Finance in Hospitality Industry

Question: Describe about theFinance in the Hospitality Industry?. Answer: 1. Sources of Funding for Businesses Service Industries:- The term funding can be described as offering financial support for any program, project, business or personal need. In the business sector, funding can be classified into two segments. The owners of the business can provide the required financial support from their own reserve. In case of companies, the requirement is fulfilled from the various reserves of the company. It can be referred as internal funding. On the other hand, external funding can be described as the funding provided by the outsiders, mainly banks, other financial organizations and personal investors. In most of the time, the businesses have to bear additional expenses for the external funding, such as, interest (Nyide et al. 2014). Various sources of business funding are discussed below:- Personal Funding:- As discussed above, business owners can fund the businesses from the personal resources. The owners can collect the fund from personal savings and other family members. They can also borrow the required amount from family members or friends. Most of the time, this kind of funding are used to be interest-free (Jones et al. 2012). Loan from Financial Institutions:- The funds are also collected through loans from various financial institutions, such as, banks, insurance, other financial companies etc. The owner has to convince the investors about the profitability of the venture for taking the loan. In many cases, the loans are granted by keeping any asset as mortgage to the loan givers. The owners have to repay the loan amount in terms of monthly, quarterly or annuals repayments along with the interest. Issue of Shares:- Fund generation by the issue of shares is possible only if the business is registered as a company. In that case, the entrepreneurs use to publish the prospective of the business and issue share in the open market. It must be noted that the purchaser of the equity shares are considered as owners of the company and the dividend, paid to them, is the share of profit, not any kind of interest. Income Generation Method for Businesses Service Industries:- Generally, the income of any business is used to be generated various means. For purpose of disclosure, these various methods of income generation have been classified on the nature of the financial activities. The business activities related to the generation of income, can be differentiated into two groups Operating and Non-operating activities. The Non-operating activities are further categorized into two groups Financing and Investing Activities. The methods of income generation are discussed below:- 2. Operating Activity:- According to the International Accounting Standard, the operating activities can be defined as the main income generating activities of an entity and other activities, which cannot be categorized as financing or investing activities. Incomes, generated from such activity, are described as operating income (Brtland 2012). Operating income is mainly earned from the basic or primary activities of any business. For example, for any manufacturing business, the operating income is the revenue, generated by the sale of manufactured products, whereas, for any service related business, it is earned by rendering service to the customers. The various sources of operating income are as follows:- Income from the sale of products or service, rendered Income from other activities, such as, royalties, discounts, commissions etc. These type of incomes are not the direct income but closely related with the operating activities Income from refunds, especially, taxes, if the tax was not paid for any financing or investing incomes. Financing Activities:- Financing activities are related to the capital acquiring processes. It reflects the amount of capital, collected from various sources and also the amount of expenses, incurred for acquiring and maintaining the capital. The main financing activities for income generation include two methods. The business can generate financing income by either equity financing or debt financing. Equity financing is the method to raise capital by issuing shares in exchange of the ownership of the company. The income from debt financing are generated by borrowing loans from market at certain interest rates. It should be noted that the income generated by debt financing is the liability for the business (Drury 2012). Investing Activities:- Investment activities are linked with the various investments made by the business entity in different type of assets. Incomes, generated from such activities, are called as Investment incomes. Generally, the term investment is meant to invest money in other business or deposit money in banks or same type of institutions. In business sector, investment activities not only include the normal investment but also the purchase of fixed assets or acquisition of other firm. The various sources of investment incomes are- Sale of equity or bonds of other businesses Sale of fixed assets Interest earned from loans given to other entities Dividend received for the equities of other businesses 3. Assessment of the Sources Structure of Trial Balance:- Trial Balance is the financial statement, prepared in the end of an accounting period for an accounting entity, by listing the closing balances of all the accounts in the debit and credit columns properly to check the accuracy of the accounting system of that entity. Though the purpose of Trial Balance is to verify the accurateness of the accounting system, it has been observed that there are many accounting errors, which cannot be detected from trial balance. The trial balance provides better results for ensuring the mathematical accuracy and detecting the single-sided errors (Mroczkowski and Flanders 2015). Sources of the Trial Balance:- The main sources of the Trial Balance are the various ledger accounts of the accounting entity, which have balances. The sources of the given trial balance are Credit balances of Capital A/c., Bank Loan A/c., Accumulated Depreciation on Fixture Fittings A/c. Trade Payables A/c. and, Debit balances of Bank A/c., Cash Cash Equivalent A/c., Furniture Fittings A/c. Trade Receivables A/c. Structure of the Trial Balance:- The basic structure of the trial balance is given below:- Accounts Type Allocated column in Trial Balance Assets Debit Column Liabilities Credit Column Revenue Credit Column Expenses Debit Column Profit Credit Column Loss Debit Column Capital Credit Column Reserve Credit Column In the given trial balance, all the accounts are either asset type or liability type, except the Capital A/c. Hence, the balances of the assets are allocated in the debit column and the liabilities Capital A/c. are listed in the credit column (Bragg 2013). Evaluation of Business Accounts, Adjustments and Notes:- Evaluation of Business Accounts:- From the accounting extracts of Faith Restaurant, it can be stated that:- The accounts are not differentiated into debit and credit columns The administrative and distribution expenses are marked differently, but the cost of sales, though being an expense item, not marked separately. There is no amount given for capital or any type of liabilities The profit and assets are different type of accounts, but in the extract these items are listed together The furniture fixture is shown at the cost price, but there is no accumulated depreciation account created for the asset Adjustments:- The adjustment entries for the transactions mentioned in the notes are as follows:- Capital A/c..Dr. 2250 [(25000-2500)x10%] To, Furniture Fixtures A/c. 2250 (Being the depreciation for the previous year charged on Furniture Fixture and adjusted with the Capital A/c.) Furniture Fixture A/cDr. 2500 To, Cost of Sales A/c. 2500 (Being the purchase of furniture, wrongly included in Cost of Sales, adjusted with Furniture Fixtures A/c.) Distribution Expenses A/c.Dr. 250 To, Administrative Expenses A/c. 250 (Being the diesel cost for distribution, wrongly included in the administrative expenses, adjusted with the Distribution Expenses A/c.) Note on Adjustments:- The adjustments entries, made above, is affecting the accounts of the business in the following manner:- According to the accounting standards taxation acts, depreciation should be charged on the assets from the first year of purchase. As, the depreciation was not charged on furniture in previous year, the profit of the firm had become overvalued and as the profit is used to be added with the Capital A/c., the Capital A/c. would also reflect an overvalued amount. Hence, in the current year, the Capital A/c. is debited to reduce it to the actual amount and the Furniture Fixtures A/c. is reduced also by crediting it for amount of depreciation, which should have been charges on the furniture previous year. The wrong entry made for purchase of furniture, has increased the amount of Cost of Sales, which in result has reduced the amount of Gross Profit, whereas, the total amount of assets has also become undervalued. Therefore, the necessary adjustment entry has been made to reduce to cost of sales and increase the value of furnitures. The last entry does not have any material effect on the business. But as per the accounting rules, the cost of diesel, used for distribution purpose, should be included in the distribution expenses rather than administrative expenses (Box 2013). Purpose Processes of Budgetary Control:- Budgetary control is the method, where the management uses to estimate certain budgetary goals, compare the goals with the actual performance and, if required, make necessary adjustments to maintain the budget (Jones 2012). Purpose of Budgetary Control:- The purposes for budgetary control are described below:- Better planning for future cost, performance and requirements of an enterprise Cost effective and efficient operations through several departments or cost centres Reduction of wastage and labor idle time Estimation of future capital expenses Amendments for the disparities in the budgeted and actual performances Centralization of the cost control system Increase in the total profitability by cost effective operation Proper job allocation and distribution of responsibility amongst the staffs (Marginson 2013) Processes of Budgetary Control:- The processes of any type of budgetary control include the following basic steps:- Preparation of Budget according to the requirements, policies and future planning of the enterprise, Comparison of the estimated budgetary performance with the actual performance of the project or business in a continuous and systematic manner Modification in the budget in accordance to the changes in the actual circumstances (Nunes and Machado 2014) Analysis and Suggestions for Variation in Budget:- Variation from Budgeted Performance:- The variation between the budget and actual performances are shown in table:- Budget Actual Budgeted Standard for Actual Participants Variance % of Variance Number of participants 20,000 15000 -5,000 -25.00% 000 000 000 000 Revenue 2000 1700 1500 200 13.33% Cost of sales -1500 -1390 -1125 265 23.56% Gross profit 500 310 375 -65 -17.33% Administrative expenses -200 -210 -150 60 40.00% Distribution expenses -150 -90 -112.5 -23 -20.00% Net Profit 150 10 112.5 103 -91.11% Many of the cost items use to vary according to quantity of the output. Therefore, the differences are calculated on the basis of budgeted standard for actual participants and actual amounts. The differences in the amounts are represented in the following chart:- The rates of variance for different items are also shown in the following chart:- From the above graphs, it can be stated that though the revenue earned from event was higher than the budgeted standard, the gross profit and net profit were significantly lower than the standard. It is mainly caused because of the drastic increase in the administrative expenses and the cost of sales. Suggestion for Future Management Actions:- As the business operation is related to event management services, the output should be budgeted in conservative manner. The administrative expense was not only higher than the budgeted amount for actual performance, but also from the budget made for 2000 participants. Hence, in future the administrative expenses should be estimated properly. Moreover, this expenses are more or less fixed type of costs. If, the output changes from the budget, these costs remain quite unchanged. The cost of sales uses to vary according to the output. In this case, the number of participants has reduced but the cost of sales has increased significantly. In future, the management should control the cost of sales more effectively (Whitecotton et al. 2013). 4. Calculation and Analysis of Ratios:- Calculation of Ratios:- a) Gross Profit Margin Ratio Paticulars 2015 2014 Sales revenue A 100,000 80,000 Gross Profit B 60,000 50,000 Gross Profit Margin Ratio B/A x 100 60.00% 62.50% b) Operating Profit Margin Ratio Paticulars 2015 2014 Sales revenue A 100,000 80,000 Operating profit C 10,000 4000 Operating Profit Margin Ratio C/A x 100 10.00% 5.00% c) Current Ratio:- Paticulars 2015 2014 Trade Receivables 9500 9200 Inventories 10000 8000 Current Assets D 19500 17200 Trade Payable 9000 9000 Current Liabilities E 9000 9000 Current Ratio D/E 2.17 1.91 d) Return on Capital Employed:- Paticulars Amount Capital Employed in 2014 F 35000 Capital Employed in 2015 G 60000 Average Capital Employed H = (F+G)/2 47500 Profit before Taxation I 5000 Interest on Loan J 5000 Profit before Interest Tax K= I+J 10000 Return on Capital Employed K/H x 100 21.05% e) Trade Receivables Period:- Paticulars Amount Opening Balance of Trade Receivables L 9200 Closing Balance of Trade Receivables M 9500 Average Trade Receivables N = (L+M)/2 9350 Sales Revenue O 100000 Trade Receivable Period N/(O/365) 34.13 f) Trade Payables Period:- Paticulars Amount Opening Balance of Trade Payables P 9000 Closing Balance of Trade Payables Q 9000 Average Trade Payables R = (P+Q)/2 9000 Cost of Sales S 40000 Trade Payable Period R/(S/365) 82.13 g) Gearing Ratio:- Paticulars 2015 2014 Bank Loan T 50000 30000 Closing Balance of Capital Employed G 60000 35000 Gearing Ratio T/G 0.83 0.86 Ratio Analysis:- The financial performance of the business is analyzed below on the basis of the ratios, calculated above:- The gross profit margin ratio is above 60%, which clarifies that the business is running quite well. But the ratio has declined from the previous year, which is matter of concern. The Operating profit margin ratio has increased to 10%. The ratio is quite low in comparison to the gross profit margin ratio. The current ratio is 2.17. It indicates that the current asset of the company is more than two times of current liabilities, which can be regarded as an ideal ratio. Return on Capital Employed rate is 21.05%. It explains that the owner is earning more than 20% on the invested capital. The business seems to be quite profitable for the owners (Muradolu and Sivaprasad 2014). The trade receivables period is 34.13 days, which can be regarded as normal average period for credit recovery. But for a restaurant business, the period is little higher than the average. The trade payables period is 82.13 days. The period is too longer for restaurant businesses. Though the gearing ratio in the current year has decreased to 0.83 from 0.86 of previous year, it is very high. It denotes that most of the business capital, invested is collected by debt financing. Recommendation for Future Management Strategies:- From the above ratio analysis, the following recommendations are suggested for the businesses:- The management should detect the reasons for decrease in the gross profit margin ratio. The operating profit ratio is very low in comparison to gross profit margin ratio. It indicates that the operating expenses other than cost of sales, are very high. The management should reduce the other operating expenses to increase the amount of operating profit. The trade payables period are quite longer. Though, it will not affect the profits of the business, to maintain proper business ethics, the management should repay their creditors earlier than the average period. The owners should decrease the amount of bank loans and rely more on personal funding (Healy and Palepu 2012). 5. Categorization of Costs:- The costs, provided in the information are categorized in the following table: Cost Details Type of Cost Reasoning Cost of Wages Variable Cost The total amount of these cost items are totally depended on the numbers of tickets. If the number of ticket varies, then it will also change accordingly. Cost of Printing Cost of Popcorn per Ticket Rent for the Hall Fixed Cost The rent of hall use to be paid as per agreements. The quantity of output does not create any imact on it. If the organizer cannot sell a single ticket, he still have to bear this cost. Electricity Bill Semi-Variable Cost In this cost item, there are some fixed amounts, which have to bear by the business as fixed costs and balance amount depends on the consumption of electricity and number of phone calls (Weygandt et al. 2015). Telephone Bill Calculation of Contribution and Estimated Sales:- Contribution per Ticket:- Calculation of Contribution Per Ticket:- Particulars Amount Per Unit Total Unit Total Amount (no. of Tickets) TOTAL SALES (A) 30 5000 150000 Variable Costs: Cost of Wages 10 5000 50000 Cost of Printing 1 5000 5000 Cost of Popcorn 2 5000 10000 TOTAL VARIABLE COST (B) 13 65000 CONTRIBUTION (A-B) 17 85000 As per the above calculation sheet, the contribution per ticket should be 17 per ticket. Estimation of Number of Tickets Sold:- The numbers of tickets, required to be sold, for achieving the targeted profit of 20,000, are calculated in the following table:- Calculation of the Number of Tickets:- Particulars Amount Per Unit Total Unit Total Amount (no. of Tickets) TOTAL TARGETED PROFIT (A) 20000 Fixed Cost: Rent of Hall 45,000 p.a. 45000 Semi Variable Cost:- Electricity Bill 7000 7000 Telephone Charge 1000 1000 TOTAL FIXED SEMI-VARIABLE COST (B) 53000 CONTRIBUTION [ C= (A+B)] 73000 Contribution Per Ticket (D) 17 Required Number of Tickets (C/D) 4294 Break Even Analysis:- If the selling price per ticket would cost to 14, then the Break-even Point in units will be, Calculation of Break-Even Point in Units:- Particulars Amount SELLING PRICE PER UNIT (A) 14 Variable Costs per unit: Cost of Wages 10 Cost of Printing 1 Cost of Popcorn 2 TOTAL VARIABLE COST PER UNIT(B) 13 Fixed Cost: Rent of Hall 45000 Semi Variable Cost:- Electricity Bill 7000 Telephone Charge 1000 TOTAL FIXED SEMI-VARIABLE COST ( C) 53000 BREAK-EVEN POINT in UNITS [C/(A-B)] 53000 The Break-Even Point in units for the selling price of 14 per ticket, would be 53000 tickets. 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