to make the expenditure.
A second capital budgeting decision is acquiring equipment to reduce

the operation’s costs. For example, a lodging operation may have leased
vehicles to provide airport transportation. However, to reduce this cost,
a van could be purchased.
A third capital budgeting decision is acquiring property and equipment to

increase sales. For example, a lodging operation may add a wing of 100
rooms or expand a dining facility from 75 to 150 seats. Another example
is a lodging operation determining which franchise is most desirable. As
a result of this expansion and/or franchise, both sales and expenses
are increased, and, if the proper decision is made, total profits should
increase to justify the capital expenditure.
A fourth capital budgeting decision is replacing existing equipment.

This replacement may be required because the present equipment
is functionally obsolete, or perhaps the replacement is simply more
economical.
A fifth capital budgeting decision may be the expansion in another

location. Often successful entrepreneurs like to add a second location
to their operations.
All five kinds of capital budgeting decisions require significant expenditures

resulting in property and equipment. The return on the expenditures
will accrue over an extended period of time. The expenditures should
generally be cost justified in the sense that the expected benefits will
exceed the cost. The more sophisticated capital budgeting models
require a comparison of current cost expenditures for the property and
equipment against a future stream of funds. In order to compare current
year expenditures to future years’ income, the future years’ income
must be placed on an equal basis. The process for accomplishing this
recognizes the time value of money.
time value of money—The process of placing future years’ income on an

equal basis with current year expenditures in order to facilitate comparison.

TIME VALUE OF MONEY

The saying, “$100 today is worth more than $100 a year from now” is true, in part because $100 today could
be invested to provide $100 plus the interest for one year in the future. If the $100 can be invested at 12
percent annual interest, then the $100 will be worth $112 in one year. This is determined as follows:
Principal + (Principal × Time × Interest Rate) = Total

100 + (100 × 1 × .12) = $112
Principal is the sum of dollars at the beginning of the investment period ($100 in this case). Time is expressed
in years, as long as an annual interest rate is used. The interest rate is expressed in decimal form. The interest
of $12 plus the principal of $100 equals the amount available one year hence.
A shorter formula for calculating a future value is as follows:
F = A(1 + i)n
where F = Future Value
A = Present Amount
i = Interest Rate
n = Number of Years (or Interest Periods)
One hundred dollars invested at 12 percent for two years will yield $125.44, determined as follows:
F = 100(1 + .12)2
= 100(1.2544)
= $125.44
An alternative to using this formula to calculate the future value of a present amount is to use a table of future
value factors, such as that found in Exhibit 4.1. The future value factors are based on present amounts at
the end of each period. For example, the future amount of $100 two years from now at 15 percent interest is
$132.25. This is determined by finding the number in the 15 percent column and the period 2 row (1.3225)
and multiplying it by $100.

The present value of a future amount is the present
amount that must be invested at x percent interest
to yield the future amount. For example, what is the
present value of $100 one year hence when the
interest rate is 12 percent? The formula to determine
the present value of the future amount is as follows:
1
P = F
(1 + i)n
where P = Present Amount
F = Future Amount
i = Interest Rate
n = Number of Years
Therefore, the present value of $100 one year hence

(assuming an interest rate of 12 percent) is $89.29,
determined as follows:
1
P = 100
(1 + .12)1
= 100(.8929)
= $89.29
The present value of $100 two years hence (assuming

an interest rate of 12 percent) is $79.72 determined
as follows:
1
P = 100
(1 + .12)1
= 100(.7972)
= $79.72
An alternative to using this formula to calculate the

present value of a future amount is to use a table of
present value factors, such as that found in Exhibit
4.2. The present value factors in Exhibit 4.2 are
based on future amounts at the end of the period. For
example, the present value of $100 a year from now
at 15 percent interest is $86.96. This is determined by
finding the number in the 15 percent column and the
period 1 row (0.8696) and multiplying it by $100. The
present value of $100 today is simply $100.

Exhibit 4.1 Table of Future Value Factors for a Single Cash Flow Most capital investments provide
a stream of receipts for several
years. When the amounts are
the same and at equal intervals,
such as the end of each year, the
stream is referred to as an annuity.
Exhibit 4.3 shows the calculation
of the present value of an annuity
(at 15 percent) of $10,000 due at
the end of each year for five years.
The present value factors used in
the calculation are from the present
value table in Exhibit 4.2.
The present value of an annuity

will vary significantly based on
the interest rate (also called the
discount rate) and the timing of the
future receipts. Everything else
being the same, the higher the
discount rate, the lower the present
value. Likewise, everything else
being the same, the more distant
the receipt, the smaller the present
value.
annuity—A stream of funds

provided by a capital investment
when the amounts provided are the
same and at equal intervals (such as
the end of each year).
discount rate—The term used for k

when finding a present value.

Exhibit 4.2 Table of Future Value Factors for a Single Cash Flow

Exhibit 4.3 Present Value of a $10,000 Five-Year Annuity at 15 percent
Years in Future
Present
Value 1 2 3 4 5
Amount $10,000 $10,000 $10,000 $10,000 $10,000
.8696
$8,696
.7561
7,561
.6575
6,575
.5718
5,718
.4972
4,972
Total $33,522
Exhibit 4.4 Shortcut Calculations of the Present Value of a than a summation of present value
$10,000 Five-Year Annuity at 15 percent factors from Exhibit 2. However,
this table of present value factors
PRESENT VALUE for an annuity will save much
YEARS HENCE FACTORS AT 15% time, especially when streams of
1 .8696 receipts for several years must be
calculated.
2 .7561
3 .6575 A problem that calls for the use of
4 .5718 both present value factors (Exhibit
4.2) and present value factors for an
5 .4972
annuity (Exhibit 4.5) is presented in
3.3522 Exhibit 4.6. This problem is solved
3.3522 $10,000 $33,522 by treating the stream of receipts
as a $10,000 annuity and two
separate payments of $5,000 and
An alternative to multiplying each future amount by the present value $10,000 due at the end of years
factor from the present value table in Exhibit 4.2 is to sum the present two and four, respectively.
factors and make one multiplication. This is illustrated in Exhibit 4.4. Thus,
the $33,522 calculated in Exhibit 4.4 equals the calculation performed Similarly, to calculate future values
in Exhibit 4.3. Rather than using the present values from Exhibit 4.2, of an annuity, it is simplest to refer
present values for an annuity are provided in Exhibit 5. As a check on to the table of future value factors
your understanding of the present value of an annuity table, locate the for an annuity (Exhibit 4.7). For
present value factor for five years and 15 percent. As you would expect, example, assume that a hotel
it is 3.3522. Thus, the present value for an annuity table is nothing more company decides to invest $10,000

at the end of each year for five years Exhibit 4.5 Table of Present Value Factors for an Annuity
at an annual interest rate of 10 percent,
compounded annually. What will be the
value of the investment at the end of
year five? Using the factor for 10 percent
and five periods from Exhibit 4.7, we can
determine the answer as follows:
$10,000 × 6.1051 = $61,051
CASH FLOW
IN CAPITAL
BUDGETING
In most capital budgeting decisions, an
investment results only when the future
cash flow from the investment justifies
the expenditure. Therefore, the concern
is with the cash flow from the proposed
investment. From the hospitality
operation’s perspective, the incremental
cash flow is the focus rather than the
operation’s cash flow. Incremental cash
flow is simply the change in the cash
flow of the operation resulting from the
investment. Cash flow relating to an
investment includes the following:
•• Investment initial cost (cash outflow)

•• Investment revenues (cash inflow)
•• Investment expenses except
depreciation (cash outflow)
incremental cash flow—The change in

cash flow of an operation that results from
an investment.
In most capital budgeting

decisions, an investment
results only when the
future cash flow from the
investment justifies the
expenditure.

Exhibit 4.6 Present Value of a Stream of Unequal Future Receipts Depreciation expense results from
writing off the cost of the investment;
however, it is not a cash outflow
Problem: and, therefore, does not affect
the capital budgeting decision. It
Determine the present value of receipts from an investment using a
15 percent discount factor that provides the following stream of income: is used in determining the income
taxes relating to the investment
Years Hence Amount since the IRS allows depreciation
0 $10,000 to be deducted in computing taxable
1 10,000 income.
2 15,000
3 10,000 Exhibit 4.8 illustrates the relevant
4 20,000 cash flows of a proposed investment
5 10,000 of the Hampton Hotel. The Hampton
Hotel is considering installing a
Solution: game room. Since space is available
Years Hence Amount Annuity Excess of Annuity with only minor modifications, the
focus is on the cost of machines
0 $10,000 $10,000 $ 0
and related future revenues
1 10,000 10,000 0
and expenses. Depreciation of
2 15,000 10,000 5,000
$7,000 per year is used only in
3 10,000 10,000 0
determining the pretax income
4 20,000 10,000 10,000
from the investment. The cash flow
5 10,000 10,000 0
generated by the investment in
Calculation: game machines is $36,840 for three
years, resulting in an incremental
Present Value of amount due today $ 10,000 net cash flow of $15,840 after the
Present Value of the $10,000 annuity for 5 years cost of the machines is subtracted.
$10,000 3.3522 33,522 The means of financing the game
Present Value of $5,000 due 2 years hence machines is not considered.
$5,000 .7561 3,781
Present Value of $10,000 due 4 years hence In capital budgeting models, the
$10,000 .5718 5,718
discount rate includes the interest
Total $53,021
cost, if any.

Exhibit 4.7 Table of Future Value Factors for an Annuity

Exhibit 4.8 Cash Flows from Game Room–Hampton Hotel
Cost of machines $21,000

Life of machines 3 years
Tax rate 40%
Salvage value of machines -0-
Annual revenues $25,000
Related annual expenses including depreciation
and income taxes $10,000
Method of depreciation Straight-line
Cash Flow Calculation

Years
1 2 3
Revenues $25,000 $25,000 $25,000

Expenses except for
depreciation and income taxes 10,000 10,000 10,000
Income taxes 2,720(1) 2,720(1) 2,720(1)
Cash flow $12,280 $12,280 $12,280
Net cash flow is determined as follows:

Cash flows from above $12,280 3 $36,840
Cost of machines 21,000
Net Cash Flow $15,840
(1) Income taxes:

Pre-depreciation income $15,000
Less: depreciation 7,000(2)
Taxable income 8,000
Taxable rate .34
Income taxes $2,720
Cost Salvage Value $21,000 0

(2) Annual depreciation $7,000
Life 3

CAPITAL BUDGETING Accounting Rate of Return

The ARR model considers the average annual project
MODELS income (project revenues less project expenses
Managers in hospitality operations use several generated by the investment) and the average
different models in making capital budgeting decisions. investment. The calculation of ARR is simply:
The models vary from simple to sophisticated. The
simple models are accounting rate of return (ARR)
and payback, while more sophisticated models, Average Annual Project Income
which require the discounting of future cash flows, ARR = Average Investment
are net present value (NPV), internal rate of return
(IRR), and profitability index (PI). The advantages The average annual project income is the total project
and disadvantages of each model are addressed income over its life divided by the number of years.
and illustrated using the investment data in Exhibit Average investment is project cost plus salvage value
4.9. ARR and NPV will be discussed in more detail divided by two. The proposed investment is accepted
throughout this chapter. if the ARR exceeds the minimum ARR required. For
example, if the minimum acceptable ARR is 40 percent,
a 52 percent ARR results in project acceptance.
accounting rate of return (ARR)—An approach to
evaluating capital budgeting decisions based on the The ARR model can be illustrated by using the
average annual project income (project revenues less Hampton Hotel’s proposed investment in pizza
project expenses) divided by the average investment. equipment illustrated in Exhibit 4.9. The total project
income over the five-year period is $89,000, which
results in an average annual project income of
payback—An approach to evaluating capital $17,800.
budgeting decisions based on the number of years of
annual cash flow generated by the fixed asset purchase The average investment is $25,000, determined as
required to recover the investment. follows:
Average Investment = Project Cost + Salvage

net present value (NPV)—An approach to evaluating 2
capital budgeting decisions based on discounting the
cash flows relating to the project to their present value; = $50,000 + $0
calculated by subtracting the project cost from the
present value of the discounted cash flow stream. = $25,000
The ARR of 71.2 percent is determined as follows:

internal rate of return (IRR)—An approach to
evaluating capital budgeting decisions based on the rate ARR = Average Annual Project Income
of return generated by the investment. Average Investment
= $ 1 7 , 8 0 0
profitability index (PI)—An approach to evaluating $25,000
capital budgeting decisions based on comparing the = 71.2%
present value of future cash inflows to the investment
cost. If the Hampton Hotel were to use this capital
budgeting model, management would invest in the
pizza equipment since the project ARR of 71.2 percent
exceeds the required minimum of 40 percent.

Some managers consider ARR Exhibit 4.9 Proposed Investment in Pizza Equipment–Hampton
to be useful because it relies on Hotel
accounting income and, thus,
it is easy to calculate and easy Investment Accept/Reject Criteria
to understand. However, these Cost of equipment $48,000 APR 40%
advantages are more than offset Installation costs 2,000 Payback 3 years
IRR 15%
by its disadvantages: ARR fails Total $50,000 NPV >0
to consider cash flows or the time
value of money. Depreciation Consideration Depreciation Percentages
Salvage value $-0 - Year
Net Present Life for tax purposes 5 years 1 15%
2 22%
Value Model 3 21%
4 21%
Both the NPV and IRR models 5 21%
overcome the weaknesses of
the previous models in that they Estimated Project Revenue and Expenses
consider the time value of money Years
over the projected life of the capital 1 2 3 4 5
project. The net present value Project revenues $100,000 $120,000 $140,000 $160,000 $180,000
approach discounts cash flows to Project expenses:
Labor 25,500 26,200 33,900 37,100 40,300
their present value. The net present Cost of product 25,000 30,000 35,000 40,000 45,000
value is calculated by subtracting Supplies 5,000 6,000 7,000 8,000 9,000
the project cost from the present Utilities 4,000 4,800 5,600 6,400 7,200
Depreciation 7,500 11,000 10,500 10,500 10,500
value of the discounted cash flow Other operating expenses 11,000 12,000 14,000 16,000 18,000
stream. The project is accepted Income taxes 11,000 15,000 17,000 21,000 25,000
if the NPV is greater than zero. Project income $ 11,000 $ 15,000 $ 17,000 $ 21,000 $ 25,000
If the capital budgeting decision
considers mutually exclusive Total project income for years 1-5 $89,000
alternatives, the alternative with the
Cash flow:
highest NPV is accepted and other Project income $11,000 $15,000 $17,000 $21,000 $25,000
alternatives are rejected. Add: Depreciation 7,500 11,000 10,500 10,500 10,500
Total $18,500 $26,000 $27,500 $31,500 $35,500
The advantage of the NPV model
over the ARR and payback models Using the Hampton Hotel’s proposed investment in pizza equipment
is the consideration of cash flows (Exhibit 4.9 and assuming a discount rate of 15 percent, Exhibit 4.10
and the time value of money. Some shows the net present value to be $39,491. Therefore, based on the
managers have suggested that a NPV model, the Hampton Hotel should make the proposed investment,
disadvantage of the NPV model is because NPV is positive.
its complexity. This argument may
have been convincing to hospitality The NPV may be easily determined using a spreadsheet program such
operations in the past, but as the as Excel. The formula is simply:
hospitality industry continues to
mature, the best methods of capital
budgeting must be used if decision- = NPV (k, CF1:CFn) + C
making is to be optimized.
where k = interest rate
CF = cash flows resulting from the investment
C = cost of the investment

Exhibit 4.10 Illustration of NPV–Proposed Investment in Pizza Equipment by Hampton Hotel
YEARS CASH PRESENT VALUE PRESENT VALUE

HENCE FLOW FACTOR (15%) OF CASH FLOW
0 $(50,000) 1.0000 $(50,000)
1 18,500 .8696 16,088
2 26,000 .7561 19,659
3 27,500 .6575 18,081
4 31,500 .5718 18,012
5 35,500 .4972 17,651
Net Present Value $39,491
The cost of the investment must be entered in a cell as a negative amount.
Exhibit 4.11 shows the use of Excel to determine the NPV for the proposed investment in pizza equipment
by the Hampton Hotel. The slight difference of $3 between the NPV of $39,491 shown in Exhibit 4.10 and the
$39,488 shown in Exhibit 12 is due to the rounding of numbers in the present value table.
Exhibit 4.11 Equipment: An Excel Spreadsheet
1
2
3
4
5
6
7
8 Hampton Hotel
9
10 k 0.15
11 Cost 50,000
12
13 Annual
14 Cash
15 Flows
16 1 18,500
17 2 26,000
18 3 27,500
19 4 31,500
20 5 35,500
21
22
23
24 NPV NPV(D10,D16:D20) D11
25 NPV $39,488
26
27 IRR IRR(D11:D20)
28 IRR 41.3726%

Capital Rationing The optimum combination is projects A, B, and E, because this yields
the highest combined NPV. Other feasible combinations result in a lower
Up to this point, no limit on projects
NPV. In the several combinations where all funds would not be spent
has been discussed as long as
on projects, excess funds would be invested at the going interest rate;
the project returns exceeded the
however, the present value of the return on the excess funds would
reject criteria. In reality, there are
be the amount invested, thus there would be no related NPV on these
often limited funds available. For
excess funds. (This assumes that the going interest rate is equal to the
example, a parent corporation may
discount rate.)
limit funds provided to a subsidiary
corporation, or a corporation may
limit funds provided to a division. Exhibit 4.12 Capital Rationing–Five Proposed Projects
This concept of limiting funds for
PROJECT
capital purposes, regardless of the PROJECT COST NPV
expected profitability of the projects,
A $ 60,000 $ 30,000
is called capital rationing. Under
B 70,000 20,000
capital rationing, the combination
C 50,000 15,000
of projects with the highest net
D 100,000 40,000
present value should be selected.
E 20,000 10,000
capital rationing—An approach to TOTAL

capital budgeting used to evaluate COMBINATION INVESTMENT TOTAL NPV
combinations of projects according A, B, & E $ 150,000 $ 60,000
to their net present value (NPV). A, C, & E 130,000 55,000
A&B 130,000 50,000
Exhibit 4.12 considers five A&C 110,000 45,000
proposed projects and calculates C&D 150,000 55,000
several possible combinations D&E 120,000 50,000
and their NPVs. In this illustration,
projects B and C are considered
to be mutually exclusive, and only
$150,000 is available for capital
projects.

WRAP UP
CONCLUSION
Managers must carefully consider many necessary additions or
changes in fixed assets in order to operate their businesses effectively.
Projects are evaluated based on their costs and corresponding
revenues. Projects that generate the most money for the firm should
be accepted and the others should be rejected. This process is called
capital budgeting.
Review Questions
1
What are four situations which might
require capital budgeting?
2
Why is one dollar today worth more than one dollar
a year from now?
3
What is incremental cash flow?
4
What models used to make capital budgeting
decisions are considered simple? Which are
considered sophisticated?
5
What is capital rationing?

CHAPTER 5
LEASE ACCOUNTING
Leases and Their Uses............................................................................64
1
Describe leases and
Advantages and Disadvantages of Leases.................................65 explain the function of
a lease agreement.
Provisions of Lease Contracts.....................................................66
2
Classification of Leases...............................................................68 Describe some of the
advantages and
Sale and Leasebacks...............................................................................70 disadvantages of
leases.
Choosing to Buy or Lease.......................................................................71
3
Calculating the Options...............................................................71 Identify and describe
common lease
Wrap Up..................................................................................................74
provisions.
4
Define sale and
leasebacks.
5
Select and use
relevant information
to make buy-or-lease
decisions.

LEASES AND THEIR USES

A lease is an agreement conveying the right to use resources (equipment,
buildings, and/or land) for specified purposes and a limited time. From
an operational perspective, the resource is available for use; operating
personnel generally have little concern whether the company owns or
leases it. Lease agreements govern the parties to the lease, usually the
lessor and the lessee. The lessor owns the property and conveys the right
of its use to the lessee in exchange for periodic cash payments called rent.
Lease—an agreement conveying the right to use resources (equipment,

buildings, and/or land) for specified purposes for limited periods of time.
The lessor owns the property and conveys the right of its use to the lessee in
exchange for periodic cash payments called rent.
Lessee—party that makes periodic cash payments called rent to a lessor in

exchange for the right to use property.
Lessor—party that owns property and conveys the right of its use to the
lessee in exchange for periodic cash payments called rent.
Rent—cash payments made by a lessee to a lessor.
Leasing is popular in the United States with businesses in general and

with the hospitality industry in particular. For example, restaurants may
lease space in shopping malls, lodging companies may lease hotels, and
gambling casinos may lease slot machines.
Historically, several hotel companies have leased many of their hotels

from real estate and insurance companies. The variable lease was a
common lease arrangement used by Holiday Corporation during the
1950s and 1960s. Holiday Corporation (the lessee) paid the lessors a
percentage of rooms, food, and beverage revenues. For example, a
25-5-5 lease resulted in the lessee paying the lessor 25 percent of rooms
revenue, five percent of food revenue, and five percent of beverage
revenue. Since these rental payments were based on revenues and since
the lessee corporation paid all operational expenses before generating
any profits, the lessee shouldered much of the hotel property’s financial
risk.
Variable lease—a form of leasing agreement in which rental payments are

based upon revenues.

Management contract—contract under which hotel flexibility to be cost-free. The greater the probability
owners make substantial payments from the hotel’s of technological obsolescence, the greater the
gross revenues to hotel management companies. lease payment (all other things being the same).
•• Leasing allows the lessee to receive tax benefits
The leasing of hotels is less popular today. Few
that otherwise may not be available. For example,
hotel companies sign new property leases. Instead,
an unprofitable operation may not be able to take
they manage hotels under management contract
advantage of tax credits available to purchasers
arrangements. Under these contracts, the hotel
of certain equipment. However, a lessor, who can
owners make substantial payments from the hotel’s
use the tax credits, may pass on part of the tax
gross revenues to the hotel management companies,
credit in the form of lower rental payments to the
much like the hotel companies used to pay lessors for
lessee.
leased properties.
•• Leasing generally places less restrictive contracts
Many hotels continue to lease equipment ranging from on a lessee than financial institutions often place
telephone systems to computers to vehicles. A recent on long-term borrowers.
study of equipment leasing by lodging firms revealed
that a majority of the firms leased equipment. Copiers •• Leasing has less negative impact on financial
are leased by nearly 57 percent of all respondents, ratios, especially when the leases are not
followed by 35.4 percent leasing mailing equipment. capitalized. Property acquired for use through an
Types of equipment leased, length of leases, and the operational lease is not shown on the balance
use of maintenance contracts for leased equipment are sheet. Future rent obligations also do not appear
shown in Exhibit 5.1. Many food service corporations on the balance sheet, although some footnote
lease both their buildings and equipment. In part, the disclosure may be required. For this reason,
extent of leasing by hospitality companies is revealed leases are often referred to as off-balance-sheet
in footnotes to their annual financial statements. financing.
•• Operating leases may allow an operation to obtain
Advantages and resources without following a capital budget.
Disadvantages of Leases
The following list presents some of the advantages Off-balance-sheet financing—term sometimes applied
of leasing. to leasing, because property acquired for use through
an operational lease is not shown on the balance sheet.
•• Leasing conserves working capital because Future rent obligations also do not appear on the
it requires little or no cash deposit; cash equal balance sheet, although some footnote disclosure may
to 20 percent to 40 percent of the purchase be required.
price is required when purchasing property and
equipment. Therefore, for the cash-strapped
operation, leasing may be the only way to obtain
the desired property or equipment.
•• Leasing often involves less red tape than
buying with external financing. Although a lease
agreement must be prepared, it usually is less
complicated than the many documents required
to make a purchase, especially when financing
is involved.
•• Leasing allows more frequent equipment changes,
especially when equipment becomes functionally
obsolete. However, the lessee cannot expect this

Exhibit 5.1 Leased equipment, Length of Lease, and Maintenance Contracts
LENGTH OF LEASE
PERCENTAGE OF MAINTENANCE
LEASED EQUIPMENT RESPONDENTS RANGE AVERAGE CONTRACT
Copiers 56.9% 1 to 20 years 4.2 years 97%
Mailing equipment 35.4% 1 to 20 years 4.1 years 86%
Vehicles 29.2% 2 to 10 years 3.8 years 44%
Telecommuncation 21.5% 1 to 6 years 3.5 years 92%

equipment
Fax machines 12.3% 1 to 20 years 5.6 years 57%
Kitchen equipment 10.8% 2 to 5 years 3.5 years 57%
Computers, services 6.2% 3 to 10 years 4 years 75%
Other items 8.0% 3 to 10 years 4.6 years 100%
Therefore, in many cases, leasing may be a lower Provisions of Lease Contracts

overall cost alternative for many hospitality operations.
Each lease is a unique product of negotiations between
However, there are also disadvantages of leasing,
the lessor and lessee that meets the specific needs
such as the following:
of each party. However, all lease contracts normally
contain certain provisions. The following list presents
•• Any residual value of the leased property benefits
some of these common provisions.
the lessor unless the lessee has the opportunity to
acquire the leased property at the end of the lease.
1. Term of lease—the term of a lease may be
•• The cost of leasing in some situations is ultimately as short as a few hours (usually for a piece of
higher than purchasing. This is especially true equipment) or as long as several decades (as
when there are only a limited number of less-than- is common with real estate). Leases should be
competitive lessors. long enough to ensure a proper return on the
investment for leasehold improvements and
•• Disposal of a financial lease before the end of the other costs. A new food service operation may
lease period often results in additional costs. desire a relatively short initial lease (say, five
The above list of advantages and disadvantages is years) with several five-year renewable options.
not exhaustive. This would allow the company to escape from an
undesirable situation.
One of the goals of the survey of hoteliers’ leasing
practices was to determine their reasons for leasing 2. Purpose of lease—this provision generally
equipment. The most common reasons were (1) limits the lessee to using the property for certain
protection from obsolescence, (2) tax advantages, (3) purposes. For example, a restaurant lease may
uniform cash flows, and (4) lower down payment with state, “The lessee shall use the leased premises
leasing versus purchasing. More details regarding as a restaurant and for no other purpose without
reasons for leasing are provided in Exhibit 5.2. first having obtained the written consent of the
lessor.”

3. Rental payments—the lease specifies the amount of rental payment and when it is due. It also indicates
any adjustments; for example, adjustments for inflation are often based on the consumer price index for
a given city. Contingent rent is also specified. For example, a lease may stipulate that contingent rent
equal to three percent of all annual food and beverage sales in excess of $700,000 is due the fifteenth
day of the first month after the end of the fiscal year.
Exhibit 5.2 Reasons to Lease Equipment (versus Purchase)
LOWER BANK- PROTECTION UNIFORM FOCUS DECREASE

DOWN CREDIT TAX FROM CASH ALTERNATIVE ON CORE IN TAX
PAYMENT LINES ADVANTAGE OBSOLESCENCE FLOW CREDIT OPERATIONS LIABILITY
Unimportant 40% 53% 27% 18% 25% 79% 44% 47%
Neutral 27% 27% 31% 16% 34% 10% 39% 38%
Important 33% 18% 42% 65% 41% 10% 16% 14%
No response 0 2% 0 1% 0 1% 1% 1%
Total 100% 100% 100% 100% 100% 100% 100% 100%
4. Renewal options—Many leases contain a clause giving the lessee the option to renew the lease. For
example, a lease may provide “an option to renew this lease for an additional five-year period on the
expiration of the leasing term upon giving lessor written notice 90 days before the expiration of the lease.”
5. Obligations for property taxes, insurance, and maintenance—Leases, especially long-term leases,
specify who shall pay the executory costs—that is, the property taxes, insurance, and maintenance costs—
on the leased property. A lease in which the lessee is obligated to pay these costs in addition to the direct
lease payments is commonly called a triple-net lease.
6. Other common lease provisions include:
• The lessor’s right to inspect the lessee’s books, especially when part of the lease payment is tied to
sales or some other operational figure.
• The lessor’s obligations to restore facilities damaged by fire, tornadoes, and similar natural phenomena.
• The lessee’s opportunity to sublease the property.
• The lessee’s opportunity to make payments for which the lessor is responsible, such as loan payments
to preclude default on the lessor’s financing of the leased property.
• Security deposits, if any, required of the lessee.
• Indemnity clauses protecting the lessor.
Contingent rent—rent based on specified variables, such as a percentage of revenues above a given amount.
Executory costs—obligations for property taxes, insurance, and maintenance of leased property.
Triple-net lease—a form of lease agreement in which the lessee is obligated to pay property taxes, insurance, and
maintenance on the leased property.

The FASB has established four capitalization criteria
for determining the status of non-cancelable leases.
If a non-cancelable lease meets any one of the four
criteria, the lessee must classify and account for the
lease as a capital lease. Non-cancelable leases not
meeting any of the four criteria may be accounted for
as operating leases. The FASB criteria are reproduced
below:
1. The property is transferred to the lessee by the

end of the lease term, referred to as the title
transfer provision.
2. The lease contains a bargain purchase option,

referred to as the bargain purchase provision.
3. The lease term is equal to 75 percent or more of

the estimated economic life of the leased property,
Classification of Leases referred to as the economic life provision.
In general, lessees classify leases for accounting
purposes as either operating leases or capital leases. 4. The present value of minimum lease payments
At the extremes of what is essentially a continuum, (excluding executory costs) equals or exceeds
operating leases differ substantially from capital leases. 90 percent of the excess of fair market value
Depending on their specific provisions, however, they of the leased property over any investment tax
can also be hard to distinguish. Operating leases (also credit retained by the lessor, referred to as the
called service leases) are normally (but not always) value recovery provision.
of relatively short duration, and the lessor retains the
responsibility for executory costs. They can usually be Title transfer provision—one of four Financial
canceled easily. Capital leases (also called financing Accounting Standards Board capitalization criteria for
leases) are of relatively long duration, and the lessee determining the status of non-cancelable leases. If the
often assumes responsibility for executory costs. In property is transferred to the lessee by the end of the
addition, they are generally non-cancelable or at least lease term, the lessee must classify and account for the
costly to cancel. Capital leases are capitalized, while lease as a capital lease.
operating leases are not.
Bargain purchase provision—one of four Financial
Operating lease—a classification of lease agreements Accounting Standards Board capitalization criteria for
that are usually of relatively short duration, easily determining the status of non-cancelable leases. Under
cancelled, and in which the lessor retains responsibility this provision, if a lease has a bargain purchase option,
for executory costs. For accounting purposes, operating the lessee must classify and account for the lease as a
leases are not capitalized, but simply recognized as an capital lease. A bargain purchase option gives the lessee
expense when rent is paid. the option to purchase the leased property at the end of
the lease at a price substantially lower than the leased
property’s expected market value at the date the option
Capital lease—a classification of lease agreements that is to be exercised.
are of relatively long duration, generally non-cancelable,
and in which the lessee assumes responsibility for Economic life provision—one of four Financial
executory costs. For accounting purposes, capital leases Accounting Standards Board capitalization criteria for
are capitalized in a way similar to the purchase of a fixed determining the status of non-cancelable leases. If the
asset (that is, recorded as an asset with recognition of lease term is equal to 75 percent or more of the estimated
a liability). economic life of the leased property, the lessee must
classify and account for the lease as a capital lease

Note that, when there is no investment tax credit,
Value recovery provision—one of four Financial
criterion #4 in effect states that if the present value
Accounting Standards Board capitalization criteria for
of minimum lease payments (excluding executory
determining the status of non-cancelable leases. If the
costs) equals or exceeds 90 percent of the fair
present value of minimum lease payments (excluding
market value of the leased property, the lease
executory costs) equals or exceeds 90 percent of the
must be capitalized.
excess of fair market value of the leased property over
any applicable investment tax credit retained by the •• Residual value refers to the estimated market
lessor, the lessee must classify and account for the lease value of the leased item at the end of the lease
as a capital lease. term. When the residual value is guaranteed by
the lessee, then the lessee is ultimately liable to
The bargain purchase option (criterion #2) means that the lessor for the residual value.
the purchase price at the end of the lease period is
substantially less than the leased property’s expected
Residual value—with regard to leasing, the estimated
market value at the date the option is to be exercised.
market value of a leased item at the end of the lease term.
The bargain price is generally considered substantially
less than the market value only if the difference, for all The aforementioned survey of leasing practices by
practical purposes, ensures that the bargain purchase hoteliers revealed that the majority of respondents
option will be exercised. The “economic life” (criterion capitalize 10 percent or less of their leases, while
#3) refers to the useful life of the leased property. just over 15 percent capitalize 75 percent of their
The following list explains several terms in the value equipment leases. More details are provided in Exhibit
recovery provision (criterion #4): 5.3.
•• Present value refers to determining present value.
Exhibit 5.3 Percentage of Leases That Are
•• Minimum lease payments consist of minimum Capitalized
rental payments during the lease term and any
bargain purchase option. If no bargain purchase PERCENT
option exists, the minimum lease payments include RANGE FREQUENCY OF TOTAL
any guaranteed residual value by the lessee or
any amount payable by the lessee for failure to 0 to 10% 39 50.6%
renew the lease. Minimum lease payments do 10 to 25% 1 1.3%
not include contingent rent (such as a percentage 25 to 50% 6 7.8%
of sales). Executory costs are also excluded in
determining minimum rental payments when the 50 to 75% 6 7.8%
lease specifies that lease payments include these 75 to 100% 12 15.6%
costs.
Missing 13 16.9%
•• Fair market value represents the amount the
Total 77 100%
leased item would cost if it were purchased rather
than leased. Which of the four FASB criteria triggered the
•• Investment tax credit is a credit that the federal requirement to capitalize these equipment leases
government used to allow against the federal by lodging firms? The bargain purchase provision
income tax liability of the hospitality operation. resulted in 50 percent of the firms capitalizing their
When it was allowed, up to 10 percent of the leases. The other provisions and related percentages,
cost of qualifying equipment could typically be according to the survey results, were as follows:
taken as a credit. The credit generally applied to
personal property (such as equipment), but not Title transfer provision 46 percent
to real property (such as land and buildings).
Investment tax credits are no longer allowed by Economic life provision 20 percent
current tax laws; however, if they are reinstated,
they would be treated as indicated by criterion #4. Value recovery provision 15 percent

Operating leases are accounted for as simple rental
agreements—that is, the expense is generally
recognized when the rent is paid. For example, if a
restaurant company leases space in a shopping mall
for $5,000 per month and pays rent on the first day
of each month, the monthly rental payment would be
recorded as follows:
Rent Expense $5,000

Cash $5,000
When rent is paid in advance, it should be recorded in

a prepaid rent account. For example, if the restaurant
company had paid three months’ rent in advance, the
proper entry would be:
SALE AND LEASEBACKS
Rent Expense $5,000 Sale and leasebacks are transactions whereby an
Prepaid Rent 10,000 owner of real estate agrees to sell the real estate to an
investor and then lease it back. The original owner’s
Cash $15,000
use of the property continues without interruption.
This accounting entry recognizes rent expense for The property is sold to the investor (lessor) at market
the current month and delays recognition of rent for value and then leased back to the seller (lessee) for an
the following two months (based on the matching amount equal to the investor’s cost plus a reasonable
principle). In the event rent is paid for a period beyond return.
twelve months from the balance sheet date, the rental
payment should be recorded as “deferred rent” and The major reason for sale and leaseback transactions
shown as a deferred charge on the balance sheet. is to raise capital that was previously tied up in the
Any rent paid for future periods is recognized during property. The investors in these transactions are
the period to which it relates by an adjusting entry. In usually looking for a financial return, as they have no
the example above, the adjusting entry to recognize interest in managing hospitality operations.
the second month’s rent would be:
The lessee should account for the lease based on
the FASB’s four criteria for classifying leases. If the
Rent Expense $5,000 seller (lessee) makes a profit from the sale of the
Prepaid Rent $5,000 now leased assets, such profit should generally be
deferred and amortized over the lease term. Losses
should be recognized in their entirety when the sale
Sale and leaseback—a transaction whereby an owner and leaseback agreement is signed.
of real estate agrees with an investor to sell the real
estate to the investor and simultaneously rent it back for
a future period of time, allowing uninterrupted use of
the property while providing the operation with capital
that was previously tied up in the property.

the first year. The initial lease payment made at the signing
of the lease is not discounted. However, the future lease
payments must be discounted to recognize the present value
of those payments. Cash flows covering the lease payments
for the five-year period should be discounted as follows:
Present value of first payment: $6,000
Present value of next four (annuity)

payments:
$5,565 (PVAn=4,k=10) = $5,565 (3.1699) $17,640
Total $23,640
CHOOSING TO This result suggests that leasing the mower would cost
$1,360 less ($25,000 – $23,640) than buying it.
BUY OR LEASE However, there are yet other considerations—in particular,
Should a hospitality operation lease or buy taxes and the salvage value of the mower at the end of
equipment? The elements to consider when the five years. Tax considerations for the purchase options
answering this question include the effect of involve treating the lease payment as an expense each
the decision on taxes and the time value of year. Salvage value must be considered since, under the
money. Each will be considered as we explore buy alternative, the salvage value provides cash.
the concept of leasing versus buying.
Assume that, based on discussions with the equipment
Calculating the Options dealer, the MR’s golf course superintendent estimates that
Suppose the management of the hypothetical the salvage value of the mower will be $6,000; that is, the
Michigan Resort (MR) must decide whether to mower can be sold for $6,000 at the end of year five. Further
buy or lease a fairway mower. To begin with, let’s assume that the MR’s tax rate is 30 percent, and that the
consider only the purchase cost of the fairway enterprise uses the straight-line method of depreciation.
mower and the lease payments the MR would Exhibit 5.4 presents the effects of considering taxes and
have to make for the buy and lease options. salvage value.
Assume that the purchase cost of the mower
is $25,000, while the annual lease payments This time, buying appears to be more advantageous than
would be $6,000 at the signing of the lease for leasing by a mere $237. Note, however, that this is just
the first year and $5,565 for the next four years an example based on assumptions. If the salvage value
(paid at the end of years 1–4). Further assume of the mower were somewhat lower, then the net result
that the MR is responsible for maintenance would probably favor leasing. On the other hand, a faster
with either option. The lease payments total depreciation of the mower under the buy option might favor
$28,260; therefore, the apparent advantage to buying, and so on.
the MR of buying over leasing is $3,260.
In addition, this example considers only the proposed lease
However, we must not forget to consider the without an option to buy the mower at a nominal price at
time value of money. Assume that the MR’s the end of the lease period. Under many leases, especially
relevant interest rate for this scenario is 10 capital leases, this option is available. When a hospitality
percent. To compare the costs of buying and business is not subject to income tax, the approach is simply
leasing, the present value of the cash payments to compare the present value of the cash flows and select the
for each must be determined. The cost of the alternative with the lowest cash outflow. Exhibit 5.5 depicts
mower is not discounted, since we assume the an example that ignores taxes and assumes a purchase
mower is paid for with cash at the beginning of price of $1,000 at the end of the lease.

These are just two examples that illustrate a systematic way of carefully comparing the alternative costs of
leasing and buying equipment. Each example will result in different numbers, yet the process of evaluation
is the same.
Exhibit 5.4 Discounted Cash Flow Payments–Considering Tax Effects and Salvage
Time Years
0 1 2 3 4 5
Purchase Option
Purchase price $ 25,000
Salvage Value $6,000
Depreciation tax
shield1 -0- $1,140 $1,140 $1,140 $1,140 $1,140
Net purchase cost
Annual cash flows 25,000 1,140 1,140 1,140 1,140 7,140
Discount factors 1 .9091 .8264 .7513 .6830 .6209
Present value of $ 25,000 $1,036 $ 942 $ 856 $ 779 $4,433
cash flows
Total present value of cash flows for purchase option $16,954
Lease Option
Lease $6,000 $5,565 $5,565 $5,565 $5,565 -0-
Lease tax shield(2,3) 1,800 1,670 1,670 1,670 1,670
Annual cash flow 6,000 3,765 3,895 3,895 3,895 1,670
Present value 1 .9091 .8264 .7513 .6830 .6209
factors
Present value of $6,000 $3,423 $3,219 $2,296 $2,660 $1,037
cash flows
Total present value of cash flows from lease option $17,191
Difference—apparent advantage of buying: $237
(1) Depreciation expense tax rate depreciation tax shield

Depreciation expense:
$25,000 $6,000 $3,800
5
$3,800(0.30) $1,140
(2) $6,000(0.30) $1,800
(3) $5,565(0.30) $1,670

Exhibit 5.5 Discounted Cash Flow Payments–Capital Lease vs. Purchase Options
Time Years
0 1 2 3 4 5
Purchase Option
Purchase price $ 25,000
Salvage Value $6,000
Annual cash flows 25,000 0 0 0 0
$6,000
Present value .1 .6209
factors
Present value of $ 25,000 $3,725
annual cash flows
Total present value of cash flows for purchase option $21,725

Lease Option
Lease payments $6,000 $5,565 $5,565 $5,565 $5,565 -0-
Nominal price $ 1,000
Nominal price $6,000
Annual cash flow 6,000 $5,565 $5,565 $5,565 $5,565 1,670
Present value .1 .9091 .8264 .7513 .6830 .6209
factors
Present value of $6,000 $5,059 $4,599 $4,181 $3,801 $3,105
cash flows
Total present value of cash flows from lease option $20,535
Difference—apparent advantage of buying: $740
*Taxes are not considered in the example. The assumed purchase
price at the end of the lease period is a nominal amount of $1,000.

WRAP UP
CONCLUSION
Leasing is a special type of financing used by many hospitality
businesses. By entering into a lease agreement, the lessee acquires
the right to use specific resources for a limited time and a specific
purpose. The advantages for the lessee include the conservation of
working capital, the benefits of tax deductions that might not otherwise
be available, and, in some cases (when the lease is accounted for as
an operating lease), a favorable effect on the balance sheet ratios.
In exchange for these advantages, the lessee must make some
sacrifices.
Review Questions
1
What are three major advantages to the lessee of
lease financing?
2
What are some provisions common to
most leases?
3
What are the FASB’s four criteria for determining if a
lease is a capital or an operating lease?
4
What is a sale and leaseback
agreement?
5
What options should be considered when deciding
whether to buy or lease?

CHAPTER 6
SYSTEM SELECTION
Information Needs..................................................................................77
1
Describe ways in
Request for Proposal .............................................................................82 which hospitality
managers can analyze
Evaluating Proposals ..................................................................85 current information
needs.
Contractual Arrangements ..........................................................87
2
System Conversion ....................................................................88 Explain the purpose
of a request for
Wrap Up..................................................................................................89
proposal (RFP).
3
Describe how
managers can
evaluate proposals
submitted by
technology system
vendors.
4
Identify arrangements
that hospitality
managers generally
negotiate with
vendors of hospitality
technology systems.

The identification, evaluation, and selection of hospitality technology
systems can be complex and time-consuming. Many properties appoint
a project team. The project leader generally has overall responsibility for
purchasing the technology system. This person determines a schedule
for the purchasing process and monitors the team’s progress. The
process begins as the team analyzes the current information needs of the
business, collects relevant technology sales literature, and establishes
system requirements. The results of this preliminary research are used
to formulate a request for proposal (RFP) from vendors. The process
continues with the evaluation of proposals and product demonstrations,
contract negotiations, and the implementation of the new system.
Throughout the process, it is helpful to keep the “ NEVERs ” of
technology purchasing in mind:
NEVER purchase hardware before software. After selecting

software first, identify the hardware it requires.
NEVER make a purchase decision based solely on cost. Too

often, economic factors are given a disproportionate
weight in the decision process.
NEVER lose control of the purchasing process. Develop

request for proposal documents, script on-site vendor
demonstrations, and apply uniform criteria when
evaluating vendor proposals.
NEVER rely on enhancement promises. A system feature that

is advertised, but not yet available for sale, may not
actually become available for some time.
NEVER be the first system user. New systems have no

operational history and, therefore, are difficult to
evaluate.
NEVER allow technology to dictate operations. Changing

operations to fit the demands of the technology is
reverse logic (i.e., the tail wagging the dog).
NEVER be the largest system user. Pushing the capabilities

of a system’s processing speed, file parameters,
memory capabilities, and other functions may lead
to a series of problems, many of which may not be
resolved in a timely manner.
NEVER be the last system user. System maintenance, ongoing

technical support, enhancements, and the like may be
difficult or impossible to obtain once the vendor has
abandoned the product.
NEVER allow a vendor to rewrite the business’s technology

requirements. The focus must be on business needs,
and a system that meets vendor specifications may
not meet business needs.

INFORMATION NEEDS
The first step in analyzing the information needs of a business is to identify the types of information that various
levels of management use in the course of operations. This can be done by compiling samples of reports
presently prepared for management—for example, the daily operations report, basic financial statements,
and reports similar to those identified in Exhibit 6.1. Once collected, the reports can be analyzed in relation
to such variables as purpose, content, distribution, and frequency.
Exhibit 6.1 Typical Management Reports
REPORT FREQUENCY CONTENT COMPARISONS WHO GETS IT PURPOSE

Daily Daily,on Occupancy, To operating Top management Basis for evaluating the
Report of accumulative average rate, plan for current and supervisors current health of the
Operations basis for the revenue by outlet, period and responsible enterprise.
month,the and pertinent to prior year for day to day
year to date. statistics. results. operation.
Weekly Weekly. Volume in covers, Previous periods Top management Staffing and
Forecasts occupancy. and supervisory scheduling; promotion.
personnel.
Summary Monthly Known elements To operating Top management Provides immediate
Report— at end of of revenue and plan; to prior and supervisory information on financial
Flash month (prior direct costs; year results. personnel results for rooms, food
to monthly estimated responsible for and beverages, and
financial departmental in function reported. other.
statement). direct costs.
Cash Flow Monthly Receipts and With cash flow Top management. Predicts availability
Analysis (and on are disbursements by plan for month of cash for operating
revolving time periods. and for year to needs. Provides
12-month date. information on interim
basis). financing requirements.
Labor Daily. Dollar cost; To committed Top management Labor cost control
Productivity Weekly. manpower hours hours in the and supervisory through informed
Analysis Monthly. expended; hours operating plan personnel. staffing and scheduling.
as related to sales (standards for Helps refine
and services amount of work forecasting.
(covers, rooms to prior year
occupied, etc.). statistics).
Depart- Monthly (early Details on main To operating Top management Knowing where
mental in following categories of plan (month and and supervisors business stands, and
Analysis month). income; same on year to date) by function (e.g., immediate corrective
expense. (month and year rooms, each food actions.
to date) and beverage
outlet, laundry,
telephone, other
profit centers).
Room Rate Daily,monthly, Actual rates To operating Top management If goal is not being
Analysis year to date. compared to plan and to prior and supervisors achieved, analysis
rack rates by rate year results. of sales and front of strengths and
category or type office operations. weaknesses is
of room. prompted.

Return on Actual Earnings as a To plan for Top management. If goal is not being
Investment computation,at percentage rate of operation and to achieved, prompt
least twice return on average prior periods. assessment of
a year. investment or strengths and
Computation equity committed. weaknesses.
based on
forecast
,immediately
prior to plan
for year
ahead.
Long- Annually. 5-yearprojectionsof Prior years. Top management. Involves staff in
Range revenue and success or failure of
Planning expenses enterprise. Injects more
Operating plan realism into plans for
expressed in property and service
financial terms. modifications.
Exception Concurrent Summary listing With operating Top management Immediate focusing on
Reporting with monthly of line item budgets. and supervisors problem before more
reports and variances from responsible for detailed statement
financial predetermined function reported. analysis can be made.
statements. norm.
Guest At least semi- Historical records With previous Top management Give direction to
History annually; of corporate reports. and sales. marketing efforts.
Analysis quarterly or business, travel
monthly is agencies,group
recommended. bookings.
Future Monthly. Analysis of With several Top management, Provides information
Bookings reservations and prior years. sales and on changing guest
Report bookings. marketing, profile. Exposes strong
department and weak points of
management. facility. Guides (1)
sales planning and (2)
expansion plans.
Report analysis identifies the types of information management uses, but does not necessarily reveal the
information needs of the business. A separate survey needs to be conducted to evaluate the effectiveness of
the format and content of current reports. Survey findings can provide the basis for immediate improvements
in the information system and enable a more in-depth analysis to include flowcharts and a property profile.
Flowcharts use specially designed symbols for diagramming the flow of data and documents through an
information system. Flowchart symbols have been standardized by the American National Standards Institute.
Some of the more commonly used symbols are illustrated in Exhibit 6.2. Standardization is achieved by using
common symbols and also by drawing flowcharts according to established procedures.

Exhibit 6.2 Common Flowchart Symbols Property profile—compiled statistics about aspects
of the current information system; useful when
communicating information needs of the business to
vendors of technology systems.
Input/Output Processing Document Exhibit 6.3 Sample Lodging Property Profile
GENERAL
Type of property (resort, hotel, motel,
Accounting File Decision convention, condo, roadside,etc.)
Record Total number of rooms
Annual occupancy
Documentation Information Merge Average room rate
Flow Flow Number of types of rooms
Number of suites
Since flowcharting reveals the origin, processing, Percentage of annual occupancy from groups
and final disposition of a document, it can be a (tours, airlines, travel agencies, etc.)
valuable technique for evaluating the business’s Seasonal period(s); seasonal rates
current information system. Weaknesses, overlapping
Average length of stay
functions, and other redundancies can be identified.
Number of permanent guests
An alternative to detailed flowchart depictions is a series Number of meeting rooms
of written narrative descriptions. Written narratives are Arrival/departure patterns
less efficient than flowcharts and are time-consuming
Number of revenue centers and locations
to develop and review. A written narrative of six to
eight pages may be needed to communicate the same RESERVATIONS
information a detailed flowchart presents in a single Volume of reservation transactions (phone,
page. telex, letter, etc.)
Volume of each type of reservation
A property profile compiles statistics about the transaction
installed information system. Exhibit 6.3 and Exhibit Percentage of reservations that require
6.4 illustrate sample property profile formats for lodging special handling (deposits, confirmations,
operations and food service operations, respectively. etc.)
The types of categories and number of individual Hours of coverage
entries will vary from property to property. A property Average wage per employee
profile can be invaluable when communicating
Annual over time costs
information needs of the business to system vendors.
A well-designed property profile allows vendors to If unionized department—will employees get
compare the property’s information needs to those raises because of automation?
of similar properties. In addition, a property profile Outside reservation services
enables management to conduct a more informed and Travel agent handling
efficient review of technology sales literature. Forecasting
Number of employees
Flowchart—specifically designed symbols to diagram HOUSEKEEPING
the flow of data and documents through an information
Number of floors
system.
Number of rooms per floor (average)
Number of rooms or units cleaned per room
attendant

Number of room attendants Number of corporate accounts

Number of inspectors Number of airline accounts
Number of room attendants per inspector Number of special accounts
FOOD AND BEVERAGE Present back office equipment
Number of outlets Cost/value/maintenance of present
Location of outlets equipment
Volume of sales Supply cost of present equipment
Number of sales FRONT DESK
Number of menu items Number of registration windows
Type of service Number of cashiering windows
Number of covers Can registration and cashiering be done by
same clerk?
Average check
Present equipment in use
Present food and beverage registers
Cost/value of present equipment
Present form of check used
Maintenance of present equipment
Pre-checking techniques (if applicable)
Cost of supplies for present equipment
Inventory control methods (tapes, forms, etc.)
Inventory volumes Number of employees per shift (average/
Percentage of sales charged to guestrooms maximum)
Number of employees Average wage and benefit cost per employee
Number of function rooms Number of registrants per day (average/
maximum)
ACCOUNTING
Number of check-outs per day (average/
Number of A/R accounts maximum)
Number of A/P accounts Number of postings per day (average/
Total A/R revenue handled per month maximum)
(average/maximum)
Total A/P revenue handled per month Exhibit 6.4 Sample Food Service Property
(average/maximum) Profile
Number of employees for A/R
Number of employees for A/P
Number of employees for general ledger
Number of employees for payroll
Number of employees for other accounting
functions
Total number of employees on payroll
(average/maximum)
Number of service bureaus presently
employed
Cost of service bureaus
Number of travel agent accounts

FILE AND TRANSACTION VOLUMES
SALES AND CASH RECEIPTS ACCOUNTS RECEIVABLE
Number of seats Number of house accounts
Number of covers per day Number of daily charges on account
Number of daily menu items Number of external charge media (American

Express, etc.)
Total number of menu items Number of daily receipts on account
FOOD INVENTORY Payroll and Labor Analysis
Number of inventory items (ingredients) Number of employees
Daily inventory receipts (vendors) New hires per year
Number of inventory items (classifications) Number of W-2s prepared

per receipt
Daily inventory requisitions (from storeroom) GENERAL LEDGER
Number of recipes Number of accounting periods
Number of ingredients per recipe Number of accounts
LIQUOR INVENTORY Standard (recurring) monthly (journal entries)
Number of inventory items Monthly general ledger postings (journal entries)
Daily storeroom requisitions (item

classifications)
Number of recipes
ACCOUNTS PAYABLE
Number of vendors
Invoices per day
Expense distributions per invoice
Checks (disbursements) per day

should include a detailed property profile based on its
information needs. Listing objectives and operational
requirements for the system offers management the
opportunity to identify and designate particular system
features as mandatory or optional, thus assisting
vendors in the preparation of responsive proposals.
An outline of the vendor’s responsibilities should
include the proposal submission deadline and should
encourage vendors to submit as much information as
possible relative to such areas as:
•• Network configurations
•• Application descriptions
•• Maintenance and support services
•• Installation and training programs
REQUEST FOR •• Guarantees and warranties
PROPOSAL •• Payment plan options
After translating information needs into system
•• Future expandability of the proposed system
requirements, management is ready to request a
property-specific proposal from industry suppliers. The second section of the RFP establishes bidding
A request for proposal (RFP) is typically made up of requirements for vendor proposals. Allowing
three major sections. One section informs the vendor vendors to formulate bids using a proprietary or
about hospitality business operations; a second arbitrary format will force management into using
section establishes bidding requirements for vendor an unstructured evaluation process. All proposals
proposals; and a third section deals specifically with should be submitted in a standardized response
user application requirements. form supplied by management to facilitate price
and performance comparisons. Exhibit 6.5 shows
a sample cost summary table. Note that structured
Request for proposal (RFP)—in relation to the
formatting enables management to conduct
purchase of a technology system, a three-part document
comparisons between proposals using a common
prepared by management. The first section orients the
set of dimensions. Vendors should also be required
vendor to management’s business operations; the second
to include a statement of financial history and stability.
section establishes bidding requirements for vendor
proposals; and the third section deals specifically with
The final section of the RFP needs to address specific
user application requirements.
system application requirements. Exhibit 6.6 shows a
sample RFP form that structures vendors’ responses
The first section of the RFP should contain an overview
to application requirements. Since all vendors are
of the hospitality business, list objectives and broad
required to use the identical response format,
operational requirements for the system, and briefly
management will be more efficient in evaluating
outline the scope of vendor relations and support
competing proposals.
services. The overview of the hospitality business

Exhibit 6.5 Sample Cost Table
REQUIREMENTS PRICE MAINTENANCE COMMENTS
Hardware
Software
Other (specify)
Discount
Subtotal
NON-RECURRING COSTS PRICE MAINTENANCE COMMENTS
Site Prep
Delivery
Installation
Training
Other (specify)
Discount
Subtotal
Total

Exhibit 6.6 Sample Format for Listing Application Requirements
Instructions: Vendors are to indicate the applications they offer that

are identical to those desired by the user (YES—Same), similar in
function to those desired by the user (YES—Similar), function not now
available but will develop (NO—Soon), or function not available (NO).
CHECK APPROPRIATE COLUMN
YES YES NO
FUNCTION: SAME SIMILAR SOON NO
Ingredient file of food items
Recipe file of ingredients
Menu file of recipe and

sub-recipes
Inventory file of food items
Payroll master file of

employees
Purchase order file by purveyor
Check register of issued

checks
Daily transaction register
Payroll register
Accounts receivable ledger

module
Accounts payable ledger

module
General ledger module
Income statement
Balance sheet
Once created, the RFP (printed, electronic, or online) is distributed to the vendor community for response.
After receiving an RFP, most vendors will contact management and conduct a site survey.

Evaluating Proposals would therefore be awarded 36 points (80 × 0.45);

vendor B given 32 points (70 × 0.45); and vendor C
After conducting a site survey, the vendor completes
assigned 23 points (50 × 0.45).
a system proposal and submits it for consideration.
While there are many ways to evaluate a proposal, a The second issue focuses on the vendor’s business
multiple rating system can be an efficient and effective reputation and includes such factors as success in
method. the marketplace, the degree of system support that
the vendor can provide, and the financial stability
A multiple rating system applies the same criteria to
of the vendor’s business. In relation to this issue,
judge the worth of each vendor’s proposal. Generally,
management will be interested in answers to such
the criteria consist of several issues that management
questions as:
considers critical to the business. Management then
rates the vendor’s response to each issue on a scale •• How long has the vendor been in the hospitality
from 1 to 100. The higher the rating, the better the technology business?
proposal is deemed to address the issue. Since some
issues will always be considered more important than •• Are hospitality systems the vendor’s principal
others, simply totaling the ratings on key issues may business?
not necessarily identify the best system proposal.
In order to identify the best proposal, management •• How many installations does the vendor currently
must rank the issues in the order of their importance. support?
This can be accomplished by assigning a percentage •• How satisfied are current users?
value (or weight) to each criterion, denoting its relative
importance within the overall evaluation scheme. •• Is the vendor’s business financially stable?
The ratings for each issue are multiplied by their
•• Is the vendor expected to remain in the hospitality
appropriate percentage values and then totaled to
technology business?
yield an overall score for each vendor proposal. The
proposals receiving the highest overall score identify Each vendor’s proposal is studied and given a rating
the vendors with whom management should seriously from 1 to 100. Vendor A receives a rating of 60,
consider scheduling product demonstrations. The vendor B a rating of 95, and vendor C a rating of 80.
following example illustrates how a multiple rating Management assigns the issue of business reputation
system can be used to evaluate proposals from three a value of 30 percent. Each vendor’s rating on the
different vendors. second issue is then multiplied by 30 percent to arrive
at a score. Vendor A scores 18 points (60 × 0.30);
Assume that a business receives three proposals, one vendor B earns 29 points (95 × 0.30); and vendor C
each from vendor A, vendor B, and vendor C. Assume totals 24 points (80 × 0.30).
further that management has decided to evaluate each
proposal on three key issues—product performance, The third issue centers on economic factors such as
vendor’s business reputation, and system cost. direct, indirect, and hidden costs of purchasing the
technology. Assume that management designed a
The issue of product performance focuses on how portion of the RFP requiring respondents to estimate
well the proposed system fits the information needs the direct costs of individual system components.
of the business. Each vendor’s proposal is studied The identification of system components enables
and given a rating from 1 to 100. For the sake of this management to:
example, assume that vendor A receives a rating of
80, vendor B a rating of 70, and vendor C a rating of •• Evaluate the benefits of installing the system in
50. Further assume that management decides that phases or modules.
product performance is the most important of the three
issues and assigns this issue a relative value of 45 •• Eliminate unnecessary hardware devices or
percent. Each vendor’s rating on the first issue is then software programs.
multiplied by 45 percent to arrive at a score that is •• Conduct comparative price shopping for system
relative to the entire evaluation scheme. Vendor A components.

The RFP should have directed Each vendor’s proposal is evaluated in relation to these factors and
vendors to estimate indirect costs, given a rating from 1 to 100. Vendor A receives a rating of 90, vendor B
such as taxes, insurance, shipping, a rating of 70, and vendor C a rating of 80. Cost issues are assigned a
and other costs that may result relative value of 25 percent. Each vendor’s rating on the third issue then
from: is multiplied by 25 percent to arrive at a score that is relative to the entire
evaluation scheme. Vendor A scores 23 points (90 × 0.25); vendor B
•• Modifying air conditioning, receives 18 points (70 × 0.25); and vendor C earns 20 points (80 × 0.25).
electrical, and communication
networking. Exhibit 6.7 shows the results of the multiple rating system used in
this example. Vendor C’s proposal will probably not receive further
•• Establishing contingency consideration as it did not score well on any of the three key issues.
backup and security Also, note that although vendor A was judged best in terms of product
procedures. performance, vendor B received the highest overall score. However, since
•• Installing uninterruptible power the overall scores of vendors A and B are close, both vendors would likely
sources, system access points, be invited to schedule a product demonstration.
and related products.
Exhibit 6.7 Multiple Rating Results
•• Maintaining an inventory of
spare parts.
VENDORS
Vendors should also be required
to estimate additional expenses, CRITERIA A B C
sometimes referred to as hidden
costs, which include such items as Product 80 × 0.45 = 36 70 × 0.45 = 32 50 × 0.45 = 23
supplies, training, overtime pay, Performance
and data conversion costs.
Vendor 60 × 0.30 = 18 95 × 0.30 = 29 80 × 0.30 = 24
Reputation
Direct costs—in relation to the
purchase of a technology system, System Cost 90 × 0.25 = 23 70 × 0.25 = 18 80 × 0.25 = 20
the costs of individual system
components. Overall Score 77 79 67
Indirect costs—in relation to

The previous example is meant only to illustrate a multiple rating system.
the purchase of a technology
A hospitality business should take care to identify and rank key issues that
system, these costs include taxes,
relate specifically to the needs and requirements of individual operations.
insurance, shipping, and other costs
Similar to how issues and relative order of importance will vary, so will
that may result from modifying
the relative percentage values assigned to each key issue.
the property’s air conditioning,
electrical, and telephone wiring
systems; establishing contingency
programs; installing uninterruptible
power sources; and maintaining an
inventory of spare parts.
Hidden costs—in relation to the

purchase of a technology system,
costs associated with supplies,
customized forms, training,
overtime pay, and data conversion
normally not included in the system
purchase price.

When a business purchases hardware components
from one source that must be modified to perform
according to specifications set by another source,
confusion can arise with respect to guarantees and
warranties. For example, when a software vendor
modifies hardware components in order for the system
to support special application programs, the hardware
manufacturer’s guarantees and warranties could
Contractual Arrangements become invalid. Hardware manufacturers generally
In relation to hospitality technology, there are several assume responsibility for product performance only
types of contractual arrangements. Three common in relation to designated performance specifications.
agreements are: Whenever hardware components must be modified,
management should insist that whoever modifies
•• Single-vendor contracts. hardware, software, or netware provide guarantees
and warranties similar to those originally provided by
•• Multi-vendor contracts. the manufacturer or developer.
•• Other equipment manufacturer (OEM) contracts.
Another area of concern in multi-vendor contracts
A single-vendor contract refers to an agreement to relates to troubleshooting and maintenance. For
purchase hardware, software, and netware from example, when a problem arises in a hotel’s reservation
the same vendor. In most cases, the vendor makes system, the reservations staff may scramble to
the necessary hardware, software, and netware implement a backup operation while management
modifications before system implementation. A contacts the hardware vendor. The hardware
single-vendor contract clearly identifies the vendor’s vendor may consider management’s description of
responsibilities in relation to system performance and the problem and conclude the reservation system
security and avoids the kind of confusion that may problem is a software problem. Management then
arise in other contractual arrangements when the lines contacts the software vendor who, after listening
of responsibility are not so clearly defined. to management’s description of the problem, may
conclude that the hotel’s problem is a hardware
A multi-vendor contract refers to an agreement to problem. Meanwhile, managers waste time, tempers
purchase system components from more than one shorten, and reservation traffic may be lost.
vendor. The hardware components may be purchased
directly from the manufacturer or purchased through An other equipment manufacturer (OEM) contract
a software vendor, who serves as a value-added refers to a situation in which a business agrees
reseller. In either case, the hardware components to purchase hardware, software, and netware
or the accompanying operating system may require from a single source, and the single source takes
modifications by the software provider in order to responsibility for the performance of the technology
perform effectively. Similarly, network features may application. OEM contracts generally involve
require modification based on hardware and software purchasing a complete system that arrives at the
specifications. property ready for installation. This kind of contractual
arrangement provides a business with the equivalent
of a single-vendor contract, as all hardware, software,
Single-vendor contract—in relation to the purchase of
and netware customization is performed by the OEM.
a technology system, an agreement to purchase hardware
and software from the same vendor. In most of these
cases, the vendor makes the necessary hardware and Other equipment manufacturer (OEM) contract—
software modifications before system implementation. in relation to the purchase of a technology system, a
contract in which a business agrees to purchase hardware
components and software packages from a single source,
Multi-vendor contract—in relation to the purchase of a and this single source takes full responsibility for the
technology system, an agreement to purchase hardware performance of the system. An OEM contract generally
and software from separate sources. involves purchasing turnkey packages.

System Conversion There are a number of conversion strategies that

combine aspects of both parallel conversion and
System conversion is the process of transitioning
direct cutover strategies. For example, lodging
from an installed (legacy) system to a new system.
properties may choose to immediately convert areas
System conversion within a hospitality operation can
such as reservations, rooms management, and
be difficult and trying. Two commonly used conversion
guest accounting, but maintain parallel conversion
strategies are parallel conversion and direct cutover
procedures for payroll and general ledger accounting
conversion.
applications. Whatever the selected strategy, balance
operational costs against risks. Risks can often be
With parallel conversion, the property continues to
minimized by careful attention to acceptance testing,
operate the legacy system while incrementally installing
training, and contingency planning.
application modules of the new system. The two
information systems operate simultaneously. Usually,
both systems are maintained for one accounting System conversion—the process of switching from
period with incremental transitioning between the the current information system to the capabilities of a
old and new systems. When comfortable with the new system.
new system’s operation, management will direct a
complete conversion to the new system. While there
is relatively little risk involved with parallel conversion, Parallel conversion—in relation to the implementation
it incurs the high costs of operating two information of a technology system, a property operates a legacy
systems simultaneously. It also assumes a lack of system and a new system simultaneously until confident
urgency in adopting the new system. enough to move entirely to the new system.
With direct cutover conversion, management chooses
a date on which the property is to switch from the
Direct cutover conversion—in relation to the
current system to the new system. Direct cutover is
implementation of a technology system, management
also called “cold turkey” because it involves a complete
chooses a date on which there is to be a complete switch
withdrawal from the previous information system on
from the current system to a new system. Also called
a targeted date. This approach may be especially
going cold turkey.
effective when the previous system is perceived
as cumbersome and inadequate, or when the new
technology is perceived as a major enhancement over
the former system. The main advantage of a direct
cutover conversion is that the hospitality business
is not required to operate two information systems
simultaneously. A disadvantage is the potential risk
of adopting a new system without the ability to revert
to old processes and procedures should operational
confusion or system failure ensue.

WRAP UP
CONCLUSION
Identifying, evaluating and implementing new systems can be
complex and time consuming. Many properties employ a project team
to evaluate options by submitting a request for proposal (RFP) to
vendors. The first step in the process is to identify the needs of the
business by identifying the types of information that various levels of
management use in the course of operations.
Review Questions
1
How can management go about analyzing the
current information needs of a hospitality
operation? How can flowcharts be used as a method
of analysis?
2
What are some of the ways management can collect
product literature regarding technology systems?
3
What factors must management take into account
when determining system requirements?
4
What are the three major sections of a “request for
proposal”? Why is it important for management to
ask vendors to follow the same format when
submitting proposals for review?
5
In relation to purchasing a technology system, what
do the terms “direct costs,” “indirect costs,” and
“hidden costs” mean? What are
some examples of each?


CHAPTER 7
BASIC COST CONCEPTS
Costs in Relation to Sales Volume.........................................................92
1
Define various types
Fixed Costs..................................................................................92 of costs and explain
how they change in
Variable Costs.............................................................................93 response to changes
in sales volume.
Total Costs...................................................................................94
2
Determination of Mixed Cost Elements................................................94 Use various methods
to estimate the fixed
High/Low Two-Point Method........................................................95
and variable elements
Fixed Versus Variable Costs........................................................97 of a mixed cost.
3
Direct and Indirect Costs.............................................................98
Explain how fixed and
Wrap Up..................................................................................................99 variable cost factors
influence purchasing
Review Questions........................................................................99 decisions.
4
Distinguish direct
costs from indirect
costs.
5
Identify overhead
costs and explain how
they may be allocated
to profit centers.

COSTS IN RELATION
TO SALES VOLUME
One way of viewing costs is to understand how they change with changes
in the activity (sales) of the hospitality operation. In this context, costs can
be seen as fixed, variable, step, or mixed (partly fixed and partly variable).
Fixed Costs
Fixed costs are those that remain constant in the short run, even when
sales volume varies. For example, room sales may increase by 5 percent
or food sales may decline by 10 percent while, in both cases, the fixed
costs remain constant. The graph in Exhibit 7.1 plots costs along the
vertical axis and sales volume along the horizontal axis. The graph shows
that total fixed costs remain constant even when sales volume increases.
Exhibit 7.1 Fixed Costs: Total and Per Unit
$
Total Fixed Costs
Fixed Co
sts Per Unit
0 1 Volume
Common examples of fixed costs include salaries, rent expense,

insurance expense, property taxes, depreciation expense, and interest
expense. Certain fixed costs may be reduced if a lodging facility closes
for part of the year. For example, insurance and labor expenses may be
avoided during the shut-down. Fixed costs that may be avoided when a
company shuts down are called avoidable costs.
Fixed costs—Costs that remain constant in the short run even though sales
volume varies; examples include salaries, rent expense, and insurance
expense.
Avoidable costs—costs that are not incurred when a hospitality operation

shuts down (for example, when a resort hotel closes for part of the year).
Fixed costs are often classified as either capacity or discretionary costs.

Capacity fixed costs relate to the ability to provide goods and services.
For a hotel, the capacity fixed costs relate to the ability to provide a
number of rooms for sale. The fixed costs include, but are not limited
to, depreciation, property taxes, and certain salaries. There is a quality
dimension related to capacity fixed period, then the average fixed cost per room sold is $3.33 ($10,000 ÷
costs. For example, if the hotel were 3,000 rooms). As the sales volume increases, the fixed cost per unit
to eliminate its swimming pool or decreases. The graph in Exhibit 7.1 also illustrates this relationship.
air conditioning system, it could still
provide the same number of rooms, Although they are constant in the short run, all fixed costs change over
but at a lower level of service. longer periods. For example, the monthly lease payment on a machine
may increase about once a year. Therefore, from a long-term perspective,
all fixed costs may be viewed as variable costs.
Capacity fixed costs—Fixed
charges relating to the physical
plant or the capacity to provide Variable Costs
goods and services to guests. Variable costs change proportionally with the volume of business. For
example, if food sales increase by 10 percent, the cost of food sold may
also be expected to increase by 10 percent. Exhibit 2 depicts total variable
Discretionary fixed —Costs that costs and variable costs per unit as each relates to sales volume. Total
managers may in the short run variable costs (TVC) are determined by multiplying the variable cost per
choose to avoid. These costs do not unit by the number of unit sales. For example, the TVC for a food service
affect an establishment’s capacity. operation with a variable cost per meal of $3 and 1,000 projected meal
sales would be $3,000.
Discretionary fixed costs do not
affect a lodging establishment’s variable costs—Costs that change proportionately with sales volume.
current capacity. They are costs
that managers may choose to Theoretically, total variable costs vary with total sales, whereas unit
avoid during the short run, often variable costs remain constant. For example, if the cost of food sold is
to meet a budget. However, 35 percent, then the unit cost per $1 of sales is $.35, regardless of sales
continued avoidance will generally volume. The graph in Exhibit 7.2 shows that unit variable costs are really
cause problems for the hospitality fixed—that is, the cost per sales dollar remains constant. In actuality, of
operation. Discretionary fixed costs course, a business should be able to take advantage of volume discounts
include educational seminars for as its sales increase beyond some level. When this occurs, the cost of
executives, charitable contributions, sales should increase at a slower rate than sales.
employee training programs, and
advertising. Generally, reducing In truth, few costs, if any, vary in exact proportion to total sales. However,
such costs has no immediate effect several costs come close to meeting this criterion and may be considered
on operations. However, if these variable costs. Examples include the cost of food sold, cost of beverages
programs continue to be curtailed, sold, some labor costs, and supplies used in production and service
sales and various expenses may operations.
be seriously affected. During a
financial crisis, discretionary fixed Exhibit 7.2 Variable Costs: Total and Per Unit
costs are likelier to be cut than
capacity fixed costs because they $
are easier to restore and have less ts
Cos
immediate impact. ble
l Varia
To ta
Fixed costs can also be related
to sales volume by determining
the average fixed cost per unit
sold. For example, if fixed costs
total $10,000 for a period in which Variable Costs Per Unit
2,000 rooms are sold, the average
fixed cost per room sold is $5.00
($10,000 ÷ 2,000 rooms). However,
if 3,000 rooms are sold during the 0 1 Volume

Total Costs DETERMINATION

Total costs (TC) for a hospitality establishment consist of the sum of
its fixed, variable, step, and mixed costs. If step costs are included OF MIXED COST
in either fixed or mixed costs, the TC may be determined by the
following equation: ELEMENTS
When making pricing, marketing, and
expansion decisions, management
TC = fixed costs + (variable cost per unit x unit sales)
needs to estimate the fixed and
variable elements of each mixed
An estimation of TC for a rooms-only lodging operation that sells
cost. There are three methods of
1,000 rooms and has total fixed costs of $20,000 and variable costs
estimating mixed cost elements: the
per unit of $20, is $40,000. high/low two-point method, the scatter
diagram, and regression analysis. The
TC = $20,000 + (1,000 × $20) maintenance and repair expense of the
hypothetical Mayflower Hotel for 20X1
= $40,000 will be used to illustrate the high/low
two-point method. Exhibit 8 presents
Total costs are depicted graphically in Exhibit 7.3. the monthly repair and maintenance
expense together with rooms sold by
Exhibit 7.3 Total Costs month for the Mayflower Hotel.
$ High/low two-point method—The

Total Costs simplest approach to estimating the
fixed and variable elements of a mixed
cost. It bases the estimation on data
Variable Costs from two extreme periods.
Fixed Costs*
* Fixed costs include fixed costs, step costs treated as

fixed costs, and the fixed element of mixed costs.
** Variable costs include variable costs, step costs treated
as variable costs, and the variable element of mixed costs.
There are three methods
0 1 Volume
of estimating mixed cost
The equation for TC corresponds to the general equation for a straight elements: the high/low
line, which is as follows: two-point method, the
scatter diagram, and
y = a + bx regression analysis.
where y = value of the dependent variable (total costs)
a = the constant term (total fixed costs)
b = slope of the line (variable cost per unit)
x = the value of the independent variable (units sold)

High/Low Two- 5. Subtract the result in Step 4 from the total mixed cost for the period
of lowest activity to determine the fixed cost for that period.
Point Method
The simplest approach to estimating 6. Check the answer in Step 5 by repeating Steps 4 and 5 for the
the fixed and variable elements period with the greatest activity.
of a mixed cost is the high/low
two-point method. This approach 7. Multiply the fixed cost per period by the number of periods in the
is simple because it bases the time span to calculate the fixed costs for the entire time period.
estimation on data from only two
periods in the entire time span of 8. Subtract the total fixed costs from the total mixed costs to determine
an establishment’s operations. The the total variable costs.
method consists of the following
eight steps: The high/low two-point method is illustrated below using data from Exhibit
7.4:
1. Select the two extreme
periods (such as months) of 1. High month—August
sales activity (for example,
rooms sold) in the time span Low month—December
under consideration (such as 2. Repair and
one year). If an extreme value Maintenance
is due to an event beyond Expense Rooms Sold
management’s control and
does not represent normal
August $8,600 2,800
operations, consider the December 5,900 1,330
next value. For example, if a Difference $2,700 1,470
country club is closed for the
month of January, the value Va r i a b l e
=
Mixed Cost Difference
for the next lowest month 3. Cost per Rooms Sold Difference
should be used. Room Sold
= $2,700
2. Calculate the differences in
total mixed cost and activity = 1,470
for the two periods. = $1.8367
3. Divide the mixed cost This result means that for every additional room sold, the hotel will incur
difference by the activity repair and maintenance variable costs of $1.8367.
difference to determine the
variable cost per activity unit
(for example, each room sold).
4. Multiply the variable cost per

activity unit by the total activity
for the period of lowest (or
highest) sales to arrive at
the total variable cost for the
period of lowest (or highest)
activity.

4. Total Variable
Cost of Repair
and Maintenance = December Rooms Sold × Variable Cost
Expense for
December
= 1,330 × 1.8367
= $2,442.81
5. Total Fixed Cost
of Repair and
Total Repair and Maintenance Cost for December − Variable Repair and Maintenance
Maintenance =
Cost for December
Expense for
December
= $5,900 − $2,442.81
= $3,457.19
6. Check results by using the high month, August.
Variable Cost = 2,800 × 1.8367
= $5,142.76
Fixed Cost = 8,600.00 − 5,142.76
= $3,457.24
Compare the result in Step 5 with Step 6 as follows:
Fixed Costs—Step $3,457.24

6
Fixed Costs—Step - 3,457.19
5
.05 (minor difference due to rounding)
7. Calculate total fixed costs for the year.
Total Fixed Costs Fixed Costs per Month × 12 Months
$3,457.19 × 12
$41,486.28
8. Determine total variable costs of repair and maintenance expense for the year.
Total Variable Total Mixed Costs − Total Fixed Costs

Costs
$85,200 − $41,486.28
$43,713.72

The high/low two-point method considers same regardless of activity and, therefore, management is able
only two extreme periods and is a fairly to lock in a maximum amount. Under a variable arrangement,
simple way of estimating the variable and the amount paid depends on the level of activity. The level
fixed elements of mixed costs. This approach of activity at which the period cost is the same under either
assumes that the extreme periods are a fair arrangement is called the indifference point. An example follows
reflection of the high and low points for the to illustrate this concept.
entire year; therefore, the results will be
inaccurate to the degree that the two periods
Indifference point—The level of activity at
fail to represent fairly the high and low points
which the cost is the same under either a fixed
of activity.
or a variable cost arrangement.
Exhibit 7.4 Monthly Repair and Assume that a food service operation has the option of signing
Maintenance Expense either an annual fixed lease of $48,000 or a variable lease set
at 5 percent of revenue. The indifference point is determined
20X1 MONTHLY REPAIR AND as follows:
MAINTENANCE EXPENSE
MAYFLOWER HOTEL
Variable Cost Percentage × = Fixed Lease Cost
Repair and Revenue
Maintenance Rooms
Month Expense Sold .05 (Revenue) = 48,000
January $ 6,200 1,860 Revenue 48,000
February 6,100 1,820
= .05
March 7,000 2,170
April 7,500 2,250 Revenue = $960,000
May 8,000 2,480 When annual revenue is $960,000, the lease expense will
June 8,500 2,700 be $48,000, regardless of whether the lease arrangement is
July 7,900 2,790 fixed or variable. Therefore, if annual revenue is expected to
exceed $960,000, then management should select a fixed
August 8,600 2,800 lease in order to minimize its lease expense. On the other
September 7,000 2,100 hand, if annual revenue is expected to be less than $960,000,
October 6,000 1,900 a variable lease will minimize lease expense. Exhibit 7.5 is
the graphic depiction of this situation. A review of Exhibit 7.5
November 6,500 1,800
suggests the following:
December 5,900 1,330
1. Using a variable lease results in an excess lease expense
TOTAL $85,200 26,000 at any revenue point to the right of the indifference point.
For example, using the previous illustration, if revenue is
Fixed Versus $1,200,000, the lease expense from a variable lease is
Variable Costs $60,000, or $12,000 more than for a fixed lease of $48,000
annually.
Many goods and services may be purchased
on either a fixed or variable cost arrangement. 2. Using a fixed lease results in an excess lease expense
For example, a lease may be either fixed at any revenue point to the left of the indifference point.
(offered at a fixed price) or variable (offered For example, using the previous illustration, if revenue is
at a certain percentage of revenues). $720,000, the lease expense is still $48,000, or $12,000
Management’s decision to select a fixed or more than for a variable lease.
variable cost arrangement is based on the
cost-benefit considerations involved. Under a
truly fixed arrangement, the cost remains the

Exhibit 7.5 Indifference Point costs of the rooms department may include payroll
and related expenses, commissions, contract
cleaning, guest transportation, laundry and dry
Indifference cleaning, linen, operating supplies, reservations,
Lease uniforms, and other expenses as well. In this
Point
context, undistributed operating expenses,
Cost e t
a bl os management fees, non-operating expenses such
(K) ri C
Vaase as property taxes and depreciation, and income
Le taxes may be considered indirect (overhead)
$60 expenses.
However, depending on the object of the incurred

Fixed
expenses, many costs may be both direct and
Lease
Cost indirect. In general, a direct cost is one readily
$48 identified with an object, whereas an indirect cost
is not readily identified with an object. Therefore,
whether a cost is direct or indirect depends upon
the context of the discussion and, in particular,
on whether the object incurring the cost can be
$36 identified in the discussion’s context. For instance,
when speaking of the service center formed by
the general manager’s department, the general
manager’s salary can be ascribed as a direct
cost of the service center and can be classified
$720,000 $960,000 $1,200,00 as a subset of administrative and general
Annual Revenue expense. However, in the context of discussing
all operated departments (profit centers) and
other service centers (for example, the marketing
department), the general manager’s salary would
Direct and Indirect Costs be ascribed as an indirect cost of these other
departments, because the object of this cost in
When we talk about expenses, certain expenses are called
those departments cannot be directly identified.
direct while other expenses are implied to be indirect. Direct
and indirect expenses are discussed as they pertain to
This distinction is important because department
the operated departments (profit centers) within a lodging
heads are responsible for the direct costs of their
establishment. In other words, the “objects” of direct/indirect
departments since they exercise control over
expenses are considered to be the operated departments
them; however, they normally are not responsible
that generate income and incur expenses, such as the rooms
for indirect costs.
department and the food department. For example, direct

WRAP UP
CONCLUSION
This chapter highlighted the variety of definitions the term cost can
have in the accounting world. In general, a cost as an expense is the
reduction of an asset incurred with the intention of increasing revenues.
Such costs include labor costs, cost of food sold, depreciation, and
others.
Review Questions
1
What are some of the different meanings of cost?
2
What is the difference between overhead costs and
indirect costs?
3
Which technique is the most accurate method of
determining the fixed and variable elements of a
mixed cost? Why?
4
Which hotel costs are fixed in the short run? The
long run?


CHAPTER 8
COST-VOLUME-PROFIT
ANALYSIS
CVP Analysis Defined...........................................................................102
1
Define cost-volume-
CVP Assumptions, Limitations, and Relationships....................103 profit analysis and
identify its major
CVP Equation—Single Product..........................................................104 assumptions and
limitations.
CVP Illustration—Single Product...............................................105
2
CVP Equation—Multiple Products.....................................................106 Use CVP equations in
both single- and
Operating Leverage..............................................................................108
multiple-product
Wrap Up................................................................................................112 environments to
determine the revenue
Review Questions......................................................................112 required to reach
specified profit levels
as well as the
following variables:
units sold, fixed
costs, selling price,
and variable cost per
unit.
3
Explain what
operating leverage is
and how it affects a
hospitality operation’s
profits and exposure
to risk.

CVP ANALYSIS DEFINED

Cost-volume-profit (CVP) analysis is a management tool that expresses
the relationships among various costs, sales volume, and profits in either
graphic or equation form. The graphs or equations assist management
in making decisions. A simple example may be used to illustrate this
process.
cost-volume-profit (CVP) analysis—A set of analytical tools used by

managers to examine the relationships among various costs, revenues, and
sales volume in either graphic or equation form, allowing one to determine the
revenue required at any desired profit level. Also called breakeven analysis.
Assume that the manager of the Red Cedar Inn, a 10-room motel, would
like to know what price must be charged in order to make a profit of $4,000
in a 30-day period. The available information is as follows:
•• Variable costs per room sold equal $10.

•• If the average price is between $45 and $50, 250 rooms can be sold.
•• Fixed costs for a 30-day period are $5,000.
Given these three pieces of information, using CVP analysis the manager
is able to calculate that the selling price must average $46 in order to
attain the goal of a $4,000 profit in a 30-day period. This selling price
is determined on the basis of the CVP model by working through the
calculations of the following formula:
Selling Variable Costs Desired Profit + Fixed Costs

= +
Price per Room Number of Rooms to be Sold
$4,000 + $5,000
= $10 +
250
= $46
Since the selling price of $46 suggested by the CVP analysis is within
the range of $45 to $50 required to sell the specified number of rooms,
the manager will be able to reach the desired goal of a $4,000 profit in 30
days by establishing the price at $46. The Red Cedar Inn’s summarized
operations budget for the 30-day period is as follows:
Room sales (250 × $46) $11,500

Variable costs (250 × $10) $2,500
Fixed costs 5,000 7,500
Profit $4,000

CVP Assumptions, Limitations, Exhibit 8.1 Graphics Depiction of Revenue

and Relationships $
CVP analysis, like all mathematical models, is based
on several assumptions. When these assumptions do
not hold in the actual situations to which the model
is applied, then the results of CVP analysis will be Revenue
suspect. The most common assumptions are as
follows:
1. Fixed costs remain fixed during the period being

considered. Over time, fixed costs do change.
However, it is reasonable to assume that fixed
costs remain constant over a short time span,
such as one year.
0 Q
2. Variable costs fluctuate in a linear fashion with
revenues during the period under consideration. The cost-volume-profit relationships depicted in CVP
That is, if revenues increase x percent, variable equations and graphs consist of fixed costs, variable
costs also increase x percent. costs, and revenues. The relationships of fixed costs,
variable costs, and revenues to volume and profits are
3. Revenues are directly proportional to volume— graphically illustrated by Exhibit 8.2. The CVP graph
that is, they are linear. As unit sales increase by shows dollars on the vertical axis and volume (rooms
x percent, revenues increase by x percent. This sales) on the horizontal axis. The fixed cost line is
relationship is shown in Exhibit 8.1. parallel to the horizontal axis from point A. Thus, the
amount of the fixed costs theoretically would equal
4. Mixed costs can be properly divided into their the loss the hospitality operation would suffer if no
fixed and variable elements. sales took place. The variable cost line is the broken
straight line from point 0. This suggests that there
5. All costs can be assigned to individual operated are no variable costs when there are no sales and
departments. This assumption limits the ability of the straight line suggests that variable costs change
CVP analysis to consider joint costs. These are proportionately with sales. The sum of variable costs
costs that simultaneously benefit two or more and fixed costs equals total costs. The total cost line
operated departments. Joint costs, or a portion is drawn from Point A parallel to the variable cost line.
thereof, are not eliminated by discontinuing the This suggests that total costs increase only as variable
offering of services such as food, beverage, costs increase, and that variable costs increase only
telephone, and so forth. Therefore, for the from increased sales.
purposes of CVP analysis, joint costs cannot be
assigned to individual operated departments.
Exhibit 8.2 Cost-Volume-Profit Graph
Because of the existence of joint costs, the
breakeven point cannot be determined by Reven
$ Profit
operated department. However, it can still be
determined for the entire operation.
Loss
6. The CVP model considers only quantitative B
factors. Qualitative factors such as employee
morale, guest goodwill, and so forth, are not
considered. Thus, management must carefully
consider these qualitative factors before making A
any final decisions.

The revenue line commences succeed; in other words, revenues must exceed variable costs. When
at point 0 and reflects a linear this is true, both revenues and costs increase in proportion to sales, but
relationship between revenue they do so at different rates. It is because of this difference in growth rates
and units sold. Point B is the of revenues and costs in relation to sales that the total revenue and
intersection of the total cost line total cost lines are bound to intersect and reach a balance (breakeven
and the revenue line. At point B, point) as sales increase.
revenues equal total costs; this is
the breakeven point. The vertical
distance between the revenue line CVP EQUATION—
and the total cost line to the right
of point B represents profit, while SINGLE PRODUCT
the vertical distance between The CVP graph, although appealing in its simplicity, is not sufficiently
these two lines to the left of Point precise, and it is often time-consuming to manually construct a graph for
B represents operating loss. each question to be solved using CVP analysis. However, computers can
produce these graphs quickly and easily. As an alternative, CVP analysis
uses a series of equations that express the mathematical relationships
breakeven point—The level depicted in the graphic model.
of sales volume at which total
revenues equal total costs. A CVP equation expresses the cost-volume-profit relationships and is
illustrated in Exhibit 8.3. At the breakeven point, net income is zero and
In this way, the CVP model shows the equation is simply shown as follows:
the relationship of profit to sales
volume and relates both to costs.
As the volume of sales increases 0 = SX – VX – F
and reaches the point where the
amount of revenues generated The equation may be rearranged to solve for any one of the four variables
by those sales equals the total as follows:
costs of generating them, then
the hospitality operation arrives
Equation Determines
at its breakeven point. As the
volume of sales increases past F
the breakeven point, the amount X = Units sold at breakeven
S–V
of revenues generated by those
sales increases at a faster rate F = SX – VX Fixed costs at breakeven
than the costs associated with
F
those sales. Thus, the growing S = Selling price at breakeven
X
difference between revenues and
cost measures the increase of F
profit in relation to sales volume. V = S– Variable cost per unit at breakeven
X
It is important to stress again that This CVP equation assumes the sale of a single product such as rooms
the CVP model of the relations or meals. Most hospitality firms sell a vast array of goods and services.
of costs, sales volume, and However, before turning to this more complex situation, let’s look at an
profit is based entirely upon its illustration of this simple CVP analysis equation through the following
assumptions about the relationship example.
of costs and revenues to sales
volume. Although both costs
and revenues are assumed to
increase in direct linear proportion
to the increase of sales volume,
revenues must increase at a faster
rate than costs if the business is to

Exhibit 8.3 C o s t - Vo l u m e - P r o f i t Analysis Exhibit 8.4 Breakeven Point–Michael Motel

Equation–Single Product
Revenue
A CVP analysis equation expresses the cost-volume-
profit relationships as follows:
Total
In = SX – VX – F Costs
Revenue $ (K)
where In = Net income
300
S = Selling price
Fixed
X = Units sold 187.5
Costs
V = Variable cost per unit

F = Total fixed cost 0 7,500 Number of Rooms Sold
therefore SX = Total revenue
VX = Total variable costs What is the occupancy percentage at breakeven
for the Michael Motel?
CVP Illustration—Single Product
The Michael Motel, a 30-room budget motel, has the Occupancy Percentage = Rooms Sold
following cost and price structure: Rooms Available
= 7,500
•• Annual fixed costs equal $187,500.
365 × 30
•• Average selling price per room is $40.
= 68.49%
•• Variable cost per room sold equals $15.
If the proprietor desires the Michael Motel to earn
What is the number of room sales required for the Michael profits of $50,000 for the year, how many rooms
Motel to break even? must be sold? This can be determined by modifying
the equation for units sold at breakeven.
F (equation for units sold at
X =
S−V breakeven) (equation for units
F + In
$187,500 X = sold at $50,000 profit
= S−V
$40 − $15 level)
= 7,500 rooms $187,500 + $50,000

=
$40 − $15
Exhibit 8.4 depicts the breakeven point of the Michael = 9,500 rooms
Motel at 7,500 rooms. The total revenue at the breakeven
point is shown as $300,000 (the result of multiplying the Therefore, for $50,000 to be earned in a year,
selling price per room by the number of rooms sold). the Michael Motel must sell 2,000 rooms beyond
its breakeven point. The profit earned on these
additional sales is the result of the selling price
less variable cost per room multiplied by the excess
rooms ($40 - $15 = $25; $25 x 2,000 = $50,000).

The difference between selling price and variable cost In = SX − VX – F (general formula)
per unit is often called contribution margin (CM). In
this example, the CM is $25—for each room sold, $25 = $40(6,500) − $15(6,500) – $187,500
is available to cover fixed costs or contribute toward
profits. Beyond the breakeven point, 2,000 additional = –$25,000
rooms sales result in a $50,000 profit (rooms sales
beyond breakeven x CM = profit). Thus, a loss of $25,000 would be incurred when room
sales are only 6,500 for the year.
contribution margin—Sales less cost of sales

for either an entire operating department or for CVP EQUATION—
a given product; represents the amount of sales
revenue that is contributed toward fixed costs MULTIPLE PRODUCTS
and/or profits. Many hospitality operations, especially hotels, sell
more than just a single product. In order to determine
Exhibit 8.5 is a graphic depiction of the $50,000 of net the operation’s breakeven point (or any profit level)
income. When total revenue is $380,000 (9,500 x $40), using CVP analysis, a different CVP equation is
expenses equal $330,000 (calculated by multiplying required. This equation is illustrated in Exhibit 8.6.
$15 by 9,500 and then adding $187,500), resulting
in a $50,000 net income. The distance between the Exhibit 8.6 Cost-Volume-Profit Analysis
total revenue line and the total cost line at the 9,500 Equation–Multiple Product
rooms point represents the net income of $50,000.
R = F + In
Exhibit 8.5 Net Income–Michael Motel
CMRw
Total Revenue
where F = Total fixed costs
Net income
of $50,000 In = Net income
Total
Revenue $ (K)
Costs Revenue at desired profit

R =
380 level
300 Weighted average

CMRw =
Fixed contribution margin ratio
Costs
187.5
The contribution margin ratio (CMR) results from
dividing CM by the selling price. (Remember that CM
is determined by subtracting the variable cost per
0 7,500 9,500 Number of unit from the selling price.) Using the Michael Motel
Rooms Sold
illustration, CMR is determined as follows:
Likewise, if rooms sales are less than the 7,500
breakeven point, $25 (CM) is lost per room not sold. CMR CM
=
For example, we can calculate the loss for the year if S
the Michael Motel sells only 6,500 rooms. Based on
the above information, the answer should be $25,000 $40 − $15
=
(CM x rooms less than breakeven). Using the general $40
formula, the proof is as follows: = –.625

The CMR means that for every $1 of sales for the Michael Motel, 62.5 percent or $.625 is contributed toward
fixed costs and/or profits. However, recall that in a multiple product situation, more than just rooms are being
sold. Therefore, the CMR must be a weighted average CMR (CMRw). That is, an average CMR for all operated
departments must be weighted to reflect the relative contribution of each department to the establishment’s
ability to pay fixed costs and generate profits.
contribution margin ratio (CMR)—The contribution margin divided by the selling price. Represents the percentage
of sales revenue that is contributed toward fixed costs and/or profits.
weighted average contribution margin ratio (CMRw)—In a multiple product situation, an average contribution
margin for all operated departments that is weighted to reflect the relative contribution of each department to the
establishment’s ability to pay fixed costs and generate profits.
The weighted average CMR can be determined from more than one formula. In the more complex formula,
a CMR is determined for each operated department and the weighted average of the various CMRs is
determined as illustrated in Exhibit 8.7. To illustrate this calculation of CMRw, assume that the Michael Motel
adds a coffee shop. Exhibit 8.8 shows a partial income statement for the Michael Motel after the first year the
coffee shop has been in operation. Using the equation in Exhibit 8.7, the CMRw of .5 for the Michael Motel
is determined as follows:
R1 R1 – TV1 R2 R2 – TV2
CMRw = × + ×
TR R1 TR R2
$300,000 ($300,000 – $112,500) $100,000 ($100,000 – $87,500)
= × × ×
$400,000 $300,000 $400,000 $100,000
= .75(.625) + .25(.125)
= .5
Alternatively, the CMRw can sometimes be determined using a simpler formula using total revenues and total
variable costs as follows:
CMRw TR – TV
=
TR
$400,000 − $200,000
=
$400,000
= –.5
The simpler formula is easier to use when you know the breakdown of fixed and variable costs for the entire
property. However, when calculating the effects of various changes within departments (for example, the sales
mix), the formula in Exhibit 8.8 allows you to substitute figures more easily.

Exhibit 8.7 Weighted Average Contribution Margin Ratio
R1 (R1 – TV1) R2 (R2 – TV2) R3 (R3 – TV3)

CMRw = × + × + × +
TR R1 TR R2 TR R3
Rn (Rn – TVn)
… + ×
TR Rn
R1 = Revenue for operated department 1
Rn = Revenue for operated department n
TR = Total revenue
TV1 = Total variable cost for operated department 1
TVn = Total variable cost for operated department n
Exhibit 8.8 Partial Income Statement–Michael Motel
OPERATED VARIABLE CONTRIBUTION

DEPARTMENT REVENUE COSTS MARGIN
Rooms $300,000 (R1) $112,500 (TV1) $187,500
Coffee Shop 100,000 (R2) 87,500 (TV2) 12,500
$400,000 (TR) $200,000 (TV) $200,000
To further illustrate the use of the CMRw formula, assume that forecasted activity at the Michael Motel shows
the variable cost percentage of the rooms department dropping to 30 percent. Since the CMR equals one
minus the variable cost percentage, the new rooms department CMR would be .7. Assuming the same sales
mix (75 percent rooms, 25 percent coffee shop), the formula can be used to revise the CMRw as follows:
Revised CMRw = .75 (7) + .25 (.125)

= .55625
OPERATING LEVERAGE
Operating leverage is the extent to which an operation’s expenses are fixed rather than variable. If an operation
has a high level of fixed costs relative to variable costs, it is said to be highly levered. Being highly levered
means a relatively small increase in sales beyond the breakeven point results in a relatively large increase in
net income. However, failure to reach the breakeven point results in a relatively large net loss.

operating leverage—The extent to which an operation’s expenses are fixed rather than variable; an operation that
substitutes fixed costs for variable costs is said to be highly levered.
If an operation has a high level of variable costs relative to fixed costs, it is said to have low operating leverage.
A relatively small increase in sales beyond the breakeven point results in a small increase in net income. On
the other hand, failure to reach the breakeven point results in a relatively small net loss.
For example, consider the cost structures of two hospitality operations illustrated in Exhibit 8.9. Note that
both properties will break even when their revenues equal $500,000. However, Property A has a CMR of .4,
while Property B has a CMR of .6. This reveals that, for each revenue dollar over the shared breakeven point,
Property A will earn only $.40 while Property B will earn $.60. On the other hand, for each revenue dollar
under the breakeven point, Property A loses only $.40 while Property B loses $.60. Both properties identify
the same breakeven point as the difference between revenues and expenses, and, for both properties, the
costs of failure equal the rewards of success. They both risk as much as they gain, but for Property B, the
stakes are higher. Property B is more highly levered than Property A.
Exhibit 8.9 Cost Structures of Properties A and B
PROPERTY A PROPERTY B
$ % $ %
Revenues $500,000 100 $500,000 100
Variable costs 300,000 60 200,000 60
Fixed costs 200,000 40 300,000 40
Net income $0 0 $0 0
Exhibit 8.10 is a graphical representation of the cost structures of Properties A and B and reflects their identical
breakeven points. However, it is the vertical distance between the total revenue and total cost lines that
measures the degree of profitability for each property. Since Property B is more highly levered, the distance
between the total cost and total revenue lines is greater at all operating levels compared to Property A, except
at the breakeven point.
The degree of operating leverage desired by a hospitality property reflects the degree of risk that the operation
desires to take. All other things being the same, the more highly levered the operation, the greater the risk.
However, the greater the risk, the greater the expected returns, as reflected in Exhibit 15. For example, if sales
are $300,000 below the breakeven point, Property A loses only $120,000 ($300,000 x .4), while the more highly
levered Property B loses $180,000 ($300,000 x.6). However, if sales are $300,000 over the breakeven point
for both operations, Property A earns only $120,000 of profit, while Property B generates $180,000 of profit.
Exhibit 8.11 contains the profit-volume graph for Properties A and B. Notice that both properties break even
when sales equal $500,000. When sales of $1,000,000 are generated, Property B earns $300,000, while
Property A earns only $200,000; however, when sales are zero, Property B loses $300,000, while Property
A loses only $200,000.

Exhibit 8.10 Operating Leverages of Properties A and B
Total
Revenue Total Total
Properties A vs. B A&B Costs
A Costs
B
$ (K)
500
400
Fixed Costs B
300
200
Fixed Costs A
100
0 Q

Exhibit 8.11 Profit-Volume Graph for Property A and B
Property B
300
Property A
200
Profit of Loss $(K)
100
Profit
0
Loss 50 100
Volume $(K)
-100
-200
-300

WRAP UP
CONCLUSION
Managers use cost-volume-profit (CVP) analysis as an analytical
tool to examine the relationships among costs, revenues, and sales
volume. By expressing these relationships in graphic form or by using
mathematical equations, management can determine an operation’s
breakeven point, sales requirements for a specified net income level,
and/or the mix of sales within the operation.
Review Questions
1
What are the assumptions underlying CVP analysis?
2
What does the term S - V represent in the CVP
equation? How does its use differ
from that of the CMR?
3
Draw a CVP graph of the following operation: F=$10;
S=$1; V=$50. What is the meaning of the regions
(between the total revenue and the total cost lines)
to the left and right of 20 units sold?
4
What is operating leverage?

CHAPTER 9
COST APPROACHES TO
PRICING
The Importance of Pricing...................................................................114
1
Discuss the
Price Elasticity of Demand.........................................................115 importance of pricing.
Informal Pricing Approaches......................................................116
2
Cost Approaches: Four Modifying Factors................................117 Calculate the price
elasticity of demand.
Pricing Rooms.......................................................................................117
3
$1 per $1,000 Approach............................................................117 Describe the informal
approaches to
Revenue Management and Dynamic Pricing.....................................118 settling prices for
selling food,
Measuring Revenue Management Yield....................................120
beverages, and
Integrated Pricing......................................................................121 rooms.
4
Wrap Up................................................................................................122
List and explain the
Review Questions......................................................................122 four modifying factors
to consider when
pricing is based on a
cost approach.
5
Define revenue
management, and
calculate a yield
statistic.
6
Describe integrated
pricing.

THE IMPORTANCE OF PRICING

A major determinant of a hospitality establishment’s profitability is its
prices. Whether prices are set too low or too high, the result is the
same—a failure to maximize profits. When prices are below what the
market is willing to pay, the establishment will realize less revenues than
it could generate through its operations. Alternatively, prices set too high
will reduce sales and thereby fail to achieve the operation’s potential for
profit. Management’s goal is to set prices that result in profit maximization.
Another factor to consider when setting prices is the “positioning” of the

establishment’s offerings within the marketplace. Prices set too low may
tend to degrade the perceived quality of products, whereas inflated prices
may tend to reduce the perceived value of products from the guest’s
perspective.
Profits should not result simply because revenues happen by chance

or luck to exceed expenses. Profits should occur because revenues
generated have been carefully calculated to exceed expenses incurred.
The emphasis should not be defensive; that is, on keeping costs down
to make a profit. Aggressive management should set out to generate
sufficient revenues to cover costs. Cost containment is a respectable
secondary objective after marketing efforts are undertaken to achieve a
reasonably high level of sales.
In this chapter, prices will be approached from a cost perspective.

However, this is not meant to suggest that non-cost factors such as
market demand and competition are irrelevant. In most situations, they
are critical to the pricing decision.
For-profit operations desire to make profits for such reasons as expanding

operations, providing owners with a return on capital invested, and
increasing the share prices of stock. Many non-profit operations must
also make a profit (often called “revenues in excess of expenses” or, more
formally, “increase in net assets”) for expanding operations, replacing
property and equipment, and upgrading services. Since both types of
operations need to generate profits, their approaches to pricing will not
necessarily be different. The differences generally relate to costs and
type of demand. For example, some non-profit food service operations,
including some in the institutional setting, do not have to cover many
capital costs such as interest expenses, property taxes, or depreciation.
Further, the demand for the products and/or services may be different.
The demand for food service in a hospital is quite different from the
demand for food service in most hotels or restaurants. Many non-profit
operations have less direct competition, so they may have greater leeway
in pricing their products and/or services.
The emphasis in this chapter will be on commercial (for-profit) operations.

However, since we will be discussing cost-oriented approaches to pricing,
our discussion will apply to non-profit operations as well.

Price Elasticity of Demand If elasticity of demand is less than 1,

demand is said to be inelastic. That
The concept of the price elasticity of demand provides a means for
is, a percentage change in price
measuring how sensitive demand is to changes in price. In general, as
results in a smaller percentage
the selling price of a product or service decreases, everything else being
change in quantity demanded.
the same, more will be sold. When the price of a product is increased,
Every operation desires an
only rarely is more of the product sold, everything else being the same,
inelastic demand for its products
and even then there may be other factors that account for the increased
and/or services. When prices
demand.
are increased, the percentage
reduction in quantity demanded
Price elasticity of demand—an expression of the relationship between a is less than the percentage of the
change in price and the resulting change in demand. price increase. Therefore, revenues
will often—but not always—
The demand for a product or service may be characterized as elastic or increase despite some decrease
inelastic. Exhibit 9.1 illustrates the price elasticity of demand formula for in the quantity demanded. A third
mathematically determining whether the demand is elastic or inelastic. situation occurs when the elasticity
The base quantity demanded (Qo) is the number of units sold during a of demand is exactly 1. In this case,
given period before changing prices. The change in quantity demanded demand is said to be unit elastic,
(ΔQ) is the change in the number of units sold during the period the meaning that any percentage
prices were changed compared with the prior period. The base price change in price is accompanied
(Po) is the price of the product and/or service for the period prior to the by the same percentage change
price change. The change in price (ΔP) is the change in price from the in quantity demanded.
base price. Strictly speaking, this equation will virtually always yield a
negative number, since it is the result of dividing a negative change in
Elastic demand—a situation in
quantity demanded by a positive price change or vice versa. (In other
which the percentage change in
words, as price goes up, quantity demanded goes down and vice versa.)
quantity demanded exceeds the
By convention, however, the negative sign is ignored.
percentage change in price.
Exhibit 9.1 Price Elasticity of Demand Formula
Inelastic demand—a situation
in which a percentage change in
∆Q price results in a smaller percentage
Qo change in quantity demanded.
Price Elasticity of Demand =
∆P
Po Unit elastic—elasticity of demand
is exactly 1. Any percentage change
where: ∆Q = Change in quantity demanded in price is accompanied by the same
percentage change in quantity
Qo = Base quantity demanded
demanded.
∆P = Change in price
Let’s look at an example illustrating
Po = Base price the calculation of price elasticity of
demand. A budget motel sold 1,000
rooms during a recent 30-day
If the elasticity of demand exceeds 1, the demand is said to be elastic. period at $60 per room. For the
That is, demand is sensitive to price changes. With an elastic demand, next 30-day period, the price was
the percentage change in quantity demanded exceeds the percentage increased to $66, and 950 rooms
change in price. In other words, any additional revenues generated by were sold. The demand for the
the higher price are more than offset by the decrease in demand. When budget motel over this time period
demand is elastic, a price increase will decrease total revenues. Up to is considered to be inelastic, since
a point, price decreases will increase total revenues.

the calculated price elasticity of demand is less than suit. A variation of this approach is changing prices
1. The calculation of price elasticity of demand is as when the leading hospitality operation changes its
follows: prices.
Although these approaches may seem reasonable

50 6 when there is much competition in a market, they
Price Elasticity of Demand = ÷
1,000 60 ignore the many differences that exist among
= .05 ÷ .1 hospitality operations, such as location, product
quality, atmosphere, customer goodwill, and so
= .5 forth. In addition, they ignore the cost of producing
the products and services sold. Hospitality operations
In general, the demand for products and services in must consider their own cost structures when making
the lodging and the commercial food service segments pricing decisions. A dominant operation with a low cost
of the hospitality industry is considered to be elastic. structure may “cause” competitors to go bankrupt if
Generally, demand will be elastic where competition those competitors ignore their own costs and price
is high due to the presence of many operations and their products following the competitive approach.
where the products and/or services offered are fairly
standardized. On the other hand, where competition Another informal pricing approach used by some
is low or nonexistent or where an operation has managers is intuition. Intuitive pricing is based on
greatly differentiated its products and/or services, what the manager feels the guest is willing to pay.
then demand may be inelastic. At the extreme, some Generally, managers using this approach rely on
resorts, clubs, high-check-average restaurants, and their experience regarding guests’ reactions to prices.
luxury hotels are known to have an inelastic demand However, as with competitive pricing, intuition ignores
for their products and services. Generally, quick- costs and may result in a failure not only to generate
service restaurants and medium and low priced a reasonable profit, but even to recover costs.
hotels/motels are considered to have elastic demand
for their products and services. However, these are A third approach is psychological pricing. Here,
generalizations, and there are exceptions. prices are established on the basis of what the guest
“expects” to pay. This approach may be used by
This analysis of demand/price relationships assumes relatively exclusive locations (such as luxury resorts)
that other things are the same. However, hospitality and by operators who think that their guests believe
operations seldom increase prices without effectively “the more paid, the better the product.” Although
advertising their products in an effort to counter psychological pricing does possess a certain merit, it
potential decreased demand. Therefore, the concept fails to consider costs and, therefore, may not result
of the price elasticity of demand tends to be more in profit maximization.
theoretical than practical in nature.
Finally, the trial-and-error pricing approach first sets
Informal Pricing Approaches a product price, monitors guests’ reactions, and then
adjusts the price based on these reactions. This
There are several informal approaches to setting approach appears to consider fully the operation’s
prices for selling food, beverages, and rooms. Since guests. However, problems with this method include:
each of these approaches ignores the cost of providing
the product, they are only briefly presented here as a
point of departure for our discussion of more scientific •• Monitoring guests’ reactions may take longer
approaches to setting prices. than the manager would like to allow.
Several managers price their products on the basis •• Frequent changes in prices based on guests’
of what the competition charges. If the competition reactions may result in price confusion among
charges $80 for a room night, or an average of $20 for guests.
a dinner, then managers using competitive pricing set
those prices as well. When the competition changes
its prices, managers using this pricing approach follow

as a competitor’s, then everything else being equal, the
•• There are many outside, uncontrollable factors
prices would have to be similar. For example, assume
that affect guests’ purchase decisions. An
that an operation’s price calculations for a gourmet
example illustrates this problem: a 10 percent
burger may suggest a $4.50 selling price; however, if
price increase in rooms may appear to be
a strong nearby competitor is charging $3.50 for a very
too high if occupancy is down by more than
similar product, everything else being the same, then
10 percent over the next 30 days. However,
competition would appear to force a price reduction.
other factors that may be part of the consumer
However, remember that it is extremely difficult for
decision include competition, new lodging
everything else to be the same: the location is at least
establishments, weather conditions (especially
slightly different, one burger may be fresher, one may
if the lodging facility is a resort), and so on.
be grilled and the other fried, and so on.
•• The trial-and-error approach fails to consider
costs. Finally, the price may be modified by price rounding.
That is, the item’s price will be rounded up to the
Although all of the informal price approaches have nearest $.25 or possibly up to $X.95.
some merit, they are most useful only when coupled
with the cost approaches we are now going to consider.
Cost Approaches: Four

Modifying Factors
Before looking at specific cost approaches to pricing,
however, we need to set the stage. When pricing is
based on a cost approach, four modifying factors
to consider are historical prices, perceived price/
value relationships, competition, and price rounding.
These price modifiers relate to the pricing of nearly
all products and services.
First, prices that have been charged in the past must

be considered when pricing the hospitality operation’s
products. A dramatic change dictated by a cost
approach may seem unrealistic to the consumer. For PRICING ROOMS
example, if a breakfast meal with a realistic price of $1 per $1,000 Approach
$6.49 was mistakenly priced at $4.49 for five years,
The $1 per $1,000 approach sets the price of a room
the food service operation may need to move slowly
at $1 for each $1,000 of project cost per room. This
from $4.49 to $6.49 by implementing several price
includes the hotel fully equipped. For example,
increases over a period of time.
assume that the average project cost of a hotel for
each room was $80,000. Using the $1 per $1,000
Second, the guest must perceive that the product
approach results in a price of $80 per room. Doubles,
and/or service is reasonably priced in order to feel
suites, singles, and so on would be priced differently,
that he or she is getting a good value. Many guests
but the average would be $80.
today appear to be more value-conscious than ever.
Most are willing to pay prices much higher than a few
years ago, but they also demand value for the price $1 per $1,000 approach—an approach to rooms pricing
paid. The perceived value of a meal includes not only that sets the price of a room at $1 for each $1,000 of
the food and drink but also the atmosphere, location, project cost per room.
quality of service, and many other often intangible
factors. This approach fails to consider the current value of
facilities when it emphasizes the project cost. A well-
Third, the competition cannot be ignored. If an maintained hotel worth $100,000 per room today may
operation’s product is viewed as substantially the same

have been constructed at $20,000 per room 40 years reservation received on the hotel’s website. Market
ago. The $1 per $1,000 approach would suggest a segments comprise homogeneous groups of buyers
price of $20 per room; however, a much higher rate whose purchase habits are indicated by their price
would appear to be appropriate. This approach also sensitivity. Price sensitivity, or the elasticity of demand,
fails to consider all the services that guests pay helps to determine the price to be offered to each
for in a hotel complex, such as food, beverages, segment.
telecommunications, laundry, and so forth. If a hotel is
able to earn a positive contribution from these services
(and the successful ones do), then the need for higher Revenue management—selling rooms in a way that
prices for rooms is reduced. maximizes total revenues. Before selling a room in
advance, the hotel considers the probability of being
able to sell the room to other market segments that are
willing to pay higher rates.
Recognizing that there are multiple revenue channels

generating demand for a hotel’s perishable product
is critical to maximizing revenue as well as profit.
Through “optimization,” or determining the optimal mix
of demand from these channels, a hotel can generate
the highest probable revenue and profit.
Before it can do any of this, however, a hotel must

determine the proper pricing for its product. In order to
do this, consideration must be given to the dynamics
of the distribution channels, purchase patterns, and
REVENUE market segments that make up the demand in a
market. The market segment and revenue channel
MANAGEMENT AND combination helps the revenue manager set prices
by creating reservation booking rules based on length
DYNAMIC PRICING of stay, number of days in advance the reservation is
Revenue management can be broadly defined as the made prior to stay, and the market segment. A real-
process of understanding, anticipating, and reacting time demand forecast is an essential tool for pricing.
to buying trends. As this field has developed in the By identifying the high and low demand periods for
hotel industry, the original focus, which was solely on a hotel, it can be determined when prices can be
revenue, has shifted to include strong consideration of increased and when they must be reduced. These
profit. Revenue management requires that the manager periods may be seasonal timeframes throughout the
analyze the changing nature of the marketplace and year, a weekly pattern that is evident from one day
the operation on a moment’s notice. This is done by to the next, or simply demand variances between
constantly reviewing the status of demand for the hotel weekdays and weekend days.
and the available supply of rooms. There are several
components that must be taken into consideration Accurate demand forecasting allows a revenue
in this process in order to maximize both revenue manager to anticipate business and price the hotel
and profit: the revenue channels supplying demand, appropriately before any bookings have been made.
the accurate forecasting of purchase patterns of Understanding the normal demand patterns for a
the customers in those channels, and the types of market helps predict future demand and establish
customers or market segments available to generate pricing. Additional understanding of the type of
demand. Pricing strategies are set based on where customer generating demand is equally important. This
the customer buys (the revenue channel) and who is known as market segmentation. An example of some
the customer is (market segment). Some revenue typical hotel market segments would be as follows:
channels cost more to operate. For example, the weekday corporate, corporate discount, weekend
commission a hotel must pay a travel agent for leisure, government, e-commerce, and group. Each
a reservation is generally more than the cost of a of these segments can have unique demand patterns

and price thresholds. By taking that into consideration that it may not be as good of an opportunity when
along with the total demand expected for a particular you consider the impact it will have on Monday and
time period, revenue managers can then determine the Tuesday.
amount of their product they want to make available to
any particular segment. Various statistics are used to The revenue from this opportunity is:
forecast demand. Call volume, cancellations, no-show
history, conversion percentage (the actual bookings
Room 150 room
divided by the number of inquiries), and booking = $15,000.00
revenue: nights at $100
pace (the speed and pattern at which the property is
receiving reservations for a particular date) all assist Meeting room
the revenue manager in evaluating demand for the $ 750.00
rental:
property.
F&B revenue: $2,250.00
Generally speaking, during a high demand period, one
would want to employ a sales strategy that restricts Total: $18,000.00
availability of discounted rates and limits business
that is unlikely to produce high profits. Lower demand The values for meeting room and food and beverage
periods allow the hotel to be more open to all business revenue must be estimated at this point based on
opportunities presented and willing to sell its inventory the likely minimum per person price possible for the
at a substantial discount. morning and afternoon breaks. Assume this is $15
per person per day.
Most of the time however, demand is complex and a
combination of many types of business are necessary Because this group will cause the hotel to exceed its
to maximize revenue and profit. guestroom capacity on Monday and Tuesday, we must
determine the revenue that this group will displace.
On Sunday there will be no displacement. However,
Here is an example to demonstrate how a hotel on Monday the forecast indicates the hotel will have
might evaluate a business opportunity. A group 180 occupied rooms, so 30 rooms will be displaced.
would like to stay at a hotel. It is calling six months On Tuesday the hotel will have 190 occupied rooms
prior to its event and its needs are as follows: and the displacement will be 40 rooms.
•• Fifty rooms for three nights

30 rooms × $130 ADR = $3,900
•• Arrival on Sunday, departure on Wednesday
40 rooms × $127 ADR = $5,080
•• Room rate of $100.00 per room per night
Total revenue displaced $8,980
•• One large meeting room for 50 people on
Monday and Tuesday By subtracting the displaced revenue from the
•• Light food and beverage needs for only morning anticipated room revenue that the group booking will
and afternoon breaks generate, you can determine if it is worth displacing
the forecasted rooms. In this case, the total value of
•• $1,000 per day budget for meeting space and the group’s room revenue is greater than the displaced
food and beverage revenue, so this would be a good opportunity to pursue
from a guestroom standpoint.
The hotel has 200 rooms. Not including this group, it is
forecasting to be at 50 percent occupancy on Sunday We have not included the value of the meeting and
with an average rate of $125, 90 percent occupancy F&B in the evaluation because the rooms revenue
on Monday with an average rate of $130, and 95 is positive. If it was not, however, the meeting and
percent occupancy on Tuesday with an average rate F&B revenue may be sufficient to make up for the
of $127. The meeting room is available. deficiency in rooms revenue and still make taking the
opportunity a good business decision.
Based on that information, this group will definitely
benefit the hotel on Sunday night. It appears, however,

Measuring Revenue The first calculation is the potential average single

rate. It is computed by multiplying the number of
Management Yield rooms of each room type by its single rack rate and
Revenue management is about enhancing revenue. dividing the result by the 150 rooms of the Beck Inn
To measure revenue achievement, a yield statistic as follows:
is calculated. The yield statistic is the ratio of actual
room revenue to potential room revenue. There are
several steps required to calculate the yield statistic: SINGLE REVENUE @
ROOM # OF RACK 100% PAID
TYPE ROOMS RATE OCCUPANCY
1. Determine the potential average single rate.
One-bed 75 $ 90 $ 6,750
2. Determine the potential average double rate.
Two-bed 75 100 7,500
3. Calculate the multiple paid occupancy Total $14,250
percentage.
4. Determine the rate spread.

$14,250
Potential average single rate = 150
5. Calculate the potential average rate.
= $95
6. Calculate the rate achievement factor.
The potential average double rate is calculated in the
7. Determine the yield statistic. same way as follows:
An illustration will demonstrate the process. Our
hypothetical hotel is the Beck Inn. The Beck Inn has DOUBLE REVENUE @
150 hotel rooms, of which 75 have a single bed and ROOM # OF RACK 100% PAID
75 have two beds. The average daily rate is $90 TYPE ROOMS RATE OCCUPANCY
and the Inn is currently operating at an average paid
occupancy of 60 percent. Management has set single One-bed 75 $110 $ 8,250
and double rack rates for each room type as follows: Two-bed 75 $120 $ 9,000
Total $17,250
PRICES
ROOM TYPE SINGLE DOUBLE $17,250

Potential average double rate = 150
One-bed room $90 $110
= $115
Two-bed room 100 120
The next step is to determine the average proportion
Thus, a one-bed room sold as a single has a targeted of rooms occupied by more than one person, which
price of $90, but the same room sold as a double has is called multiple paid occupancy percentage.
a targeted price of $110. This information indicates sales mix and helps in
determining future demand. If 75 of the 150 rooms
of the Beck Inn are normally occupied by more than
one person, the multiple paid occupancy percentage
is 50 percent.
The next step is to determine the rate spread between

the various room types, which is simply the difference
between the potential average single rate and the
potential average double rate. The rate spread for

the Beck Inn is $115 - $95, or $20. The next step is to determine the potential average rate. This calculation
is based on the potential average single rate, the multiple paid occupancy percentage, and the rate spread.
For the Beck Inn, the potential average rate is determined as follows:
Multiple
paid Rate
Potential average rate = × + Potential average single rate
occupancy Spread
percentage
= (.50 × $20) + $95
= $105
Next we must calculate the rate achievement factor. This factor expresses the difference between the property’s
actual average rate and its potential average rate. The rate achievement factor is calculated by dividing the
actual average rate by the potential average rate. For the Beck Inn, the rate achievement factor is $90 +
$105, or 85.7 percent.
Now the yield statistic can be calculated. The yield statistic is determined by multiplying the paid occupancy
percentage by the rate achievement factor. For the Beck Inn, the yield statistic is 60 percent x .857, or 51.42
percent. A yield statistic of 51.42 percent clearly shows that the Beck Inn is falling considerably short of its
potential.
Integrated Pricing
Many businesses in the hospitality industry, especially the lodging sector, have several revenue-producing
departments. Allowing each profit center to price its products independently may fail to optimize the operation’s
profits. For example, suppose the swimming pool department manager decides to institute a direct charge to
guests. This new pricing policy may maximize swimming pool revenues, but, at the same time, guests may
choose to stay at other hotels where pool privileges are provided at no additional cost. Therefore, revenues
would be lost from guests who selected competing hotels because of the new pool charge policy. Prices for
all departments should be established such that they optimize the operation’s net income. This will generally
result in some profit centers not maximizing their revenues and thus their departmental incomes. This integrated
pricing approach is essential and can only be accomplished by the general manager and profit center managers
coordinating their pricing.
Integrated pricing—An approach to pricing in a hospitality operation having several revenue-producing departments
that sets prices for goods and/or services in each profit center so as to optimize the entire operation’s net income.

WRAP UP
CONCLUSION
An optimal pricing structure can play a large role in the profitability
of a hospitality operation. If rooms are underpriced, profits are lost.
If meals are overpriced, demand may decrease, causing a decrease
in profits. Management needs to be aware of these effects and set
prices accordingly.
Review Questions
1
What is price elasticity of demand?
2
What is the difference between elastic and
inelastic demand?
3
What are three informal pricing approaches?
4
How is the $1 per $1,000 technique used to price
rooms?
5
What is a yield statistic and how is it calculated?

CHAPTER 10
MANAGING
PRODUCTIVITY AND
CONTROLLING LABOR
COSTS
1
Productivity Standards........................................................................125
Describe the difference between
CONTENTS & COMPETENCIES a productivity
Determining Productivity Standards..........................................125

standard and
performance standard. Explain
how to determine productivity
Planning Staffing Requirements.........................................................128
standards.
Fixed and Variable Labor...........................................................128
2
Developing a Staffing Guide......................................................128Define fixed staff positions and
variable labor staff positions,
Forecasting Business Volume...............................................................130
and explain how to develop a
staffing guide.
The Nature of Forecasting.........................................................130
3
Base Adjustment Forecasts.......................................................131Describe the importance of
forecasting, and calculate a
Moving Average Forecasts........................................................131
variety of forecasts.
The Staffing Guide as a Control Tool.................................................134
4
Demonstrate how the staffing
Variance Analysis......................................................................136
guide can be used as a
scheduling
Labor Scheduling Software..................................................................137 tool and control tool.
Monitoring and Evaluating Productivity...........................................140
5
Describe what a variance
analysis does.
Wrap Up................................................................................................142
6
Review Questions......................................................................142
Explain the purpose and benefits
of labor scheduling software.
7
List the steps supervisors can
take to increase productivity.

The hospitality industry is labor-intensive; people, not machines and
computers, produce and deliver the products and services that guests
desire. Hospitality operations commonly spend 30 percent or more of
their revenue to meet payroll costs. This fact underscores the importance
of the supervisor’s role in managing productivity and controlling labor
costs. No hospitality operation of any size, or containing any number of
operating units, can afford unproductive employees and wasted labor
hours.
labor-intensive—The situation in which employees, not machines or

computers, are required to produce and deliver products and services
productivity—Output relative to the input needed to produce products and

services meeting quality standards.
Assume that a hospitality operation’s profits equal 8 percent of the revenue

it generates from the sale of products and services. This means that, for
every dollar of revenue, the operation earns a profit of eight cents. Also
assume that supervisors who engage in poor scheduling practices create
overstaffing that generates $500 in unnecessary labor costs every week.
How much additional revenue must the operation generate to cover the
$500 it wasted in higher-than-necessary labor costs?
The answer is not $500. Revenue must also pay for food, labor, and other
operating costs, as well as mortgage or lease payments, taxes, and many
other expenses. Therefore, the $500 in excessive labor costs must come
out of the operation’s profits. To maintain an 8-percent profit level, the
operation must earn back the $500 it lost in profit by generating additional
weekly revenue of $6,250 ($500 divided by the .08 profit requirement).
If that sounds like a lot of money, it is! If a hotel’s average daily rate
was $150, the first 42 rooms rented each week would generate only the
revenue required to make up for the lost profit ($6,250 in revenue divided
by a $150 room rate equals approximately 42 rooms). If a restaurant
had a customer check average of $25, the 250 customers who dined
there during the week would spend enough money to generate the profit
needed to make up the $500 in lost profits ($6,250 in revenue divided
by an average $25 check equals 250 customers).
The results of understaffing a department can be just as disastrous. While

having too few employees to serve guests might decrease labor costs
in the short term, over time it will likely increase turnover and decrease
profits. The stress of constantly working short-handed will prompt
employees to quit. When performance standards are not consistently
met, revenues and profits will decrease due to guest dissatisfaction and
lost business.

This chapter focuses on the supervisor’s responsibility standards) and quantity (productivity standards) in
to schedule the correct number of employees, with relation to the volume of business and the level of
the right skills, at the right time each day. The chapter service their departments provide.
presents step-by-step procedures that can help
hospitality supervisors: For example, housekeeper duties vary widely among
economy/limited-service, mid-range-service, and
1. Develop productivity standards based on world-class-service hotels due to differences in room
established performance requirements. sizes and furnishings. Therefore, the productivity
standards for housekeepers also vary among these
2. Construct a staffing guide based on productivity types of properties. In fact, within the same hotel, the
standards. productivity standards for housekeepers might vary
according to the different types of rooms that must
3. Create employee work schedules by using the be cleaned.
staffing guide with business forecasts.
4. Increase productivity by appropriately revising

Determining Productivity
performance standards. Standards
A supervisor begins to establish productivity standards
PRODUCTIVITY by answering the question: How long should it take
for an employee to perform a specific task according
STANDARDS to the department’s performance standards?
Productivity standards define the acceptable Assume that a housekeeping supervisor at the
quantity of work to be done by trained employees St. George Hotel determines that a fully trained
who perform their work according to established housekeeper can meet performance standards by
performance standards. Performance standards cleaning a guestroom in approximately 30 minutes.
explain the quality of the work that must be done. For Exhibit 10.1 presents a sample productivity standard
example, the productivity standard for housekeepers worksheet and shows how a productivity standard can
in a housekeeping department establishes the time be established for full-time housekeepers. Calculations
it should take a trained housekeeper to clean one within the exhibit consider the time needed for
guestroom according to established performance beginning- and end-of-shift duties, a 30-minute
standards. That time assumes the housekeeper has unpaid lunch break and two paid 15-minute breaks.
been properly trained and has the required equipment, The exhibit shows that the productivity standard for
tools, materials, and supplies to do the job. The housekeepers is to clean 14 guestrooms per eight-
productivity standard for a food server might establish hour shift. Similar observations and calculations would
the number of guests a trained staff member can serve be made for other positions in the housekeeping
while meeting performance standards. department, such as for inspectors, housepersons,
and lobby attendants.
productivity standard—An acceptable amount of work
that must be done within a specific time frame according
to an established performance standard.
The hospitality industry is
performance standard—A required level of labor-intensive.
performance that establishes the quality of work that
must be done.
Performance standards vary according to the unique

needs and requirements of each hospitality operation.
Therefore, it is not possible to identify productivity
standards that apply throughout the industry.
Supervisors must balance quality (performance

A dining room supervisor can also determine productivity standards by observing and tracking the time it takes
for several fully trained employees to perform tasks according to performance standards. As with productivity
standards for housekeepers, the productivity standards for dining room positions vary according to the style of
service and the specific menu items served during different meal periods. Exhibit 10.2 presents a worksheet
that a supervisor can use to determine a productivity standard for food servers. The worksheet provides
columns for data and observations on the work of a single server over five lunch shifts. For each lunch shift,
the supervisor records the following data:
•• Number of guests the server served

•• Number of hours the server worked
•• Number of guests served per hour worked
•• Comments concerning how well the server performed according to performance standards
Exhibit 10.1 Productivity Standard Worksheet–Housekeepers
Step 1
Determine how long it should take, on average, to clean one guestroom according to the
department’s performance standards.
Approximately 30 minutes*
Step 2
Determine the total shift time in minutes.
8.5 hours × 60 minutes = 510 minutes
Step 3
Determine the time available for guestroom cleaning.
Total Shift Time................................................................................... 510 minutes
Less:
Beginning-of-Shift Duties .................................................................15 minutes
Morning Break (paid)........................................................................15 minutes
Lunch Break (unpaid).......................................................................30 minutes
Afternoon Break (paid).....................................................................15 minutes
End-of-Shift Duties...........................................................................15 minutes
Time Available for Guestroom Cleaning............................................. 420 minutes
Step 4
Determine the productivity standard by dividing the result of Step 3 by the result of Step 1.
420 minutes 14 guestrooms
30 minutes = per 8-hour shift
*Since performance standards vary from property-to-property and even within properties, this figure is used for
illustrative purposes only. It is not a suggested time figure for cleaning guestrooms.

Exhibit 10.2 Productivity Standard Worksheet–Food Servers
Position Performance Analysis

Position: Service Name of Employee: Joyce
Shift: A.M.
4/14 4/15 4/16 4/17 4/18

No. of Guests Served 38 60 25 45 50
No. Hours Worked 4 4 4 4 3.5
No. of Guests/Labor Hour 9.5 15 6.3 11.3 14.3
Review Comments Even Was really Too much No problems; Worked fast
workflow; rushed; could “standing handled whole shift;
no problems not provide around”; very everything well better with
adequate inefficient fewer guest
service
General Comments
Joyce is a better than average server; with all the tasks that service personnel must do in our restaurant, approximately 10
guests per labor hour can be served by one server. When the number of guests goes up, service quality decreases. When
Joyce really had to rush, some guests waited longer than they should have had to. When the number of guests per labor
hour dropped and Joyce was not busy, there was a lot of unproductive time.
Suggested Meals/Labor Hour Performance C. Brown
10 Review by:
(for this position): Restaurant Manager
The exhibit shows that on April 14, Joyce served 38 guests during a four-hour shift. Joyce takes no breaks
during four-hour shifts, so she served 9.5 guests per hour worked (38 guests divided by four hours of work).
Over a five-day period, the supervisor observed her work and then recorded comments relating to her efficiency.
Before calculating a productivity standard for this position, the supervisor would have completed worksheets
for several trained servers who worked similar lunch shifts. In our example, the supervisor determined a
productivity standard of 10 guests per labor hour. That is, in the supervisor’s view, trained servers should be
able to serve 10 guests for each hour worked without sacrificing established performance standards. Similar
observations and calculations would be made for other dining room positions, such as hosts, buspersons,
bartenders, and bar servers.
With slight alterations, Exhibit 10.2 can be used to determine productivity standards for other hospitality
positions, such as cooks, pantry workers, front desk agents, cashiers, and reservationists. For example, a
productivity worksheet for a lunch cook would have space to record the number of meals prepared, the number
of hours the cook worked, and the number of meals prepared per hour worked. Similarly, a worksheet for day-
shift front desk agents would have space to record the number of check-ins and check-outs processed, the
number of hours the agent worked, and the number of check-ins and check-outs processed per hour worked.

PLANNING STAFFING •• Assign salaried staff duties normally performed

by hourly employees. For example, an assistant
REQUIREMENTS restaurant manager might be stationed at the
host stand to seat guests and take reservations.
The first step in planning staffing requirements is to
Some operations use this tactic routinely to reduce
determine which positions within the department are
variable labor hours and related costs, but doing
fixed and which are variable relative to changes in
so has its downside as well. The salaried manager
business volume. Once this is determined, productivity
who must work these hours still must find time to
standards can be used to develop a staffing guide for
do the other tasks he or she would normally do at
variable staff positions.
this time. Adding excessive hours to the schedules
of salaried employees can affect their morale and
staffing guide—A labor scheduling and control tool that contribute to turnover.
indicates the number of labor hours that must be worked
•• Adjust tasks performed by hourly staff. For
by persons in variable staff positions as the volume of
example, given the proper cross-training, a front
expected business changes.
desk agent might also function as a cashier and/
or reservationist during times of low business
volume.
variable staff positions—Positions filled in relation to
changes in business volume; for example, as more guests Each of the above and other possible ways to
are served or as more meals are produced, additional temporarily reduce labor costs must be carefully
service or kitchen labor is needed. considered and planned. Ideas should be obtained
from the employees who will be affected by them. In
Fixed and Variable Labor addition, supervisors should ensure that all affected
employees are trained to perform additional duties
Fixed staff positions are those that must be filled
and that no actions taken will reduce the quality of
regardless of the volume of business. Many of these
guests’ experiences.
positions are salaried and managerial in nature, and
include department managers, assistant managers, The number of variable staff positions to be filled on
and some supervisors. The actual number and type of any given day will depend on the expected volume
fixed staff positions will vary from property-to-property. of business. For example, the number of front desk
agents scheduled to work will increase as the expected
fixed staff positions—Positions that must be filled number of morning check-outs and afternoon/evening
regardless of the volume of business; the minimum check-ins increases. In the housekeeping department,
amount of labor required to operate a property regardless the number of housekeepers, housepersons, and
of the volume of business. inspectors needed will depend primarily on the number
of rooms occupied during the previous night. Similarly,
Because fixed labor is the minimum amount of the number of kitchen and dining room staff members
labor needed to operate the lodging or food service scheduled to work will depend on the number of guests
facility regardless of business volume, it represents expected for breakfast, lunch, and dinner.
the minimum labor expense. During slow business
periods, labor expense should be kept as low as Developing a Staffing Guide
possible. Therefore, several times during the year,
A staffing guide indicates the number of labor hours that
top managers should review the amount of fixed
must be worked by persons in variable staff positions
labor needed in each department. During this review,
as the volume of expected business changes. When
managers might consider the following temporary
a fairly reliable forecast of business volume has been
actions to reduce labor expense during slow business
made, a supervisor can properly schedule the correct
periods:
number of employees to work each day. Exhibit 10.3
shows a sample staffing guide for housekeepers. This
•• Eliminate or curtail a particular service. For
staffing guide uses the 30-minute productivity standard
example, reduce the hours of dining room,
identified in Exhibit 10.1. If the hotel is forecasted to
concierge, or valet parking service.
be at 90 percent occupancy, there will be 225 rooms

to clean the next day (250 rooms × 0.9). It will take a total of 113 labor hours to clean them (225 rooms × 0.5
hours, rounded to 113). At 80 percent occupancy, there will be 200 rooms to clean (250 rooms × 0.8). It will
take 100 labor hours to clean them (200 rooms × 0.5 hours).
Exhibit 10.3 Sample Variable Labor Staffing Guide for Housekeepers
PRODUCTIVITY STANDARD = 30 MINUTES/ROOM
Occupancy % 100% 95% 90% 85% 80% 75% 70% 65% 60% 55% 50%
Rooms
250 238 225 213 200 188 175 163 150 138 125
Occupied
Housekeepers’ 125 119 113 107 100 94 88 87 75 69 63

Labor Hours
(rooms only)
While the above calculations are easy to make, a of full- time and part-time employees the supervisor
significant amount of experience and judgment is schedules to work. In this example, the supervisor
required to translate the number of hours in the staffing might schedule 16 full-time housekeepers who clean
guide into the actual number of housekeepers’ hours 14 rooms each, but he or she might instead schedule
that should be scheduled. First, a hotel may have 12 full-time housekeepers who clean 14 rooms
rooms of different sizes, bedding configurations, and each and eight part-time housekeepers who clean
amenities such as kitchenettes and furnishings. Each about seven rooms each in four-hour shifts. Many
of these factors affect the time required to clean them. combinations of full-time and part-time employees
To complicate the scheduling decision even further, (as well as the number of hours part-time employees
the same room may take significantly more or less work) can be scheduled to meet the 14-room per FTE
time to clean on some days. Consider the implications productivity standard.
of the following:
•• The room is occupied for one night by one person full-time equivalent (FTE)—A measure of staffing
who arrives late and departs early. needs expressed as the number of full-time (40 hours
per week) employees it would take to meet the need.
•• The room is occupied by a family who spend Actual staffing may include full-time and/or part-time
significant time in it. employees.
•• The room is a stayover with no bedding changes. When calculating the number of housekeepers needed
•• The room is occupied by a person who wishes on a given day, supervisors generally take into account
to work in it all day and just requests some fresh a variety of factors. These include the variables in
face cloths and coffee packets. rooms and occupancy uses such as those discussed
earlier. In addition, supervisors might schedule more
Determining the Number of Employees. The labor hours than indicated by the staffing guide to
staffing guide helps a supervisor determine how many cover the estimated number of employees who call
employees to staff. For example, when the hotel is at in sick or who will otherwise be unavailable to work
90 percent occupancy, the staffing guide in Exhibit all or some of their scheduled hours on a given shift.
10.3 indicates that there will be 225 rooms to clean.
Dividing 225 rooms by the 14 per eight-hour shift Another important adjustment relates to the effect of
standard in Exhibit 10.1 indicates that it will take the turnover on productivity. If a department has a high
equivalent of 16 full-time housekeepers to clean those turnover of employees, the supervisor rarely has a
rooms (225 rooms ÷ 14 = 16.07, rounded to 16). This complete staff of fully trained employees. The staffing
number is expressed as full-time equivalents or FTEs. guide’s productivity ratios assume a fully trained staff.
The actual number of housekeepers scheduled to work High turnover in a department can create a situation in
on any given day will vary depending on the number which 30 percent or more of the staff at any time is in

some stage of training. This means they will be unable periodically reviewed and revised on the basis of new
to perform at the speed and efficiency demanded by information obtained after the forecasts were made.
the productivity ratios used in the staffing guide.
Forecasting involves uncertainty. If managers were
In these cases, supervisors must either constantly certain about what circumstances would exist during
over-schedule labor hours or revise the staffing guide the forecasted period, they could easily prepare
to reflect more realistic productivity ratios based on the forecasts. Virtually all situations that managers
performance levels of under-trained employees. These confront involve uncertainty; therefore, managers must
factors illustrate that the ideal ratio of housekeepers gather information on which to base their forecasts
to rooms (one to fourteen in our example) is a good and make judgments.
place to start, but that ratio must often be modified to
fit different situations in the same property. Assume that room sales for a major hotel are forecasted
one year in advance. The manager (i.e., the forecaster)
might be uncertain about competition, guest demand,
FORECASTING room rates, and other factors. Nevertheless, using the
BUSINESS VOLUME best information available and his/her best judgment,
the manager must make a forecast.
No matter how precise the department’s staffing
guide, accurate labor scheduling depends on the Forecasts generally rely on information such as
reliability of forecasts that predict the volume of historical data about check-ins and check-outs, group
business for a particular month, week, day, or meal histories, weather, and special events and holidays.
period. Forecasting in large hospitality properties Historical data like past transient room sales might
is often the responsibility of a committee made up not be a strong indicator of future activity, but they are
of representatives from key departments. In small considered reasonable starting points.
properties, the general manager and/or designated
supervisors might prepare the necessary forecasts. Many computer-based property management
systems and point-of-sale systems include revenue
Many hospitality organizations develop monthly, ten- management software programs, which consider
day, and three-day forecasts of business volume. The a number of factors to make forecasts. When no
supervisor uses the monthly forecast to generate initial such tools are available, managers and supervisors
work schedules for employees in the department. The involved in forecasting should modify their forecasts
ten-day and three-day forecasts are used to fine-tune when current factors make historical information less
the work schedules and to anticipate increases or useful for the future time period. For example, an
decreases in business. approaching snow storm might have a major impact
on hotel occupancy for a three-day period, regardless
The Nature of Forecasting of past trends.
To use forecasts as effective labor scheduling By their nature, forecasts are generally less accurate
tools, supervisors must understand the nature and than desired. Managers can often improve forecasts by
limitations of forecasting. Forecasting deals with the investing in revenue management software programs.
future. A forecast made today is for activity during a However, slight changes should be expected between
future period, whether it is tonight’s dinner sales or forecasted demand and actual demand on any given
next year’s room sales. day.
The time period involved is significant. A forecast Supervisors should monitor their reservation systems
today for tomorrow’s sales is generally much easier to make necessary adjustments to their three-day
to develop, and is likely to be more accurate, than a forecasts. In addition, long range forecasts should
forecast today of next year’s sales. The further the be revised as soon as there is a change in the
forecast period is from the date the forecast is made, circumstances on which the forecasts were based.
the greater the difficulty in making the forecast. In For example, an increasingly excellent food and
addition, there is a greater risk that the actual results beverage reputation due to favorable publicity might
will differ from the forecast. Long-range forecasts are

call for reforecasting (i.e., increasing) next month’s Exhibit 10.4 reveals weekly meals served for weeks 1
food and beverage revenue. through 12. Using a three-week moving average, the
estimate for the number of meals to be served during
Base Adjustment Forecasts the thirteenth week is 1,025. It is calculated from the
information in Exhibit 10.4, beginning with week 10:
One of the simplest forecasting methods is to use
the most recently collected data as the basis for the
forecast. This is called the base adjustment forecast. = 1,025 + 1,000 + 1,050
For example, a food service manager’s revenue
3-Week Moving
3
projections for the current month might be based
Average
on revenue generated the previous month. To take = 1,025 meal
seasonality into account, a manager might use
revenue from the same month of the previous year As new weekly results become available, they are used
as a base, then add or subtract a certain percentage in calculating the average by adding the most recent
to make the revenue goal more accurate. week and dropping the earliest week. In this way,
the calculated average is “moving.” It is continually
updated to include only the most recent information
base adjustment forecast—A forecasting system that for the last three weeks. Note that the greater the
uses the most recently collected information as the basis number of periods averaged, the less effect random
of the forecast. variations will have on the forecast.
For example, assume that a hotel’s dining room

generated revenue in January 20X1 of $150,000. The moving average forecasting method—A method of
projection for January 20X2, using an anticipated 10 forecasting in which historical data over several time
percent increase due to expected increases including periods are used to calculate an average; as new data
menu selling price increases, would be $165,000, become available, they are used in calculating the average
computed as follows: by adding the most recent time period and dropping the
earliest time period. In this way, the calculated average
is a “moving” one because it is continually updated
Base × (1 + 10%) = Forecast for January 20X2 to include only the most recent data for the specified
number of time periods.
$150,000 × 1.1 = $165,000
Exhibit 10.4 Weekly Meals Served
Although this method is very simple, it might provide
reasonably accurate forecasts, especially for estimates ACTUAL MEALS
of up to one year. WEEK SERVED
1 1,000
Moving Average Forecasts 2 900
In some cases, the major cause of variations in
3 950
the data used to make forecasts is randomness.
Managers attempt to remove the random effect by 4 1,050
averaging the data from specified time periods. One 5 1,025
such approach to forecasting is the moving average
6 1,000
forecasting method. This method can be expressed
as follows: 7 975
8 1,000
Moving Activity in Previous n Periods 9 950
=
Average n 10 1,025
11 1,000
12 1,050

The Staffing Guide as a front desk agents might be needed during those
hours. Also, additional housekeepers might need to
Scheduling Tool be scheduled to work earlier in the day to ensure that
Sales or revenue forecasts are used in conjunction with clean rooms will be available for the large number
the staffing guide to determine the “right” number of of expected arrivals. If the dining room attracts local
labor hours to schedule each day for every position in business people during the lunch period, more cooks
the department. Supervisors have found the following and servers might need to be scheduled during the
tips helpful when developing and distributing work rush time than are scheduled for other hours during
schedules: the shift.
•• A schedule should cover a full workweek. Some supervisors use a schedule worksheet to
determine when employees are needed to work.
•• Workweeks often are scheduled from Saturday Let’s review how the supervisor might have completed
to Friday because weekend leisure business is the schedule worksheet shown in Exhibit 10.5. After
generally more difficult to forecast beyond a three- receiving the forecast of 250 estimated guests, the
day forecast. supervisor checked the staffing guide and found that
•• The work schedule should be approved by 18 labor hours should be scheduled for the position
appropriate managers before it is posted or of assistant cook for the evening shift. Knowing that
distributed to employees. the peak hours during the dinner period are between
7:30 p.m. and 9:30 p.m., the supervisor staggered
•• Schedules should be posted at least three days the work schedule of three assistant cooks to cover
before the beginning of the time period for which these peak hours. Joe was scheduled to work earlier
they apply. to perform duties at the beginning of the shift, and
Phyllis was scheduled to work later to perform duties
•• Schedules should be posted in the same location
at the end of the shift.
and at the same time each week.
•• Days off, vacation time, and requested days off Not every supervisor would need to complete a
should be planned as far in advance as possible schedule worksheet for each position during every
and indicated on the posted work schedule. work shift. In many departments, business volume
Decisions about these schedule issues should stabilizes, creating a pattern of labor demands that
be made on the basis of policies that apply to all makes scheduling relatively easy. However, all
employees in all departments. supervisors must develop work schedules that meet
the particular business demands of their departments.
•• The work schedule for the current week should be The following sections present useful alternative
reviewed daily in relation to forecast information. scheduling techniques. These techniques might also
If necessary, changes to the schedule should be meet the needs of many employees and, properly
made. implemented, could increase staff morale and job
satisfaction.
•• Any scheduling changes should be noted and
highlighted directly on the posted work schedule
so the changes are not overlooked by the affected alternative scheduling—Scheduling staff to work
employees. hours different from the typical 9 a.m. to 5 p.m. workday.
Variations include part-time and flexible hours,
•• A copy of the posted work schedule can be used
compressed work schedules, and job sharing.
to monitor the daily attendance of employees. This
copy should be retained as part of the department’s
Stagger Regular Work Shifts of Full-Time
permanent records.
Employees. Because the volume of business varies
Whenever possible, work schedules should be from hour to hour, there is no need for all employees
developed to meet the day-to-day (and even hour- to begin and end their shifts at the same times. By
by-hour) demands of business volume. For example, staggering and overlapping work shifts, the supervisor
if a large convention group is expected to check in can ensure that the greatest number of employees is
between 2 p.m. and 4 p.m. on a particular day, additional working during peak business hours.

Compress the Work Week of Some Full-Time Employees. For departments such as housekeeping, it
might be possible to offer some full-time employees the opportunity to work the equivalent of a standard work
week in fewer than the usual five days. One popular arrangement compresses a 40-hour work week into four
10-hour days. This technique can benefit lodging operations whose primary market is the business traveler.
A compressed work schedule for some full-time housekeepers would meet the demands of high occupancy
during the middle of the week.
Exhibit 10.5 Schedule Worksheet
Day: Monday Estimated Guests: A.M. Department: Food Service

P.M.
Date: 8/1/XX 250 Position: Assistant Cook
Shift: P.M.
6:00 a
7:00 a
8:00 a
9:00 a
10:00 a
11:00 a
12:00 p
1:00 p
2:00 p
3:00 p
4:00 p
5:00 p
6:00 p
7:00 p
8:00 p
9:00 p
10:00 p
11:00 p
12:00 a
1:00 a
2:00 a
3:00 a
4:00 a
5:00 a
6:00 a
Planned
Total
Employee Hours
Joe 7.0
Sally 6.5
Phyllis 4.5
18.0
Position: Assistant Cook
Standard Labor Hours: 18

Planned Labor Hours: 18
Difference: 0
Implement Split Shifts. A split shift schedules an employee to work during two separate time periods on the
same day. For example, a day-shift dining room server might be scheduled from 8 a.m. to 10 a.m. to handle
breakfast business and, on the same day, be scheduled from 11:30 a.m. to 1:30 p.m. to handle lunch business.
This technique helps the supervisor ensure that the greatest number of employees is working during peak
business hours. However, it will likely meet the personal needs of very few full-time employees (though offering
split shifts to part-time employees might give them a convenient way to increase their earnings).
Increase the Number of Part-Time Employees. Employing a substantial number of part-time workers
provides the supervisor with greater scheduling flexibility. Part-time employees can easily be scheduled to
match peak business hours. Also, employing part-time workers can reduce labor costs, because the costs of
benefits and overtime pay generally decrease.

Increase the Number of Temporary Employees. employee bulletin board, the schedule can also be
Temporary employees can also be used. Many electronically sent to employees with Internet access.
properties keep a file of names of people who do not As well, some hospitality operations also have one
want steady work, but like to work occasionally. A large or more employee-accessible computers at the work
banquet, employee illness, or similar circumstances site, and they can be used to obtain the employee
might create the need for temporary assistance. schedule.
While these scheduling principles are helpful, two of

the most useful scheduling tools are the supervisor’s intranet—A portioned section of the public website that
past experience in developing work schedules and is password-protected to provide staff members with
the supervisor’s knowledge of the staff’s capabilities. timely access to important work-related information.
In many food and beverage operations, the pattern of
business volume stabilizes and creates a repeating Of course, schedule plans do not always work.
pattern of labor requirements. The more experience a Employees might call in sick or fail to show up without
supervisor acquires in relation to a specific operation, warning. Also, the number of actual guests and
the easier it becomes to stagger work schedules, the volume of meals might be lower or higher than
balance full-time and part-time employees, and expected. Therefore, it is often necessary to revise,
effectively use temporary workers. post, and/or distribute modified work schedules.
Similarly, the better a supervisor understands the Management must continually encourage employees
capabilities of the operation’s staff, the easier it to adhere to posted work schedules. Policies providing
becomes to schedule the right employees for particular for on-call staff members might help protect the
times and shifts. For example, some servers might operation when the unscheduled absences of staff
work best when they are scheduled for the late dinner members result in a reduced number of employees.
shift, or some cooks might not perform well when Supervisors, of course, must comply with all union,
experiencing the stress of a busy lunch rush where legal, or other restrictions regarding policies that
fast service is the norm. These factors can be taken require employees to call in or be available for work
into account when planning work schedules. on days when they are not scheduled.
Whenever possible, managers or supervisors with

scheduling responsibilities should consider their
employees’ preferences. Employees can be given
schedule request forms to indicate which days or shifts
they want off. These requests should be submitted by
employees several weeks in advance and honored by
management to the maximum extent possible. THE STAFFING GUIDE
Once the working hours for each employee are AS A CONTROL TOOL
established, they should be combined in a schedule Using the department’s staffing guide and a reliable
and posted for employee review and use. The posted business volume forecast to develop employee work
schedule attempts to provide employees with the best schedules is a sound business practice. However, it
possible advance notice of their work hours. does not guarantee that the hours employees actually
work will equal the number of hours for which they
Technology can also help with the distribution of were scheduled to work. Managers must monitor and
employee work schedules. For example, some evaluate the scheduling process by comparing, on a
hospitality organizations have an intranet system weekly basis, the actual hours each employee works
designed to facilitate communication among staff. with the number of hours for which the employee was
An intranet is a partitioned section of the public scheduled to work. Information about actual hours
website that is password-protected to provide staff worked is usually obtained from the accounting
members with timely access to important work- department, from a staff member assigned to maintain
related information. For example, in addition to the payroll records, and/or from electronic payroll systems.
traditional posting of employee schedules on an These are discussed later in this chapter.

Exhibit 10.6 presents a sample weekly department labor hour report for the food service department in a hotel.
Actual hours worked by each employee are recorded for each day of the week in columns 2 through 8. Actual
total hours worked for each employee and for the position categories are totaled in column 9. These actual
hours worked can be compared with the scheduled labor hours shown in column 10.6. Significant variances
should be analyzed and corrective action taken when necessary.
Exhibit 10.6 Weekly Department Labor Hour Report
Weekly Department Labor Hour Report
Week of: 7/14/XX Department: Food Service Supervisor: Sandra

Shift: P.M.
Actual Labor Hours Worked

Position/ 7/14 7/15 7/16 7/17 7/18 7/19 7/20 Total Labor Hours
Employee Mon Tues Wed Thurs Fri Sat Sun Actual Std.
Jennifer 7 — 7 6.5 7 6 — 33.5 31.0

Brenda — 7 6.5 7 6.5 6.5 5 38.5 38.5
Sally — 5 8 7 8 10 — 38.0 36.0
Patty 8 6 6 4.5 — — 6 30.5 31.0
Anna 4 4 6.5 — 4.5 — 5 24.0 22.0
Thelma 6 5 5 5 5 — — 26.0 24.0
Elsie 6 — — 6 6 8 8 34.0 34.0
224.5 216.5
COOK
Peggy 4 4 4 4 4 — — 20.0 20.0
Kathy 4 4 4 — — 4 4 20.0 20.0
Tilly 4 — — 4 4 4 4 20.0 18.0
Carlos — 4 4 4 4 4 — 20.0 20.0
Sam 4 4 — — — — 4 12.0 12.0
92.0 90.0
DISHWASHING
Terry — — 6 6 6 — — 18.0 18.0
Andrew 6 6 — — 8 5 5 30.0 30.0
Robert 8 8 8 8 — — 6 38.0 38.0
Carl 5 — 5 5 5 6 — 26.0 26.0
112.0 112.0
Total (all personnel) 428.5 418.5

Remarks: 7/18 — Jennifer, Sally and Elsie given extra
hours to learn tableside flaming Difference 10.00
7/19 — Sally stayed 2 hours—special cleaning
7/20 — Tilly stayed 2 hours—cleaned storeroom
shelves

Variance Analysis There may be explainable reasons for a difference

between standard and actual results. While
The sample weekly labor hour report (Exhibit 10.6)
management must decide what constitutes an
shows that during the week of July 14, 216.5 labor
acceptable reason, examples might include:
hours were scheduled for dining room employees, but
the actual hours worked totaled 224.5. This indicates •• Hours worked by new employees and included in
a variance of eight hours. Is eight hours a significant the weekly department labor hour report represent
variance? Should the manager or supervisor training time rather than time spent on productive
investigate it? work.
To answer these questions, let’s do some quick •• Out-of-order equipment such as a broken dish
calculations. Assuming an average hourly wage machine results in additional manual labor.
exclusive of fringe benefits of $12, the variance of
eight hours costs the operation a total of $96 for the •• New menu items or new work procedures create
week of July 14. If actual hours worked differed from a training or transitional period and increase labor
scheduled labor hours at this rate for the entire year, it hours.
would cost the operation a total of $4,992 ($96 weekly If these types of situations explain reasons for
× 52 weeks) in lost profits. Because no manager wants variances, corrective action is not needed. The
to lose any amount of potential profit, the variance is supervisors and managers are aware of the problem
indeed significant. and its cause, expected duration, and estimated
cost. These reasons for variances are understood by
The remarks at the bottom of the report address the management and are within its control.
variances in relation to each employee. If similar
variances and remarks occur over a period of several Occasionally, problems might exist for which
weeks, corrective action might be necessary. For immediate causes or solutions are not apparent.
example, the manager or supervisor might need to In these situations, the manager or department
do a better job at planning and scheduling necessary supervisor could ask employees for ideas about the
cleaning for the dining room and storage areas. problem. Also, the manager or supervisor could work
in the affected position for a shift or two. Unknown
A weekly department labor hour report will almost reasons for variances, while rare, deserve high priority
always reveal differences between the hours to ensure that the operation is in control of labor costs
scheduled and the actual hours worked. Generally, a at all times.
small deviation is permitted. For example, if the labor
performance standard for a position is 210 hours for The procedures discussed so far use one week as
the week, a variance of 2 percent, approximately 4.2 the time period for comparing labor standards and
hours, might be tolerated. So, if actual labor hours actual labor hours. If comparisons are made too
do not exceed 214.2 (210.0 + 4.2), no investigation infrequently, time is wasted and labor dollars are
is necessary. If actual labor hours increase beyond lost before managers notice that a problem might
214.2, analysis and corrective action might be exist. On the other hand, if comparisons are made
required. too frequently, excessive time and money is spent in
assembling data, performing calculations, and making
comparisons. Some time is necessary for labor hours
and costs to average out. Obviously, labor hours can
be higher than established labor standards on some
days and lower on other days.

When a comparison of labor standards with actual

labor results indicates unacceptable variances,
answering several questions might help uncover
potential causes:
•• Are the labor standards established by

position performance analyses correct? If they
are incorrect, the staffing guide itself will be
incorrect. A recurring problem might call for
reviewing position performance analyses and
evaluating the accuracy of the labor standards
used to construct the staffing guide.
LABOR SCHEDULING
•• How accurate are the forecasts used for
scheduling staff? Additional labor hours might SOFTWARE
have been necessary if more meals were Scheduling the right number of employees with
produced and served than forecasted. If this the right skills at the right time requires a thorough
happens frequently, the forecasting techniques understanding of a department’s functions, staff, and
should be reevaluated. demand-drivers (i.e., the factors that affect business
volume). Add to this the reality of a tight labor market
•• Are employees performing tasks that are not in which employees expect schedules to be based
listed in their job descriptions? These tasks upon their preferences, seniority, and union contract
might not have been considered in the initial provisions, and you see there are quite a number
position performance analyses that established of variables that must be taken into account when
labor standards. creating an optimum labor schedule.
•• Are there new employees who do not perform
as efficiently as employees did during the initial demand driver—Factors that influence business
position performance analyses? volume.
•• Have factors affecting labor efficiency changed,
such as menu revisions or new equipment
purchases? If so, updated position performance property management system (PMS)—The set of
analyses leading to revised labor standards application programs that directly relate to a hotel’s
might be necessary. front and back office activities. Note that “application”
is a term for programs that tell a system’s hardware what
•• Are personal or professional problems among it is supposed to do and when and how to do it.
the staff affecting efficiency?
Labor scheduling software packages are designed to
prompt supervisors about their staffing requirements
based on programming that considers the property’s
A weekly department labor hour productivity requirements, group bookings,
report will almost always reveal reservations, and other demand-drivers. The more
differences between the hours sophisticated software packages interface with the
hotel’s computerized property management system
scheduled and the actual hours (PMS). This allows for constant, real-time monitoring
worked. of the conditions that affect a specific department’s
staffing requirements.
The key to such software’s ability to aid management

in optimizing the labor scheduling process is the
interface with computerized systems for reservations,
group histories, forecasting, and human resources

data. The ability to forecast workloads based on the member per 50 corporate checkouts, as opposed to
demand-drivers of specific departments makes a a ratio of 1 staff member per 30 leisure checkouts.
software-aided scheduling process a powerful tool The reason for this discrepancy is that business
for supervisors. travelers often use express check out and direct
billing, while leisure guests do not. Failing to
The procedures to develop a labor schedule in a consider these and related factors can lead to
computerized system are basically the same as when unnecessary over-scheduling or under-scheduling.
a manual system is used. First, desired productivity Through the interface with the hotel’s PMS, the
standards must be established. For example, a scheduling software can capture data needed
housekeeping manager might select 30 minutes as for predicting staffing requirements quickly and
the time it should take a housekeeper to clean a room. accurately.
Then the manager or supervisor must consider the
factors that affect staffing requirements. Examples With the desired productivity standards in place
include the number of forecasted arrivals, departures, and the demand-drivers selected, it takes a
and stayovers for each day, the number of guests per simple “point-and-click” of the PC’s mouse for
room, and the types of rooms. supervisors to generate the staffing requirements
for their departments. Scheduling software also
One of the most important features of employee lets supervisors assign employees to specific work
scheduling software packages is the interface with schedules based on their preferences, seniority,
the hotel’s PMS. Seldom is forecasted demand union contract, wage costs, and proficiency. This
identical to actual demand, and the supervisor must employee-centered scheduling approach might
routinely access the reservation system to determine if improve morale, reduce turnover, and create
adjustments to the next day’s schedule are warranted. maximum flexibility when allocating a hotel’s
The interface enables the software to monitor in real greatest resource—its people.
time the reservations activity, and automatically alerts
the supervisor when forecasted demand significantly When the software alerts a supervisor about the
differs from actual demand and warrants adjustments need to increase staffing levels, it presents a
in staffing levels. prioritized list of employees available to work that
shift. A supervisor can edit the schedule by dropping
Other demand factors can be programmed as well. employees into the scheduling pool for call outs.
Consider how the type of group and its history
affect staffing requirements. A conference of health- Exhibit 10.7 presents a sample software-generated
conscious physicians will likely elicit few sales at schedule of housekeepers to work the week of
the bar, but will increase restaurant sales of health- September 17 through 23. Clicking on “Availability”
conscious items. A fraternal organization will likely at the bottom of the screen alerts the supervisor to
boost beverage sales and lower food sales. These the names of housekeepers available to work each
different groups with different histories will prompt day of the week. The supervisor can scroll down
adjustments to the labor hours scheduled for the bar the list and click on the employee he or she wishes
and dining room. to assign to the schedule.
Experience shows that the number of arrivals and

departures is generally an insufficient predictor of
staffing requirements for the front desk. A departing
group of 200 guests between the hours of 9:00 and
9:45 A.M. will require a larger staff than 200 departures
spread across an entire morning. The type of guest
(such as leisure or corporate) will also have an impact
upon the front desk’s labor requirements.
Front desks might be staffed on a ratio of 1 staff

Exhibit 10.7 A Software-Generated Schedule
An important feature is the software’s ability to automatically produce a labor cost summary. This allows the
supervisor to make comparisons of the scheduled week’s labor costs with what has been budgeted. The
supervisor can review the impact of a possible schedule on the labor budget before the schedule is finalized.
Once the schedule has been approved by the supervisor, an individualized schedule for the upcoming week
can be printed for each employee.
Scheduling software that interfaces with payroll, time and attendance, and back office accounting packages
eliminates the need to re-key data from one software package to another, saving management both time
and money. Managers can choose from numerous reports to make well-informed business decisions. The
selected reports can be formatted by employee, by day, by shift, by department, by union contract, or by other
selected factors.
Another important feature is that scheduling, payroll, and other labor databases can be made available to
corporate controllers on virtual private networks over the Internet. With this easy access, controllers can quickly
generate answers to specific questions and customize reports requested by managers at their individual units
or properties.

MONITORING AND EVALUATING Step 1—Collect and Analyze Informatio

done by simple observation. If supervisors k
PRODUCTIVITY they can observe what is actually being d
A supervisor is often evaluated on the basis of how well he or she manages performance standards for positions within
the productivity of the department’s employees while meeting budget.
This chapter presented practical procedures with which supervisors can: •• Can a particular task be eliminated? Bef
must ask whether the task needs to be
•• Develop productivity standards based on established
performance expectations. •• Can a particular task be assigned to a di
their own carts at the beginning of their
•• Construct a staffing guide based on productivity standards. This could increase the productivity of
•• Create employee work schedules by using the staffing guide in •• Are the performance standards of anoth
conjunction with business volume forecasts. department? For example, the on-site l
linens your department needs. Product
However, even if a supervisor carefully follows these procedures, the
frequent trips to the laundry area to pic
actual productivity of employees on a given day will rarely, if ever,
correspond exactly to the established standards. This is because forecasts
of business volume are themselves rarely, if ever, exact. Therefore,
some variance in productivity is to be expected. For example, when
the actual volume of business is greater than the forecasted volume,
productivity generally increases—but only because the department is
understaffed. Conversely, when the actual volume of business is less
than the forecasted volume, productivity generally decreases—but only
because the department is overstaffed.
The supervisor’s responsibility is to minimize variances in productivity

when, for whatever reason, the department is understaffed or overstaffed.
Supervisors must plan for these occurrences so that appropriate action
can be taken quickly the very day (or shift) that the situation arises. For
example, on a day that the department appears to be understaffed, a
supervisor could call in the appropriate number of full-time or part-time
employees who were not scheduled to work. Part-time employees might
be preferred to avoid possible overtime costs for full-time employees
working an extra shift. On a day that the department appears to be
overstaffed, a supervisor could check if any scheduled employees would
volunteer to take the day off or work shorter shifts.
These are the kinds of adjustments that supervisors must make on a

daily basis to ensure the productivity of employees in their departments. A
challenge for all hospitality supervisors and managers is to be continually
alert to methods that increase the productivity of employees. Understaffing
the department is not an effective solution to increasing productivity.
One of the most difficult and challenging tasks for supervisors is to create
new ways of getting work done in the department. Too often supervisors
get caught up in routine, day-to-day functions (“we have always done it
this way!”) and then fail to question the way things are done. The best way
to increase productivity is to continually review and revise performance
standards. A five-step process for increasing productivity by revising
performance standards can be used.

on about Current
Step 2—Generate
Performance Ideas
Standards.
for New Ways
Often to Get
this thebeJob Done. Generally, when work problems arise, there
can
know what must
is morebe done to meet
than one waycurrent performance
to resolve standards,standards for many hospitality positions are complex.
them. Performance
done and note
It is any
oftendifferences. When analyzing
difficult to pinpoint the exacttasks listed
reasons forincurrent problems or new ideas about completing the
the department,
job moresupervisors should ask the following questions:
efficiently.
fore revising the way in which

Employees, a task is performed,
other supervisors, the supervisor
and guests are important sources of information who can help a supervisor
e carried outpinpoint
in the first
tasksplace.
for revision. Employees who actually perform the job are often the best source for suggested
improvements. Other supervisors might be able to pass on techniques they successfully use to increase
ifferent position? For example,
productivity in theirinstead
areas. of housekeepers
Also, networkingstocking
with colleagues often results in creative ideas that can be
r shifts, the applied
task could be assigned to a night-shift
to other areas. Completed guest houseperson.
comment cards and/or personal interviews with selected guests
day-shift housekeepers by half aofroom.
might reveal aspects the department that supervisors consistently overlook.
her department decreasing the productivity of employees in your
Step 3—Evaluate Each Idea and Select the Best Approach. The actual idea selected might be a blend
laundry area might not be supplying the correct amount of clean
of the best elements of several different suggestions. When selecting the best way to revise current
tivity suffers when housekeepers or dining room staff must make
performance standards, confirm that the task can be done in the time allowed. It is one thing for a “superstar”
ck up clean linens as they become available.
employee to clean a room or register a guest within a specified time; however, it might not be reasonable
to expect an average employee—even after training and with close supervision—to be as productive.
Remember, performance standards must be attainable to be useful.
Step 4—Test the Revised Performance Standard. Have a few employees use the revised performance
standard for a specified time to closely monitor whether the new procedures increase productivity. Remember,
old habits are hard to break. Before conducting a formal evaluation of the revised performance standard,
employees will need time to become familiar with the new tasks and build speed.
Step 5—Implement the Revised Performance Standard. After the trial study has demonstrated that
the new performance standard increases productivity, employees must be trained in the new procedures.
Continual supervision, reinforcement, and coaching during the transitional period will also be necessary.
Most important, if the increased productivity is significant, it will be necessary to change the department’s
staffing guide and then base scheduling practices on the new productivity standard. This will ensure that
increased productivity translates to increased profits through lower labor costs.
WRAP UP

CONCLUSION
Hospitality operations commonly spend 30 percent or more of their
revenue to meet payroll costs. This fact highlights the importance of
the supervisor’s role in managing productivity and controlling labor
costs. This chapter focused on the supervisor’s responsibility to
schedule the correct number of employees, with the right skills, at
the right time each day. It presented step-by-step procedures that
can help hospitality supervisors.
Review Questions
1
Why is it impossible to identify productivity
standards that would apply to all properties
throughout the hospitality industry?
2
How are productivity standards determined?
3
What is the relationship between performance
standards and productivity standards?
4
What is the difference between fixed staff and
variable staff positions?
5
What purpose does a staffing guide serve?
6
How does a base adjustment forecast differ from a
moving average forecast?
7
How can supervisors use a weekly hour labor
report to control and evaluate
the scheduling process?

CHAPTER 11
MANAGING INVENTORIES
Par Levels..............................................................................................144
1
Define par, par levels,
Linens.....................................................................................................145 and par
number.
Types of Linen...........................................................................145
2
Establishing Par Levels for Linens............................................145 Identify the
challenges to
Determining When to Change Linens........................................147 inventory control for
linens in a
Taking a Physical Inventory of Linens.......................................149
housekeeping
Uniforms................................................................................................154 operation.
3
Establishing Par Levels for Uniforms.........................................154
Describe how to
Cleaning Supplies..................................................................................155 establish par levels
and inventory control
Types of Cleaning Supplies.......................................................155 for uniforms.
Establishing Inventory Levels for Cleaning Supplies.................156
4
Describe how to
Wrap Up................................................................................................157 establish par levels
and inventory control
Review Questions......................................................................157 for cleaning supplies.

The executive housekeeper is responsible for two major types of
inventories. Recycled inventories are those items that have relatively
limited useful lives but that are used over and over again in housekeeping
operations. Recycled inventories include linen, uniforms, guest loan
items, and some machines and equipment. Non-recycled inventories are
those items that are consumed or used up during the course of routine
housekeeping operations. Non-recycled inventories include cleaning
supplies, small equipment items, and guest supplies and amenities.
This chapter describes the types of inventories maintained by the

housekeeping department and explains how par stock levels are
established for each type of inventory item. This chapter also discusses
important inventory control measures.
inventories—Stocks of merchandise, operating supplies, and other items

held for future use in a hospitality operation.
recycled inventories—Those items in stock that have relatively limited

useful lives but are used over and over in housekeeping operations. Recycled
inventories include linens, uniforms, major machines and equipment, and
guest loan items.
non-recycled inventories—Those items in stock that are depleted or used

up during the course of routine housekeeping operations. Non-recycled
inventories include cleaning supplies, guest supplies, and guest amenities.
PAR LEVELS
One of the first and most important tasks in effectively managing
inventories is determining the par level for each inventory item. Par
refers to the standard number of inventoried items that must be on hand
to support daily, routine housekeeping operations.
Par levels are determined differently for recycled and non-recycled

inventories. The number of recycled inventory items needed for
housekeeping functions is related to the operation of other hotel functions.
For example, the par level of linen depends upon the hotel’s laundry
cycle. The number of non-recycled inventory items a property needs is
related to the usage rates of different items during daily operations. For
example, par levels of particular cleaning supplies depend upon how fast
they are depleted through routine cleaning tasks.
Inventory levels for recycled items are measured in terms of a par

number—or a multiple of what is required to support day-to-day functions.
Inventory levels for non-recycled items are measured in terms of a range
between minimum and maximum requirements. When quantities of a
non-recycled inventory item reach the minimum level established for that
item, supplies must be reordered in the amounts needed to bring the
inventory back to the maximum level established for the item.

procedures for managing linen inventories also apply
par—The standard quantity of a particular inventory
to blankets and bedspreads.
item that must be on hand to support daily, routine
housekeeping operations.
Establishing Par
par number—A multiple of the standard quantity of a Levels for Linens
particular inventory item that must be on hand to support The first task in effectively managing linens is to
daily, routine housekeeping operations. determine the appropriate inventory level for all
types of linen used in the hotel. It is important that
the inventory level for linens is sufficient to ensure
smooth operations in the housekeeping department.
Shortages occur when the inventory level for linens

is set too low. Shortages disrupt the work of the
housekeeping department, irritate guests who have to
wait for cleaned rooms, reduce the number of readied
rooms, and shorten the useful life of linens as a result
of intensified laundering. Although housekeeping
operations run smoothly when inventory levels are
set too high, management will object to the inefficient
use of linen and to the excessive amount of cash
resources tied up in an overstock of supplies.
The par number established for linen inventories is the

LINENS standard stock level needed to accommodate typical
housekeeping operations. One par of linens equals
Linen is the most important recycled inventory item the total number of each type of linen that is needed
under the executive housekeeper’s responsibility. to outfit all guestrooms one time. This is a number
Next to personnel, linen costs are the highest expense that has recently been revised upward in those hotels
in the housekeeping department. Careful policies and that have adopted triple sheeting and extra pillows
procedures are needed to control the hotel’s inventory for each bed. One par of linen is also referred to as
of linen supplies. The executive housekeeper is a house setup.
responsible for developing and maintaining control
procedures for the storage, issuing, use, and
replacement of linen inventories. house setup—The total number of each type of linen
that is needed to outfit all guestrooms one time. This is
also referred to as one par of linen.
Types of Linen
The executive housekeeper is generally responsible Clearly, one par of linen is not enough for an efficient
for three main types of linen: bed, bath, and table. Bed operation. Linen supplies should be several times
linens include sheets (of various sizes and colors), above what is needed to outfit all guestrooms
matching pillowcases, mattress pads or covers, just once. Two par of linens is the total number of
and duvets. Bath linens include bath towels, hand each type of linen needed to outfit all guestrooms
towels, specialty towels, washcloths, and fabric bath two times; three par is the total number needed to
mats. The housekeeping department may also be outfit all guestrooms three times; and so on. The
responsible for storing and issuing table linens for executive housekeeper must determine how many par
the hotel’s food & beverage outlets. Table linens of linens are needed to support efficient operations
include tablecloths and napkins. Banquet linens are in the housekeeping department. When establishing
a special type of table linen. Due to the variety of a par number for linens, the executive housekeeper
sizes, shapes, and colors, banquet linens may need needs to consider three things: the laundry cycle,
to be kept separate from other restaurant linens in replacement linens, and emergency situations.
the inventory control system. The basic principles and

The hotel’s laundry cycle is the most another par of linen to cover linens that are in transit between the hotel
important factor in determining and the outside linen service. In addition, some commercial laundries
linen pars. Most hotels change will not collect and deliver on weekends. This means that extra stock will
and launder much of their linens be required to cover those days.
daily (the old “wash everything,
every day” rule has been relaxed The second factor to consider when establishing linen par levels is the
in many hotels—usually with replacement of worn, damaged, lost, or stolen linen. Since linen losses
guest approval—because of vary from property to property, executive housekeepers will need to
environmental concerns). At any determine a reasonable par level for linen replacement based on the
given time, large amounts of property’s history. The need for replacement stock can be determined by
linen are in movement between studying monthly, quarterly, or annual inventory reports in which losses
guestrooms and the laundry. and replacement needs are documented. A general rule of thumb is to
When setting an appropriate linen store one full par of new linens as replacement stock on an annual basis.
inventory level, the executive
housekeeper must think through the Finally, the executive housekeeper must be prepared for any emergency
laundry cycle in terms of the hotel’s situation. A power failure or equipment damage may shut down a hotel’s
busiest days—when the hotel is at laundry operation and interrupt the continuous movement of linens
100 percent occupancy for several through the laundry cycle. The executive housekeeper may decide to
days in a row. If housekeeping hold one full par of linens in reserve so that housekeeping operations
manages an efficient on-premises can continue to run smoothly during an emergency.
laundry operation, the laundry cycle
indicates that housekeeping should Therefore, the hotel’s laundry cycle, linen replacement needs, and
maintain three par of linens: one reserve stock for emergencies suggest that a minimum of five par of
par—linens laundered, stored, and linen should be maintained on an annual basis. Properties using an
ready for use today; a second par— outside commercial laundry service will need to add a sixth par to cover
yesterday’s linens, which are being linens in transit.
laundered today; and a third par—
linens to be stripped from the rooms Exhibit 11.1 illustrates a sample par calculation for the number of king-
today and laundered tomorrow. size sheets required for a hotel with 300 king-size beds. In this example,
Executive housekeepers also need 4,500 king-size sheets should be in the hotel linen inventory at all times.
to figure in guest requests for extra Similar calculations need to be performed for every type of linen used
linens, and linens for rollaway beds, in the hotel.
sofa beds, and cribs.
Exhibit 11.1 Sample Par Calculation
The laundry cycle in properties
that use an outside commercial This is a sample calculation of how to establish a par stock level for
laundry service will be somewhat king-size sheets for a hotel that uses an in-house laundry operation
longer than the cycle in properties and supplies three sheets for each of the property’s 300 king-size
with their own in-house laundry beds.
operation. The frequency of
300 king-size beds × 3 sheets per bed = 900 per par number
collection and delivery services
from the commercial laundry will One par in guestrooms 1 × 900 = 900
affect the quantities of linen the One par in floor linen closets 1 × 900 = 900
property needs to stock. The more
frequent the service, the less stock One par soiled in the laundry 1 × 900 = 900
is needed to cover the times when One par replacement stock 1 × 900 = 900
the hotel’s linen is being transported
One par for emergencies 1 × 900 = 900
to and from the laundry service.
A typical turnaround time for a Total number 4,500
commercial laundry is 48 hours. 4,500 sheets ÷ 900 sheets/par = 5 par
In this situation, the executive
housekeeper may need to add

Determining When to Change Linens

Should a hotel change bed sheets in occupied rooms every day? Or is it acceptable to change sheets every
second or third day? Riding the coattails of the environmental movement in the United States, some hotel
managers are asking housekeeping executives to implement a policy to change sheets on alternate days.
With increasing hotel rates and increased guest expectations on one side of the debate, and increased
environmental awareness and responsibility and increased profitability on the other, can hotels create a
win-win situation for everyone?
In a recent survey, half of all respondents stated they already had a policy of changing bed sheets on the
second or third day of a guest’s stay. Since all types of hotels were represented in the group of respondents,
the decision does not seem to be based upon price levels.
Hotel management must decide what policy to adopt. Some hotels will change sheets in every occupied room
every day. Others will place a card on the bed or the doorknob and let the guest decide, the guest can indicate
on the card if he or she wants the sheets changed. Still other hotels will mandate sheet changing only every
second or third day of a stay and will not inform the guest or request guest input.
There are only a few pros and cons to weigh in this policy decision. First and foremost, what does the guest
want? Since serving the guest in a way that will create return business and positive word-of-mouth publicity
is a hotel staff’s first mission, it is important to measure guest feedback on this question. Although hotels that
currently change sheets on alternate days report that they do have some guest complaints, the majority of
their guests support the effort to limit the use of water and chemicals to help protect the environment. Hotels
must obtain feedback from their own guests.
Beyond just seeking feedback, research has shown that the message on the cards left for guests may
influence their choice to reuse their linens or not. The most effective message tested (resulting in about a 45
percent participation rate by guests) stated, “We’re doing our part for the environment. Can we count on you?
Because we are committed to preserving the environment, we have made a financial contribution to a non-
profit environmental protection organization on behalf of the hotel and its guests. If you would like to help us
recover the expense while conserving natural resources, please reuse your towels during your stay.”
Second, what procedures can be implemented to ensure that the room-cleaning process remains acceptable
and invisible to guests while retaining quality controls?
Third, will the cost savings in labor, chemicals, or energy cover any extra costs in guest complaints, labor to
redo early departures, or other efforts to maintain the system? Some hotels have realized as much as a 1.8-
room improvement in productivity per day, but many report no change.

Some operational issues include:
1. Housekeeping employees who have been trained to change bedsheets daily or face disciplinary action
or termination must be retrained. Although most room attendants are happy to avoid changing every
bed, communicating which beds should be changed and which should not can be difficult. Hotels with
employees who speak little or no English face an even greater communication challenge.
2. A system must be devised to record which beds have been changed and which have only been
made up. The system must include a code that identifies the status of each bed in two-bed rooms.
This system must provide for guests who were supposed to stay over, but departed early. The room
attendant (if he or she is still on the property) should return to the room to make the bed again, but
with fresh linen. If the room attendant has departed for the day, someone else must remake the bed
before the room can be noted as clean and vacant.
3. If bed linen is changed only on alternate days, establish a system to note on the room attendant’s
daily assignment sheet which beds to change that day. This can be accomplished when the person
preparing the morning report reviews the arrival date of each stayover and highlights or marks the
rooms in which to change sheets.
4. Since some hotels give the guest a card to indicate whether he or she wants the linen changed, the room
attendant must mark the assignment sheet as to whether the sheets were changed. If a guest returns
to the room after business hours and complains that the bed was not changed, the staff member on
call will have to quickly remake the bed and later check the day’s records to investigate the complaint.
5. Room attendants must learn how to decide whether to change sheets on days when it is not required
but when the sheets are not acceptably clean. For instance, would makeup on a sheet mean changing
the linen? What if there were an ink pen mark on the pillowcase?
6. Because most hotels want the guest to feel like the bed has been changed, they tuck the bedspread
over the pillows. A different approach might be to leave the bed with a turndown look that is welcoming
to guests but also signals staff that the sheets have not been changed.
7. If the staff chooses to let the guest decide whether to have the sheets changed, the language of
the information card or door hanger should be carefully selected. There are groups that will provide
collateral materials, such as the American Hotel & Lodging Association. One card offered in AH&LA’s
materials is designed for towels and asks guests to put the towel back on the rack if they are willing
to use it again. The second card is for bed sheets. Usually, the cards are laminated for longer life and
contain translations in English, French, German, Japanese, and Spanish.
The percentage of sheets left unchanged may vary among hotels, depending on the average length of stay
and type of guest. If, for instance, the hotel’s average length of stay is 2.8 days, and the policy is to change
sheets every three days, in effect, the policy is to change sheets in checkouts only.
General managers want to know how this change in policy affects the bottom line. While room-cleaning
productivity may remain relatively unchanged, some hotels project that linen life may be prolonged by 15
percent and outside laundry costs may be reduced by 9 percent. In fact, real savings come from the laundry.
In a national survey conducted by Ecolab, the average cost of cleaning hotel guestroom linens is $0.232 per
pound. These cost factors were compiled with laundries operating at maximum efficiency. Considering that
a king sheet weighs about 1.8 pounds; a double sheet 1.2 pounds; and a pillowcase .3 pounds; there is a
minimum potential savings of 3 pounds, or almost a dollar per room.

The most important factor is for the control is vital for maintaining a careful budget and for ensuring that the
staff to be honest with themselves housekeeping department has adequate supplies to meet the hotel’s
and the guests. Is saving the linen needs. The need to replenish the hotel’s linen supply is determined
environment the issue? Or is it on the basis of each physical inventory.
saving the bottom line? Guests
may not appreciate a reduction in Typically, the physical inventory is conducted by the executive
service if they do not see consistent housekeeper and the laundry supervisor working together. In large hotels,
environmental actions in other other housekeeping staff may be recruited to help count linen supplies.
areas (such as compact fluorescent In most cases, the inventory is taken by staff members working in teams.
light bulbs, recycling bins, or One person calls out the count for each type of linen, while the other
motion sensors to control HVAC). records the quantity on an inventory count sheet. It is not unusual for the
Will guests stop staying at a hotel hotel’s controller or a representative of the accounting department to be
just because their sheets are not involved in spot-checking counts and verifying the accuracy of the final
changed? Can we expect guests inventory report. When the inventory is complete, a final report is sent to
to ask during reservation calls, “Do the hotel’s controller or general manager for final verification and entry.
you change your bed sheets every
day?” Will we see advertisements All linens in all locations must be included in the count. The executive
with the tag line “We change sheets housekeeper should plan to take the inventory at a time when the
daily”? Probably not. In fact, if a movement of linen between guestrooms and the laundry can be halted.
hotel provides proper training, This typically means that the inventory is taken at the end of a day shift
thorough operational procedures, after the laundry has finished its work, after all guestrooms have been
and related environmental efforts, made up with clean linens, and after all floor linen closets have been
it can save many gallons of water, brought back to their par levels. All soiled linen chutes should be sealed
tons of detergent, and vast amounts or locked to avoid any further movement of linen.
of energy—and still please guests.
If guests are supportive of the
The next step is to determine all the locations in the hotel where linens
efforts, it is a win-win situation.
may be found. The executive housekeeper needs to take all possible
locations into consideration, including:
Taking a Physical
Inventory of Linens •• Main linen room.
A physical inventory of all linen •• Guestrooms.
items in use and in storage is the
most important part of managing •• Floor linen closets.
linen inventories. A complete count •• Room attendant carts.
should be conducted as often as
once a month. At the very least, •• Soiled-linen bins or chutes.
physical inventories should be taken
•• Soiled linen in laundry.
quarterly. Typically, the physical
inventory is taken at the end of •• Laundry storage shelves.
each accounting month to provide
the executive housekeeper with •• Mobile linen trucks or carts.
important cost-control information •• Made-up rollaway beds, cots, sofa beds, cribs, etc.
needed to monitor the department’s
budget. The executive housekeeper should prepare a linen count sheet which
can be used to record the counts for every type of linen in each location.
As a result of regular physical Space should be allocated at the top of each count sheet for the date,
i n v entor i es, th e e xecu tive location, and names of the staff members performing the count. Down
housekeeper has accurate figures the left side of each count sheet should be a list of every type of linen
on the number of all items in use, as item to be counted. In making up the inventory list for the count sheets,
well as those considered discarded, the executive housekeeper should be sure to differentiate among all
lost, or in need of replacement. This

types, sizes, colors, and other linen features. In addition, the counting The second line on the chart
process will be quicker and easier if the inventory listing is organized in identifies the date that a physical
the same way as linen items on storage shelves. Exhibit 11.2 shows a inventory was last taken. The
sample count sheet for recording linen quantities in a ﬂoor linen room executive housekeeper should
and on corresponding room attendant carts. transfer linen counts from previous
inventory records onto this line.
Exhibit 11.2 Sample Linen Count Sheet
The third line on the chart is used
to record the numbers of new
linen items received since the last
Inventory Count Sheet–Guestroom Linens
physical inventory. These figures
Name Date Floor should include both unopened linen
shipments received and new linen
items that have already been put
Item Closet Cart 1 Cart 2 Cart 3
into use.
Pillowcases
The fourth line totals the on-hand
quantities from the previous
King-Size Sheets
physical inventory (line 2) and the
Queen-Size Sheets quantity of newly received linen
items (line 3).
Twin Sheets
Next, line five is used to record the
Bath Mats number of linen items known to
have been discarded since the last
Bath Towels physical inventory. These totals can
be obtained by examining the linen
Hand Towels discard record (see Exhibit 11.3).
Washcloths By subtracting the numbers of

discarded linens (line 5) from the
subtotals (line 4), the executive
Using the count sheets, two-person teams can conduct the physical housekeeper knows the totals
inventory at each linen location. One person should count and call out for each linen type that can be
the number corresponding to a particular kind of linen, while the other expected to be on hand. These
person records the quantities in the appropriate place on the standard expected totals are recorded on
count sheet. A third person might spot-check counts to ensure accuracy. line 6.
After the counting process is completed and all standard count sheets The second part of the form
have been filled out, the executive housekeeper should collect the sheets provides spaces for recording the
and transfer the totals to a master inventory control chart. Once the totals counted for every linen type
totals are collected, the results of the inventory can be compared to the at each of the linen locations. These
previous inventory count to determine actual usage and the need for totals are obtained by tallying and
replacement purchases. transferring the totals listed for
each linen type on the standard
Exhibit 11.4 shows a sample master inventory control chart for linens. count sheets. The quantities of
Across the top of this master control chart in the first part of the form is each linen type counted at every
a line for listing all inventory items in the hotel’s linen supply. This listing location are totaled on line 15 of the
should correspond to the listing of linen items used on the standard form. These figures represent the
count sheets. actual on-hand quantities for every
type of linen in the hotel’s inventory.

The third part of the form helps the executive
housekeeper analyze the results of the physical
inventory. By subtracting the counted totals for each
linen item (line 15) from the corresponding expected
quantities (line 6), the executive housekeeper can
determine an accurate number lost for each linen
item. This figure is recorded on line 16. Linen loss
is the variance between the totals from the previous
inventory (plus new purchases received) and the
results of the current inventory. While the physical
inventory reveals the losses for linen items, it does
not show why these losses occur. If the variance
between expected and actual quantities is high,
further investigation is needed.
After each physical inventory, the executive

housekeeper should make sure that the par levels
are brought back to the levels originally established
for each linen item. The par numbers for each linen
type are recorded on line 17. These figures represent
the standard numbers of each linen type that should
always be maintained in inventory. By subtracting
the actual quantities of each linen type on hand (line
15) from the corresponding par levels (line 17), the
executive housekeeper can determine the quantities
of each linen type that are needed to bring inventories
back up to par. These amounts are recorded on line
18. By subtracting quantities of linen items that are
on order but not yet received (line 19), the executive
housekeeper knows precisely how many of each linen
type still needs to be ordered to replenish the par
stock. This figure is recorded on line 20. As a result
of the physical inventory, the executive housekeeper
can determine which linens and what amounts of each
type are needed to replace lost stock and maintain
established par levels.

Exhibit 11.3 Sample Linen Discard Record
Front Page
LINEN DISCARD RECORD
HOUSEKEEPER’S INITIALS: GENERAL MANAGER’S INITIALS: PERIOD ENDING:
Mattress Pad
Mattress pad
Washcoths
Bedspread
bedspread
Pillowcase
Pillowcase
Crib Sheet
Bath Mats
Curtains
Shower
Blanket
Blanket
Towels
Towels
Double
Double
Double
Double
Double
Double
Sheets
Sheets
Pillow
Pillow
Hand
Bath
King
King
King
King
King
Kinf
DATE
Total
Discarded
Back Page
DISCARD METHODS
ITEM HOW DISCARDED ITEM HOW DISCARDED
COMMENTS:
BY:
(EXECUTIVE HOUSEKEEPER)

Exhibit 11.4 Sample Master Inventory Control Chart
HOUSEKEEPING LINEN INVENTORY

LOCATION NAME: LOCATION NUMBER:
GM’S INITIALS: PREPARED BY: INVENTORY DATE:
Part I
1. Item
2. Last Inventory Date ()
3. New Record
4. Subtotal 2 + 3
5. Recorded Discards
6. Total 4 ─ 5
Part II
7. Storage Room
8. Storage Room
9. Storage Room
10. Linen Room
11. Laundry
12. On Carts
13. In Rooms
14.On Rollaways, Cribs, Etc.
Total On Hand
15. Add 7 Through 14
Part III
16. Losses 6 ─ 15
17. Par Stock __________ Turns
18. Amount Needed 17 ─ 15
19. On Order
20. Need To Order 18 ─ 19

The completed master inventory
control chart should be submitted
along with the linen discard record
(Exhibit 11.3) to the hotel’s general
manager. The general manager
will then verify and initial the
report before transferring it to the
accounting department. The hotel’s
accounting department will provide
the executive housekeeper with
valuable cost information related
to usage, loss, and expense per
occupied room. This information
is useful in determining and
monitoring the housekeeping
department’s budget.
Physical inventories of table linen

used by the food & beverage
department should be handled
in much the same way as room
linens. The same general rules and
procedures should be followed—
and the same general forms used.
Inventory lists should be prepared
for each food and beverage outlet—
including banquet facilities—that
itemize all types, sizes, and colors
of table linens the hotel uses. The
inventory should be taken when UNIFORMS
the movement of table linens to Many hotel departments have uniformed staff members. Sometimes,
and from the laundry can be halted each department is responsible for maintaining its own inventory of
and each food and beverage outlet uniform types and sizes. More typically, the housekeeping department
is fully stocked to its established stores, issues, and controls uniforms used throughout the property. This
par levels. By following the same can be a very complex responsibility—especially in a large hotel with
procedures used for room linens, many uniforms of varying types, quantities, and sizes.
the total inventory of table linens can
be calculated, and the executive Establishing Par Levels for Uniforms
housekeeper can determine the Determining the number of types and sizes of uniforms to have on hand
need for replacement stock. can be very difficult. Among the factors that can make the task a true
challenge are varying department needs, uneven distribution of size
requirements, unavoidable turnover, and unpredictable damage from
accidents.
The executive housekeeper can ensure that a sufficient supply of all types
of uniforms is placed into service based on information supplied by the
department heads. To establish par levels for all types of uniforms, the
executive housekeeper needs to know how many uniformed personnel
work in each department, what specific uniforms they require, and how
often uniforms need cleaning. Sizing problems can be handled by having
uniforms tailored when they are first issued to new employees.

Another factor to consider in The executive housekeeper may also want to consider the needs of
establishing par levels is the uniformed personnel across various departments. Since front-of-the-
turnaround time required by the house employees are continuously in the public eye, their need to be neat
laundry for processing uniforms. and clean all day is particularly important. The executive housekeeper
The par level for uniforms depends, may want to maintain higher uniform pars for front office employees,
in large part, on how frequently since they may need to change uniforms more frequently. Similarly, chefs,
uniforms need laundering. If, for stewards, and other kitchen personnel may need two daily changes of
example, uniforms are laundered uniforms, since cleanliness is important for hotel staff dealing directly
only once a week, each employee with food.
would have to be issued five
uniforms weekly. In this unlikely In many hotels, the employees themselves are responsible for the
situation, each employee would maintenance of the uniforms. However, since the law may require that
exchange five soiled uniforms employees be compensated for uniform cleaning, a hotel may be able to
for five cleaned uniforms at the reduce costs by processing uniforms through the property’s own laundry
beginning of each week. Counting service.
the uniform worn on the day of
the exchange, this would require
maintaining a par of eleven
uniforms for each employee.
A more likely scenario would involve

laundering uniforms on a daily basis
and exchanging a clean uniform
for a soiled one each day. In this
situation, a minimum of three par
of uniforms would be required. One
par is worn by employees, another
is turned in to be cleaned, and a
third is issued in exchange. Daily
washing would be more practical
and less costly than laundering
uniforms on a weekly basis. Every
employee would have a spare clean CLEANING SUPPLIES
uniform (in addition to the one being Cleaning supplies and small cleaning equipment are part of the non-
worn) in case it was needed during recycled inventory in the housekeeping department. These items are
the day. Uniform rooms could be depleted in the course of routine housekeeping operations. Controlling
staffed for daily uniform exchanges inventories of all cleaning supplies and ensuring their effective use is an
at the beginning of each shift. important responsibility of the executive housekeeper. The executive
housekeeper must work with all members of the housekeeping department
The executive housekeeper to ensure the correct use of cleaning materials and adherence to cost-
may decide that five par is more control procedures.
reasonable. This would keep
an adequate supply on hand for Types of Cleaning Supplies
new employees and for replacing
A variety of cleaning supplies and small equipment is needed to carry
uniforms for existing personnel.
out the tasks of the housekeeping department. Basic cleaning supplies
Five par would also ensure that an
include all-purpose cleaners, disinfectants, germicides, bowl cleaners,
adequate supply of spare uniforms
window cleaners, metal polishes, furniture polishes, and scrubbing pads.
was available during the day in
case of accidents or unexpected Small equipment needed on a daily basis includes applicators, brooms,
damage. dust mops, wet mops, mop wringers, cleaning buckets, spray bottles,
rubber gloves, protective eye covering, and cleaning cloths and rags.

Establishing Inventory Levels The maximum quantity established for each cleaning
supply item refers to the greatest number of purchase
for Cleaning Supplies units that should be in stock at any given time. An
Since cleaning supplies and small equipment are part executive housekeeper should consider several
of non-recycled inventories, par levels are closely tied important factors when determining maximum
to the rates at which these items are depleted in the inventory quantities for cleaning supplies. First, he or
day-to-day housekeeping operations. A par number for she must consider the amount of available storage
a cleaning supply item is actually a range between two space in the housekeeping department and the
figures: a minimum inventory quantity and a maximum willingness of suppliers to store items at their own
inventory quantity. warehouse facilities for regular shipments to the
hotel. Second, the shelf lives of certain items need
The minimum quantity refers to the fewest number of to be taken into account. The quality or effectiveness
purchase units that should be in stock at any given of some products deteriorates if they are stored too
time. Purchase units for cleaning supplies are counted long before being used. Third, maximum quantities
in terms of the normal shipping containers used for the should not be set so high that large amounts of the
items such as cases, cartons, or drums. The on-hand hotel’s cash resources are unnecessarily tied up in
quantity for a cleaning supply item should never fall an overstocked inventory.
below the minimum quantity established for that item.
Minimum quantities are established by considering lead-time quantity—The number of purchase units
the usage factor associated with each item. The usage consumed between the time that a supply order is placed
factor refers to the quantity of a given non-recycled and the time that the order is actually received.
inventory item that is used up over a certain period.
The rate at which cleaning supplies are consumed minimum quantity—The fewest number of purchase
by housekeeping operations is the chief factor for units that should be in stock at any given time.
determining inventory levels for these non-recycled
items. safety stock—The number of purchase units that must
always be on hand for smooth operation in the event of
The minimum quantity for any given cleaning supply emergencies, spoilage, unexpected delays in delivery,
item is determined by adding the lead-time quantity or other situations.
to the safety stock level for that particular item. The
lead-time quantity refers to the number of purchase
maximum quantity—The greatest number of purchase
units that are used up between the time that a
units that should be in stock at any given time.
supply order is placed and the time that the order
is actually received. Past purchasing records will
show how long it takes to receive certain supplies.
Executive housekeepers should keep in mind not
only how long it takes suppliers to deliver orders, but
also how long it takes the hotel to process purchase
requests and place orders. The safety stock level for
a given cleaning supply item refers to the number
of purchase units that must always be on hand for
the housekeeping department to operate smoothly
in the event of emergencies, spoilage, unexpected
delays in delivery, or other situations. By adding the
number of purchase units needed for a safety stock
to the number of purchase units used during the lead-
time, the executive housekeeper can determine the
minimum number of purchase units that always needs
to be stocked.

WRAP UP
CONCLUSION
This chapter describes the types of inventories maintained by
the housekeeping department and explains how par stock levels
are established for each type of inventory item. This chapter also
discusses important inventory control measures.
Review Questions
1
What are some of the typical items in recycled and
non-recycled inventories?
2
What is the basic premise for establishing par
levels for recycled inventories? for
non-recycled inventories?
3
What three factors should be considered when
setting par levels for linen?
4
What are some of the typical ways the executive
housekeeper and the laundry supervisor work
together to control linen inventories?
5
What are the main benefits of conducting physical
inventories? How often should physical inventories
be taken?
6
What factors make it difficult to establish par levels
for uniforms?
7
What is meant by minimum quantity?
Maximum quantity?

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DISCLAIMER

This publication is designed to provide accurate and authoritative information in

-From the Declaration of Principles jointly adopted by the American Bar

Nothing contained in this publication shall constitute a standard, an endorsement,

All rights reserved. No part of this publication may be reproduced, stored in

2016 American Hotel & Lodging Educational Institute

Purposes of the Balance Sheet.................................................................2

Balance Sheet Formats.................................................................4

2016 American Hotel & Lodging Educational Institute

Balance sheet—statement of the financial position of the hospitality

Management, although generally more interested in the income statement

Current ratio—ratio of total current assets to total current liabilities

Creditors are interested in the hospitality operation’s ability to pay its

Investors are most often interested in earnings that lead to dividends. To

2016 American Hotel & Lodging Educational Institute

2016 American Hotel & Lodging Educational Institute

Account format—a possible

The group totals on the report

The daily report of

2016 American Hotel & Lodging Educational Institute

Exhibit 1.2 Balance Sheet Account Format CONTENT OF

2016 American Hotel & Lodging Educational Institute

Current Assets. Current assets, listed in the order

2016 American Hotel & Lodging Educational Institute

2016 American Hotel & Lodging Educational Institute

2016 American Hotel & Lodging Educational Institute

3. Should some of the dollars invested in marketable

Horizontal analysis—comparing financial statements

Comparative balance sheets—balance sheets from two

The relative change (also called the percentage Vertical Analysis

2016 American Hotel & Lodging Educational Institute

Vertical analysis—analyzing individual financial statements by reducing financial information to percentages of a

Exhibit 1.5 Comparative Balance Sheets

COMPARATIVE BALANCE SHEETS - STRATFORD HOTEL

2016 American Hotel & Lodging Educational Institute

Exhibit 1.6 Fluctuation Explanation ($5,000) may not be excessive

Marketable Securities Common-size balance sheets—

Treasury Bills 150,000 25,000 125,000 Examine the Stratford Hotel’s

2016 American Hotel & Lodging Educational Institute

COMMON-SIZE BALANCE SHEETS - STRATFORD HOTEL

Marketable Securities 784,687 155,465 7.5 1.6

Total 7,440,760 7,018,500 71.5 70.2

2016 American Hotel & Lodging Educational Institute

Exhibit 1.8 Base-Year Comparison

BASE-YEAR COMPARISONS CURRENT ASSETS STRATFORD HOTEL

20X2 20X1 20X0

Cash 126.30% 103.33% 100.00%

Marketable Securities 339.32% 67.23% 100.00%

Accounts Receivable (net) 124.39% 102.92% 100.00%

Inventories 110.55% 104.02% 100.00%

Other 114.11% 103.37% 100.00%

Total Current Assets 152.71% 98.18% 100.00%

2016 American Hotel & Lodging Educational Institute

2016 American Hotel & Lodging Educational Institute

Major Elements of the Income Statement............................................16

2016 American Hotel & Lodging Educational Institute

Users of financial statements examine an operation’s income statements

1. How profitable was the hospitality operation during the period?

2. What were the total sales for the period?

3. How much was paid for labor?

4. What is the relationship between sales and cost of sales?

5. How much have sales increased over last year?

7. How much was spent to market the hospitality operation’s services?