Step 2: Departmental Revenue Adjustments

There are two ways in which departmental revenue can reasonably be adjusted, using a POR adjustment, or a percentage of revenue adjustment.

To use a POR adjustment, take the budgeted revenue POR for each department other than rooms, and multiply it by the new number of occupied rooms implied by the adjusted occupancy percentage. For example, the budget contemplated Food & Beverage (F&B) revenue of $47.25 POR in 2010. The adjusted 2010 occupancy for our hotel is 65.3%, implying 47,634 occupied rooms (65.3% X 200 rooms X 365 days). Thus, the adjusted F&B budget revenue for 2010 is $2,346,684, compared with the $2,173,000 budgeted.

To use a percentage of revenue adjustment, adjust the revenue for each department to match the percentage of total revenue indicated by the budget. For example, to calculate the adjusted F&B revenue, take the adjusted Rooms Revenue of $6,743,842 and divide by 69.0% to get the total revenue that is consistent with the budget expectation that Rooms Revenue would account for 69.0% of total revenue. The result is $9,774,684. Take that number and multiply it by 24.0%, the budgeted F&B Revenue percentage of total revenue. The result is $2,345,684.

There are several factors to consider in deciding which of the two adjustment approaches to use. If, for instance, actual market RevPAR turned out to be better than expected primarily because occupancy was greater than anticipated, it may make more sense to use a POR adjustment. If market ADR turned out to be higher than estimated (possibly as an indication that guests are becoming less price sensitive), a percentage of revenue adjustment may be more appropriate. It is, of course, possible that both occupancy and ADR turn out to be significantly different than projected. Attention should be paid as to whether market segmentation changed significantly, as some segments tend to spend more throughout the hotel than others. For instance, groups tend to consume more F&B (through catering events) than individual travelers. There is no single perfect adjustment, but making one simple adjustment that is reasonable is a good starting point. In any case, the result should provide a more relevant comparison than the unadjusted budget.

Step 3: Departmental Expense Adjustments

Adjusting departmental expenses can be done based on POR or departmental expense percentages. For the Rooms department, using the same expense POR as the original budget usually makes the most sense. For other departments, adjusting the dollar amounts to keep the same expense ratios as the original budget is generally the best policy.

Departmental expense ratios tend to decrease—i.e., get better—as related revenue increases (because fixed expenses logically stay the same while only variable expenses increase). However, determining the exact ratio of fixed to variable expenses can be somewhat subjective. In order to avoid introducing such subjectivity, we favor a simplistic approach. Individual cases may warrant different treatment.

Step 4: Undistributed and Fixed Expense Adjustments

Undistributed operating expenses and fixed expenses tend to be more fixed than departmental expenses. Hence, keeping them more in line with the original budget tends to make the most sense.

In cases where there are wide differences in occupancy between the adjusted and original budgets, adjusting POM and Utilities expenses in the adjusted budget to match the original budget’s percentages of total revenue or POR amounts could be warranted.

With the exception of Reserve for Replacement, fixed expenses do not vary with changes in revenue. In our example, we kept Property Taxes and Insurance the same as in the original budget. We assumed Reserve for Replacement would remain at a constant 3.0% of total revenue.

Financial Pro Forma Review

Table 5 shows the 2010 budget adjusted for actual market performance, as well as the hypothetical 2010 actual performance. We added two variance columns, one comparing the percentage differences between 2010 actual and the original budget, and a second one comparing actual results against the adjusted budget.

As can be seen, had our hotel maintained the same occupancy and ADR penetration levels it held in 2009, it should have been able to produce income of $1.7 million, compared with the $1.3 million that was actually generated and the $1.2 million that was budgeted. The difference between the originally budgeted $1.2 million and the adjusted $1.7 million can be attributed primarily to a more favorable market than the budget anticipated. While management produced actual net income that was 8.0% better than budgeted, this result fell 24.8% below where it should have been had the hotel’s competitiveness been maintained.

As with any financial review, it is important to look at more than one point of comparison. Reviewing previous-year performance and longer-standing historical trends should also be part of a thorough financial evaluation.

Management’s job is to maximize both cash flow and long-term asset value. Customer and employee satisfaction, service delivery, life and safety issues, physical maintenance, and community development are only some of the additional elements that can play an important part in building an asset’s long-term value. Focusing on short-term financial results, while important, should not be the only measure to evaluate management’s performance.