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Finance in Hospitality Sample

Know the Imporatnce of Finance in Hospitality

INTRODUCTION

Finance plays an important role in the growth and development of an organization. Without it no organization can survive in this competitive world. In the present report sources of finance are discussed in detail and some of them are recommended to the reader. Apart from this components of cost are also described in detail. At middle part of the report trial balance is prepared and adjustments are done. After that ratio analysis is done and recommendations are given in respect to performance improvement. At the end of the report using break even analysis proposals are evaluated and recommended to the firm.

TASK 1

1.1 Sources of finance

Case of Mr. Stephen

Two sources of finance for Mr. Stephen are as follows.

Bank loan- Mr. Stephen can take bank loan from a specific bank. If he does not get entire amount from single bank then he can take loans from the multiple banks. These loans are available at fixed or floating interest rate. There are some benefits and limitations of taking bank loan. If floating interest rate gets increased then finance cost of the firm will also be increased. Same risk is not available in case of fixed interest rate loan. Hence, loan with fixed interest rate is recommended to Mr. Stephen.

Venture capital- Under this source of finance, there is a firm that gives capital to an individual for operating new business. In return that firm gets a stake in a newly formed company (Ratha, 2005). It also gets an amount of share in the company’s profitability. This source of finance is an alternative of loan and in this it is not necessary to pay return to capital lender on time. While major limitation of this source of finance is that control of real owner of the company gets diluted. Hence, they cannot take entire business decisions individually. Due to availability of flexibility at the time of returning of amount, this source of finance is recommended to Mr. Stephen.

(a)Sources of finance for large sized business

Equity- Large sized corporation is eligible for bringing IPO on the basis of passing a certain parameters that can raise capital through this source of finance. If capital is raised through this source of finance then business will get lots of benefits. In case of equity it is not necessary to pay dividend every year (Zhengfei and Lansink, 2006). Hence, finance cost can be controlled. This is a major benefit that business gets from this source of finance. However, issue of equity leads to dilution of the control of existing shareholders. This is a major limitation of this source of finance. But in case of this source of finance majority of holding remains with the company owners. Thus it is not matter of concern.

Private equity-It is a variant of equity, but in this like venture capital firm there is a company that gives capital to the company. In return, they get share in the profit. Due to shareholding they have right to give guidance to the firm. With the help of guidance, firm can operate business in an effectual manner. It is also its main advantage. Main limitation of using this source of finance is that control of existing shareholders get diluted in the company (Tarca, Morris and Moy, 2013).

Short term loan- Firms can take short term loan in order to get finance according to its working capital requirements. Thus, business operations do not impede due to lack of finance. This is also its major advantage. Limitation of this sources is only that interest needs to pay on time.

1.2 Contribution of different things on business profitability

There are various things that affect business profitability.

Sales- By generating sales firm can enhance its level of profitability. Hence, firm must adopt measures that elevate its sales for upcoming year.

Sponsorship- Under this a company takes a sponsorship of any event. In return it gets a right to advertise its products or brand name at large scale. As a result, prestigious image of the company product is created among people. Ultimately this leads to increase in sale of the company product.

Grants- In many nations government gives a grant to business organizations. Firms use these grants for their business expansion. This gives boost to the company’s cash flows. Hence, profitability of the company also gets increased.

TASK 2

2.1 Elements of cost, gross profit and sales price

There are two types of costs. These costs are discussed below as:

Direct cost- It refers to the cost that is incurred in the production process. These costs may be raw material purchase cost etc.

  • Direct material cost- It refers to that material that is used in the production process. Raw material purchase is the best example of direct cost.
  • Direct labor cost- It refers to the employees that are involved in the production process. Employee cost related to these labors is counted in direct labor cost (Williamson, 2010).
  • Direct expense cost- It refers to the expenses that are related to the production of goods and services. Carriage expenses are counted in direct expense cost.

Indirect cost- Indirect cost is those costs that are not related to the production process. Administrative cost is best example of indirect expenses.

  • Indirect material cost- It refers to those materials that are used in normal operations of the business. Expenses incurred on sales and office operations come under indirect expenses.
  • Indirect labor cost- It indicates the cost related to employees that are not involved in the production process (Kothari, Li, and Short, 2009). Employee cost related to manager is the best example of indirect labor cost.
  • Indirect expense cost- It is a cost that is not related to the production process. Expenses related to purchase of clean equipment are the best example of indirect expense cost.

Fixed cost- It refers to the cost that remains fixed and does not get changed. Purchase of machinery is the best example of fixed cost.

Variable cost- It refers to the cost that very with change in production process. Raw material cost is a well-known example of indirect cost.

Semi variable cost- It is a cost whose some part remain fixed and some remain variable.

Gross profit percentage- It is calculated by using gross profit and net sales (Thompson, Jones-Evan and Kwong, 2009). By dividing gross profit from net sales and multiplying it by hundred gross profit percentages is calculated.

Sales price- There are two elements of sales price including cost and margin percentage. By adding both elements, sales price is calculated.

2.2 Methods to control stock and cash

In a hotel there are many kinds of rooms with different capacities and price. In order to control room’s prediction must be made in this regard After this way in which rooms are allocated to the guests must be reviewed. Suppose there is a room for four people and two people want that room. It is a basic logic that cost of four people cannot be charged on two people (Osterwalder and Pigneur, 2010). If firm allots room to that two people then it will face loss. Hence, at place of giving room to that people firm can wait and can allot room to other four people in the group. Conclusion is that on the basis of prediction and trends of room filling, rooms must be allocated to the prospective guests.

Cash can be controlled by using cash management strategy. By using this strategy cash can be received quickly from the debtors and late payment can be made to the creditors. If more time is taken by the debtor in making payment then by making late payment to the creditors lag time can be offset using this tactics.

TASK 3

3.1 Drafting a trial balance

Table 1: Trial balance as on 31 December 2014

Particulars

Debit

Credit

Cash

11,700

 

Debtors

12,000

 

Rates

1,880

 

Bank Loan interest

1,400

 

Other expenses

11,020

 

Vehicles

2,020

 

Trade Creditor

 

11,200

Sundry creditors

 

1,620

Purchases

12,400

 

Bank Loan

 

12,000

Capital

 

13,000

Sales

 

14,600

Balance

52,420

52420

Procedure of preparing a trial balance

  • Preparing a journal account- In this step a journal account is prepared in which separate entry is entered related to each and every transaction. These transactions are further grouped on the basis of similarities in a separate account.
  • Source of ledger/Preparing a ledger account- In this step a ledger account is prepared in which person wise and item wise account are created (Gali, Gertler, and Lopez-Salido, 2007). In theledger account balance of debit and credit side of account is matched in order to ensure that no mistake is made in the accounts entry.
  • Preparation of trial balance- On the basis of ledger account, all details related to transaction are necessary to entered into the trial balance.

3.2 Adjustments and notes

Table 2: Adjusted Trial Balance

Particulars

L/F

Debit Amount

Credit Amount

(in £)

(in £)

Opening Stock

86,000

 

Purchases

1336000

 

Salaries

110000

 

Wages

61,000

 

Carriage Inwards

26,900

 

Trading Charges

64,000

 

Carriage Outwards

52,500

 

Rent received

 

178300

Cash

62,500

 

Capital

 

344700

Bank (Overdraft)

 

37,980

Commission

42,780

 

Creditors

 

468000

Sales

 

1548700

Debtors

256000

 

Machinery

480000

 

Total

 

2,577,680

2577680

Adjustments explanation

Purchase of machinery- Purchase of machine on credit means that machine was purchased from someone without making payment and that transaction was not recorded. Machinery of 200000 is purchased on credit and its entry was not made. In order to make changes in trial balance adjustments are made. In this regard purchase value in trial balance is increased by 200000. In same way creditors are also increased by the same value. Hence, changes come in both purchase and creditors headings in trial balance.

Wages adjustment- Wage amount of 43,000 was wrongly added to salary. In order to make correction changes are made in the trial balance. In this regard, 43,000 is deducted from salary and same is added to wages. Hence, entry affects both wages and salary.

3.3 Purpose and process of budgetary control

Main purpose of preparing budget is to perform a control function. In budget figures are determined about the sales and purchase as well as other things. Manager makes an attempt to maintain expenses in a determined limit through preparing budget. Second main purpose of preparing budget is to motivate managers to make extra effort to control expenses. Budget reflects the expectation of top level management from the managers. Hence, budget acts as a motivating factor for managers (Olson, Slater and Hult,, 2005). Process of budgetary control is as follows.

  • Preparing standard- In this step standards are determined which will be followed for controlling the cost of company. These standards are determined on the basis of past data and management expectation about the future scenario. Hence, accurate estimation about future is required for preparing standards for the budget.
  • Measuring a performance- In this step manager measures the performance of company in terms of sales and expenses. After measuring results report is prepared and communicated to the top level management for further action.
  • Preparing of corrective action- After communicating results to top level management, middle level managers are focused on taking corrective actions in order to ensure that same mistakes will not be committed in future (Graf, 2005).
  • Modification- If top managers recommend some changes then that modifications are added into the corrective actions. After that, these actions are implemented in order to make sure that same mistakes will no again committed by the employees.

3.4 Analysis of variance and reasons behind change variance in values

Table 3: Direct material price variance

Actual price

9.5

Budgeted price

10

Actual produce

1000

Direct material price variance

-500

Interpretation

Material price variance of the firm is favorable and this reflects that firm purchases raw material at a lower cost than stated in a budget (Baden-Fuller and Morgan, 2010). This happens because firm purchases raw material in a bulk. While purchasing in a bulk company gets a huge amount of discount. As a result, price of raw material is less than its actual price. Strong upward in currency movement may be another reason behind purchasing of raw material at least price. Thus, due to low price firm direct material price variance is positive.

Table 4: Direct material total variance

Actual price

9.5

Budgeted price

10

Actual production

1000

Budgeted production

1200

Direct material total variance

-2500

Interpretation

This variance indicates the total variance in the direct material. Due to less raw material price and less production of goods, budgeted lots of amount are saved. Hence, lot of amount is saved from the firm side. Fewer units may be produced due to lack of demand. Substantial availability of unsold stock may be another reason behind the production of less unit than budgeted amount.

Table 5: Direct material usage variance

Actual quantity used

4850

Standard quantity

5000

Standard cost per KG

10

Direct material usage variance

1500

Interpretation

This variance indicates that firm use more raw material than budgeted cost or not (Reijers and Mansar, 2005). In the present case variance is favorable because less quantity of raw material is used for the production. Hence, on this front company gives good performance.

Table 6: Labor efficiency variance

Actual output

1000

Actual hours

4200

Standard cost of actual hours

21000

Standard hours

4000

Standard cost

20000

Labor efficiency variance

1000

Interpretation

This variance indicates that firm take more work from its workforce than budgeted hours or not. Variance is positive and within budgeted. This reflects that labor is efficiently utilized by the firm.

Table 7: Total direct labor variance

Standard rate

5

Standard hours

4000

Actual rate

5.05

Actual hours

4200

Total direct labor variance

-1210

Interpretation

This indicates the rate at which labors are paid. If variance is unfavorable then actual labor rate will be higher than the budgeted rate. In this case same thing happens. This happens because time was short to complete an order. Hence, extra amount is paid to the employees so that order gets completed on time. Hence, labor rate is high in this case..

Table 8: Variable production overhead variance

Variable cost

8

Number of units produced

1000

Budgeted variable cost of production

8000

Actual variable cost

9450

Variable production overhead variance

-1450

Interpretation

Variable cost is lower than budgeted and due to this reason variable is positive. This happens because firm follows a policy to control variable cost.

Table 9: Fixed cost overhead variance

Budgeted fixed overhead

24000

Actual fixed overhead

25,000

Fixed cost overhead production variance

-1,000

Interpretation

These variances indicate that company makes fixed expenditures above budgeted level or not (Weeks and Feeny, 2008). Variance is negative and this reflects that firm makes extra expenses as fixed cost. This may happen due to firm aggressive expansion policy.

TASK 4

4.1 Calculation of ratio analysis

 

Grimes theme park

 

Giants House theme park

 
 

2013

2014

2013

2014

Sales

 

10%

 

-5%

Gross profit

24000

26400

60000

55000

Net profit

10000

11000

25000

20000

Net sales

40,000

44,000

100,000

95,000

Gross profit margin

60%

60%

60%

58%

Net profit margin

25%

25%

25%

21%

Net profit

10000

11000

25000

20000

Equity

110000

110200

700000

700000

ROE

9%

10%

4%

3%

Net profit

10000

11000

25000

20000

Assets

53,000

51,000

170,000

173,000

ROA

19%

22%

15%

12%

COGS

15,000

14,000

50,000

48,000

Net sales

40,000

44,000

100,000

95,000

Stock turnover ratio

0.38

0.32

0.50

0.51

Creditors

2,100

2,016

5,200

5,120

Net purchase

16,000

17600

40000

40000

Payment days

47.91

41.81

47.45

46.72

Current assets

38,000

37,000

120,000

125,000

Current liabilities

44,000

35,000

110,000

105,000

Current ratio

0.86

1.06

1.09

1.19

Quick assets

23,000

23,000

70,000

77,000

Current liabilities

44000

35000

110000

105000

Quick ratio

0.52

0.66

0.64

0.73

DPS

8p

10p

12p

10p

Interpretation

  • Sales- Sales growth rate is higher in case of Greams then Giants. Hence, Greams is considering in better position than Giants.
  • Gross profit margin- It indicates the percentage of gross profit that firm is earning on sales and it also indicates firm capacity to control direct expenses (Buhaug and Lujala, 2005). In this ratio, Gream is again in the better position than Giants.
  • Net profit margin- Net profit ratio indicates firm capacity to control its indirect expenses. Ratio of Gream is stable and it indicates the level of control on its indirect expenses. Hence, Gream performs better than Giant.
  • ROE- It indicates the return that a firm is giving to its shareholders. In case of Gream return plunged by 1%. Whereas, inverse happen in the case of Giant. Hence, performance of Gream is considered better than Giant.
  • ROA- It indicates return that firm is earning on assets (Yang, 2007). Return is higher in case of Gream relative to Giant. Thus, Gream is in the better condition than Giant.
  • Stock turnover ratio- It indicates number of times a stock turned into an asset. This ratio is higher in case of Giant. Thus, Giant performs better than Gream.
  • Payment days- It indicates the number of days in which company is making payment to its creditors (Creditor payable days. 2015). In case of both companies days are declined that indicates that financial position of both firms is good. However, on the basis of value Gream is considered better than Giant.
  • Current ratio- It indicates firm capability to pay current liability using current assets. Here, Giant performs better than Gream. Hence, Giant is considered in the better condition than Gream.
  • Quick ratio- This ratio indicates the firm capacity to pay current liability using quick assets (Quick ratio. 2015). Here, value of ratio is higher in case of Giant. Thus, Giant is considered in the better condition than Grimes.
  • DPS- In case of Grimes, DPS is increasing. Whereas, in case of Giants it is declining. Hence, Grimes is in the better condition than Giant.

4.2 Strategy for Grimes and Giant

In case of Grimes good performance is observed, but it needs to improve its ROA and ROE. In this regard it needs to boost its sales. By doing these, both ratios can be increased (Miller and Blair, 2009). This will also elevates values of ratio like gross and net profit as well as current and liquid ratio. In case of Giant improvements are required. In this regard it can follow cash management strategy so as to improve current ratio. It also needs to increase its revenue in order to improve performance in profitability and liquidity ratios.

TASK 5

5.1 Categorizing cost in to fixed, variable and semi variable

  • Fixed cost- It refers to a cost that cannot be changed. Catering cost is a fixed cost in this case study.
  • Variable cost- It is a cost that vary with change in production (Williamson, 2010). In case study per unit cost that is charged on customers is variable cost.
  • Semi variable cost- It is a cost whose some part is fixed and some is variable. 350 is standard cost and catering cost in same is fixed and remaining part is variable cost.

Table 10: Break even sales

Fixed cost

350

Variable cost

10.5

Sales value

20

Break even sales

36.84 (approximate number of customers)

Value (36.84*20)

736.8

Actual sales (80* 20)

1600

Margin of safety

1600-736.8 = 863.2 units

Margin of safety (in %)

54%

Interpretation

In order to cover fixed cost firm needs to receive order from at least thirty six people. Only after this, company can earn profit on received order.

5.2 Evaluation of proposal

Fixed cost

350

Variable cost

10.5

Sales value

18.5

Break even

43.75

Value

809.375

Actual sales

1850

Margin of safety

1850-809.375 = 1040.62

Margin of safety (in %)

56%

Interpretation

In comparison to first proposal in this case sales price is reduced from 20 to 18.5. Hence, break even sales unit’s requirement increases in this proposal. Due to this reason, value increases and contribution is get declined. Margin of safety is also higher in case of 100 people proposal. Hence, second option seems lucrative.

5.3 Selection of option

On the basis of margin of safety and profit second option is selected for the firm because margin of safety is high in case of 100 people. In this case, actual sales highly exceed budgeted sales. However, break even sales is high but margin of safety is also very high. Hence, proposal of 100 people is considered better than 80 people.

CONCLUSION

On the basis of above discussion it is concluded that every firm needs to control its cost in order to elevate its profitability level. Moreover, firm needs to evaluate its performance on the regular basis by using ratio analysis. By formulating tactics on time, company’s performance can be kept on track. At the end, it is recommended that firm must make extra efforts to control variable expenses in order to minimize cost.

REFERENCES

Books & journals

  • Baden-Fuller, C. and Morgan, M. S., 2010. Business models as models. Long range planning.
  • Buhaug, H. and Lujala, P., 2005. Accounting for scale: Measuring geography in quantitative studies of civil war. Political Geography.
  • Gali, J., Gertler, M. and Lopez-Salido, J. D., 2007. Markups, gaps, and the welfare costs of business fluctuations. The review of economics and statistics.
  • Graf, L., 2005. Incompatibilities of the low-cost and network carrier business models within the same airline grouping. Journal of Air Transport Management.
  • Kothari, S. P., Li, X. and Short, J. E., 2009. The effect of disclosures by management, analysts, and business press on cost of capital, return volatility, and analyst forecasts: A study using content analysis. The Accounting Review.
  • Miller, R. E. and Blair, P. D., 2009. Input-output analysis: foundations and extensions. Cambridge University Press.
 
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