Financial Management in the Hospitality Industry PDF

UNIT 1: FINANCIAL MANAGEMENT AND THE HOSPITALITY INDUSTRY Learning Outcomes: At the end of the Chapter, you should be able to: 1.​ Understand the financial management challenges of hospitality organizations. 2.​ Realize the importance of forecasting revenues and controlling expenses in...

UNIT 1: FINANCIAL MANAGEMENT AND THE HOSPITALITY INDUSTRY Learning Outcomes: At the end of the Chapter, you should be able to: 1.​ Understand the financial management challenges of hospitality organizations. 2.​ Realize the importance of forecasting revenues and controlling expenses in achieving target profit. 3.​ Understand the importance of finance in organizations. 4.​ Identify the three areas of finance in organizations. 5.​ Discover the goals of firms. 6.​ Review the forms of organizations. 7.​ Understand the relationship of intrinsic value and stock market price. INTRODUCTION Hospitality is an exciting and multifaceted industry that offers a variety of career opportunities to those who have earned a hotel/ restaurant management degree. Careers with hotel, restaurant, airline, cruise line, gaming, and wine and spirit companies are readily available to such graduates. In addition, careers with service firms that support hospitality companies in the areas of accounting, consulting, real estate development, architecture, interior design, real estate brokerage, hotel valuation, investment banking, mortgage brokerage, insurance, advertising, and technology are also available to those with hospitality degrees. Although dynamic and interesting, the business of hospitality presents many challenges. For example, hospitality businesses operate on low profit margins with fluctuating sales volumes. The ability to forecast revenues and control expenses is critical to achieving budgeted profits and a favorable return on investment for the owners of the company. Also, because hospitality businesses are labor intensive, scheduling employee hours so they are consistent with forecasted revenues and monitoring payroll cost daily are just two major management challenges. While a hospitality business typically requires a relatively low level of operating inventories, it requires a relatively high level of capital for its real estate component. This component often includes buildings, operating systems, guest room furniture, and restaurant equipment. Securing financing to acquire these assets is a continuing challenge for management. Finally, hospitality businesses rely heavily on the discretionary income of their customers. During a weak economy, when household discretionary income is low, the hospitality industry usually suffers. High-end establishments, such as resorts and fine dining restaurants, normally feel the effects of a weak economy first, but eventually, the entire industry feels the financial pain. However, as soon as the economy takes a turn for the better, consumers return, discretionary spending increases, and the industry prospers. Accurately predicting these economic fluctuations, and knowing when to buy and sell hospitality assets, can be financially lucrative for the astute hospitality investor. OVERVIEW OF FINANCIAL MANAGEMENT What is finance: cash flows between capital markets and firm’s operations (1) Cash raised by selling financial assets in financial markets (2) Cash invested in firm’s operations and used to purchase real assets (3) Cash generated from firm’s operations (4a) Cash reinvested in firms’ operations (4b) Cash returned to investors Financing decisions vs. investment decisions: raising money vs. allocating money Activity (1) is a financing decision Activity (2) is an investment decision Activities (4a) and (4b) are financing decisions The role of a financial manager: Forecasting and planning of firms’ financial needs Making financing and investment decisions Coordinating with other departments/divisions Dealing with financial markets Managing risks Finance within an organization: importance of finance Finance includes three areas (1) Financial management: corporate finance, which deals with decisions related to how much and what types of assets a firm needs to acquire, how a firm should raise capital to purchase assets, and how a firm should do to maximize its shareholders wealth - the focus of this class (2) Capital markets: study of financial markets and institutions, which deals with interest rates, stocks, bonds, government securities, and other marketable securities. It also covers Federal Reserve System and its policies. (3) Investments: study of security analysis, portfolio theory, market analysis, and behavioral finance The goal of a firm To maximize shareholder’s wealth (or firm’s long-run value) Why not profit or EPS (earnings per share) maximization? Profit maximization usually ignores timing and risk of cash flows EPS sometimes can be manipulated or misleading Forms of business organization Proprietorship: an unincorporated business owned by one individual Advantages: Easy and inexpensive to form Subject to less government regulations Lower income taxes Disadvantages: Unlimited personal liability Limited lifetime of business Difficult to raise capital Partnership: an unincorporated business owned by two or more people Advantages vs. disadvantages: similar to those of proprietorship, in general Corporation: legal entity created by a state Advantages: Limited liability Easy to transfer the ownership Unlimited lifetime of business Easy to raise capital Disadvantages: Double taxation (at both corporate and individual levels) Cost of reporting S Corporation: allows small business to be taxed as proprietorship or partnership Restrictions: no more than 100 shareholders; for small and privately-owned firms Limited Liability Company (LLC) and Limited Liability Partnership (LLP): Hybrid between a partnership and a corporation - limited liability but taxed as partnership LLPs are used in professional fields of accounting, law, and architecture while LLCs are used by other businesses Intrinsic value and market price of a stock Intrinsic value is an estimate of a stock’s “fair” value (how much a stock should be worth) Market price is the actual price of a stock, which is determined by the demand and supply of the stock in the market Determinants of intrinsic value and stock price Intrinsic value is supposed to be estimated using the “true” or accurate risk and return data. However, since sometimes the “true” or accurate data is not directly observable, the intrinsic value cannot be measured precisely. Market value is based on perceived risk and return data. Since the perceived risk and return may not be equal to the “true” risk and return, the market value can be mispriced as well. Stock in equilibrium: when a stock’s market price is equal to its intrinsic value the stock is in equilibrium Stock market in equilibrium: when all the stocks in the market are in equilibrium (i.e. for each stock in the market, the market price is equal to its intrinsic value) then the market is in equilibrium Actual prices vs. intrinsic values When the intrinsic value of a stock is higher than the market price of the stock, we say that the stock in the market is under-valued (under-priced) For example, if the intrinsic value for a stock is $26 and the market price is $25, then the stock is under-valued. When the intrinsic value of a stock is lower than the market price of the stock, we say that the stock in the market is over-valued (over-priced) For example, if the intrinsic value for a stock is $30 and the market price is $32, then the stock is over-valued. When the intrinsic value of a stock is equal to the market price of the stock, we say that the stock in the market is fairly priced (the stock is in equilibrium)