Measuring hotel performance is an extremely important part of the management process. For years, one of the key performance indicators of hotel performance has been RevPAR, or Revenue Per Available Room. This metric, although useful, is lacking because it does not measure the profitability of your hotel, only top line performance. When analyzing our hotel investments, our priorities should be net cash generated and return on investment, which stems from profitability, and RevPAR only captures half of the equation.
Recently, profitability measures have been picking up steam as useful tools to evaluate hotel performance. Flex/Flow and GOPPAR have provided some useful insights at Genesis Hospitality Management, and we are confident that they can for your properties as well.
Flex and Flow monitoring is a tool to analyze how well you are managing costs when revenues change. Flex/Flow analysis is essentially cost control analysis, but viewing it in the manner below adds some context for differing levels of revenue. It may also allow us to see if we are being too tight, which may provide short-term profitability gains, but decrease overall guest satisfaction which may decrease profitability in the long run.
Flow tells us how well we controlled costs when revenue is over budget or target.
Flex tells us how well we controlled costs when revenue is under budget or target.
We can calculate this simply by taking profit variance divided by revenue variance. An example will illustrate how this works. Let’s assume the following:
The above example shows a flow situation. Our actual revenue performance exceeded budget. Our flow percentage is calculated as 60% ($15,000/$25,000.) 60% of our additional revenue was turned into net profit. Determining if this percentage is acceptable or not is the challenge. Here are a few suggestions on how to properly analyze this flex/flow situation:
If you look at our budget, we have budgeted for a net profit percentage of 40% ($80,000/$200,000.) Thus, we have turned our additional revenue into profit at a greater rate than budgeted. You might think this is good, however, if you give it some thought, our additional revenue should be retained at a higher level due to the fact that our fixed costs are already covered. We will only have additional variable costs with every incremental dollar of revenue. So, we may decide that 60% flow is not an acceptable target.
Determining an acceptable Flow target is best done by using historical hotel information. If you take a years worth of data and calculate Flex/Flow by month, you will be able to determine what your Flow percentage is on average. If possible, you can compare this to other properties in your portfolio that are similar in nature. Then, you may be able to determine if there is the opportunity to increase your Flow percentage. You can dive deeper into this to determine the actual expense areas for improvement with budget and actual percentages of revenue on your P&L, and even better, per room expense stats on your P&L.
Here, our flex percentage is calculated as 20% ($(5,000)/$(25,000)). With Flex percentage, a lower number is better. The thought is, we lost a lesser amount of our lost revenue to profit than expected. Another way to look at it is we budgeted for 40% net margin ($80,000/$200,000), but we achieved a 43% net margin ($75,000/$175,000.)
Like the Flow situation above, we must remember that we have fixed costs. So, our flex percentage target must consider this. When we make less revenue, we would expect a diminished return since we have less revenue over and above our fixed costs on a per room basis. Aiming for a Flex percentage below your target margin percentage is likely good. In some cases we may be happy with a flex percentage equal to our target margin percentage.
As with Flow, we would want to analyze historical data to see our historical Flex percentages. This situation is likely to differ more on a per hotel basis, as fixed costs are different in each hotel. For example, you may have a location with unionized employees where cutting hours down to preserve profit is difficult per the Collective Agreement. Thus, comparing hotels in flex is harder, but again, trying to find hotels that are similar in nature should allow you to see where you are and are not adequately cutting costs when revenue is under-performing.
What if I am over one target, and under the other?
In addition to the above two situations, you may have situations where you are below your revenue target but beat your profit target. You may also have the opposite, where you hit your revenue target but fail to meet your profit target. These situations usually require less analysis with Flex/Flow because you already know you either controlled costs very well, or failed to control them adequately. However, the analysis can still be done, and it still works.
This may also prove to be a good error detection method. When these situations exist, it could mean we have an expense recorded in the wrong period. However, there are situations when you could have unexpected or unusual expenses that cause this. Remember, this calculation incorporates your budget, so if your budget is unreliable this may not indicate a real problem.
To illustrate, see the example below:
Here, we have a flex situation where we missed our revenue but beat our profit target. Our flex calculation ends up being -100% ($5,000/$(5,000)). As mentioned above, the smaller the flex percentage, the better, so a negative flex percentage is actually good. Usually, negative flex will happen when revenue was very close to target. However, if revenue was missed by a large number and you are still in negative flex, it is likely that an accounting error was made.
Flex/Flow is an extremely useful analysis when determining if budget overages or shortfalls were accompanied by good or poor cost management. This can be an effective tool for evaluating managers, as well as determining areas where you can save more money. This is especially powerful when you have a P&L with percentage of revenue and per occupied room data for each expense line. Using this data allows us to key in on the specific expense items that are high, so we can take corrective action and retain more cash on our investment.
GOPPAR, or Gross Operating Profit Per Available Room, takes the RevPAR equation one step further by calculating your profit per room. The calculation is below:
Gross Operating Profit/# Rooms Available in Period
This presents us with a better metric for measuring financial performance in our hotels. It allows us to include our overhead and compare hotels with different room counts, giving us an efficiency based metric to compare properties within our portfolio, or potential new investments we may be looking to add to a portfolio.
The main issue with GOPPAR is that we don’t have a standard on what is and isn’t included in the calculation of Gross Operating Profit. We keep hearing that Smith Travel is eventually going to begin reporting on this metric. Once that happens, we will have a standard calculation. Until then, as long as the calculation is the same between hotels you are comparing, your GOPPAR calculation will be able to provide the comparability analysis you are looking for.
Another issue with GOPPAR is comparing hotels with Food & Beverage to hotels without. Since the F&B profit percentage is different than that generated from guest rooms, the calculated percentages are likely to be different between limited and full service offerings. Therefore, it is important to compare similar hotel products when possible.
Adding GOPPAR to the summary page of our financial statements at hotels managed by Genesis has proven useful. We can better compare managers, and have strengthened our due diligence on potential acquisitions. We suggest you add it to your financial analysis toolbox as well. In the future, we hope to see an indexed measure that normalizes the calculation for CompSet revenues, similar to RevPAR index. This would take the comparability one step further by adjusting for differing ADR levels in similar hotel products in different geographic locations.
As you can see from the above, profitability analysis such as Flex/Flow and GOPPAR provides us the benefit of increasing net cash retained in our current hotels, and more accurately evaluating potential new hotel investments. Feel free to reach out to anyone on our team to further discuss profitability analysis and how we can help you more effectively manage your hospitality portfolio.