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Student Study Notes - Chapter 6 Purpose and Value of Ratios      Ratios are important in a variety of fields. This is especially true in the hospitality industry. If you are hospitality manager with a foodservice background, you already know about the importance of ratios. For examples of how ratios are used in foodservice, see Go Figure! in the text. A ratio is created when you divide one number by another. A special relationship (a percentage) results when the numerator (top number) used in your division is a part of the denominator (bottom number). In fraction form, a percentage is expressed as the part, or a portion of 100. Thus, 10 percent is written as 10 “over” 100 (10/100). In its common form, the “%” sign is used to express the percentage. If we say 10%, then we mean “10 out of each 100”. The decimal form uses the (.) or decimal point to express the percent relationship. Thus, 10% is expressed as 0.10 in decimal form. The numbers to the right of the decimal point express the percentage. Each of these three methods of expressing percentages is used in the hospitality industry. To determine what percent one number is of another number, divide the number that is the part by the number that is the whole (see Go Figure! in the text). Many people become confused when converting from one form of percent to another. If that is a problem, remember the following conversion rules:  To convert from common form to decimal form, move the decimal two places to the left, that is, 50.00% = 0.50.  To convert from decimal form to common form, move the decimal two places to the right, that is, 0.50 = 50.00%. Value of Ratios to Stakeholders   All stakeholders who are affected by a business’s profitability will care greatly about the effective operation of a hospitality business. These stakeholders may include:  Owners  Investors  Lenders  Creditors  Managers Each of these stakeholders may have different points of view of the relative value of each of the ratios calculated for a hospitality business. Owners and investors are primarily interested in their return on investment (ROI), while lenders and creditors are mostly concerned with their debt being repaid. 1      At times these differing goals of stakeholders can be especially troublesome to managers who have to please their constituencies. One of the main reasons for this conflict lies within the concept of financial leverage. Financial leverage is most easily defined as the use of debt to be reinvested to generate a higher return on investment (ROI) than the cost of debt (interest). For an illustration of financial leverage, see Go Figure! in the text. Because of financial leverage, owners and investors generally like to see debt on a company’s balance sheet because if it is reinvested well, it will provide more of a return on the money they have invested. Conversely, lenders and creditors generally do not like to see too much debt on a company’s balance sheet because the more debt a company has, the less likely it will be able to generate enough money to pay off its debt. Ratios are most useful when they compare a company’s actual performance to a previous time period, competitor company results, industry averages, or budgeted (planned for) results. When a ratio is compared to a standard or goal, the resulting differences (if differences exist) can tell you much about the financial performance (health) of the company you are evaluating. Types of Ratios     The most common way to classify ratios is by the information they provide the user. Managerial accountants working in the hospitality industry refer to:  Liquidity Ratios  Solvency Ratios  Activity Ratios  Profitability Ratios  Investor Ratios  Hospitality Specific Ratios Most numbers for these ratios can be found on a company’s income statement, balance sheet, and statement of cash flows. (See Figures 6.1, 6.2, 6.3, and 6.4). Definitions, sources of data, formulas and examples of each ratio are summarized at the end of this section in the Ratio Summary Tables. Some managers use averages in the denominators of some ratios to smooth out excessive fluctuations from one period to the next. With the exception of inventory turnover, the ratios in this chapter will not use averages in the denominators. Liquidity Ratios  Liquidity is defined as the ease at which current assets can be converted to cash in a short period of time (less than 12 months). Liquidity ratios have been developed to assess just how readily current assets could be converted to cash, as well as how much current liabilities those current assets could pay. 2  In this section we will examine three widely used liquidity ratios and working capital. These are:  Current Ratio  Quick (Acid-Test) Ratio  Operating Cash Flows to Current Liabilities Ratio  Working Capital Current Ratio     One of the most frequently computed liquidity ratios is the current ratio. When current ratios are:  Less than 1: The business may have a difficult time paying its short term debt obligations because of a shortage of current assets.  Equal to 1: The business has an equal amount of current assets and current liabilities.  Greater than 1: The business has more current assets than current liabilities and should be in a good position to pay its bills as they come due. It might seem desirable for every hospitality business to have a high current ratio (because then the business could easily pay all of its current liabilities). That is not always the case.  While potential creditors would certainly like to see a business in a position to readily pay all of its short-term debts, investors may be more interested in the financial leverage provided by short-term debts. The current ratio is so important to a hospitality business that lenders will frequently require that any business seeking a loan maintain a minimum current ratio during the life of any loan it is granted. Quick (Acid-Test) Ratio    Another extremely useful liquidity ratio is called the quick ratio. The quick ratio is also known as the acid-test ratio. The main difference between the current ratio formula and the quick ratio formula is the inclusion (or exclusion) of inventories and prepaid expenses. The purpose of the quick ratio is primarily to identify the relative value of a business’s cash (and quickly convertible to cash) current assets. Investors and creditors view quick ratios in a manner similar to that of current ratios. Investors tend to prefer lower values for quick ratios, while creditors prefer higher ratios. Operating Cash Flows to Current Liabilities Ratio   The operating cash flows to current liabilities ratio relies on the operating cash flow portion of the overall statement of cash flows for its computation. It utilizes information from the balance sheet and the statement of cash flows. In general, investors and creditors view the operating cash flows to current liabilities ratio in a manner similar to that of the current and quick ratios. 3 Working Capital   A measure that is related to the current and quick ratios is working capital. Although not a true ratio because it does not require that one number is divided by another number, it is a measure that many lenders require. Because of financial leverage, investors tend to prefer lower values for liquidity ratios, while creditors prefer higher values. Solvency Ratios  Just as liquidity ratios address the ability of a business to pay its short term debt, solvency ratios help managers evaluate a company’s ability to pay long term debt. Solvency ratios are important because they provide lenders and owners information about a business’s ability to withstand operating losses incurred by the business:  Solvency Ratio  Debt to Equity Ratio  Debt to Assets Ratio  Operating Cash Flows to Total Liabilities Ratio  Times Interest Earned Ratio Solvency Ratio    A business is considered solvent when its assets are greater than its liabilities. The solvency ratio compares a business’s total assets to its total liabilities. This ratio is really a comparison between what a company “owns” (its assets) and what it “owes” those who do not own the company (liabilities). Creditors and lenders prefer to do business with companies that have a high solvency ratio (between 1.5 and 2.00) because it means these companies are likely to be able to repay their debts. Investors, on the other hand, generally prefer a lower solvency ratio, which may indicate that the company uses more debts as financial leverage. Debt to Equity Ratio    The debt to equity ratio is a measure used by managerial accountants to evaluate the relationship between investments that have been made by the business’s lenders and investments that have been made by the business’s owners. From a lender’s perspective, the higher the lender’s own investment (relative to the actual investment of the business’s owners) the riskier is the investment. Owners seek to maximize their financial leverage and create total liabilities to total equity ratios in excess of 1.00. Debt to Assets Ratio  The debt to assets ratio compares a business’s total liabilities to its total assets. 4  As with the other solvency ratios, more debt will be favored by investors because of financial leverage and less debt will be favored by lenders to ensure repayment of loans. Operating Cash Flows to Total Liabilities Ratio   The operating cash flows to total liabilities ratio compares the cash generated by operating activities to the amount of total liabilities. In nearly all cases, both owners and lenders would like to see this ratio kept as high as possible because a high ratio indicates a strong ability to repay debt from the business’s normal business operations Times Interest Earned Ratio   The times interest earned ratio compares interest expense to earnings before interest and taxes (EBIT). Earnings before interest and taxes (EBIT) are labeled as net operating income on the USALI. The higher this ratio, the greater the number of “times” the company could repay its interest expense with its earnings before interest and taxes. Activity Ratios   The purpose of computing activity ratios is to assess management’s ability to effectively utilize the company’s assets. Activity ratios measure the “activity” of a company’s selected assets by creating ratios that measure the number of times these assets turn over (are replaced), thus assessing management’s efficiency in handling inventories and long-term assets. As a result, these ratios are also known as turnover ratios or efficiency ratios. In this section you will learn about the following activity ratios:  Inventory Turnover  Property and Equipment (Fixed Asset) Turnover  Total Asset Turnover Inventory Turnover    Inventory turnover refers to the number of times the total value of inventory has been purchased and replaced in an accounting period. In restaurants, we will calculate food and beverage inventory turnover ratios (refer to Figure 6.5) The obvious question is, “Are the food and beverage turnover ratios good or bad?” The answer to this question is relative to the target (desired) turnover ratios. For a discussion of food and beverage turnover ratio analysis, see Go Figure! in the text. A low turnover could occur because sales are less than expected, thus causing food to move slower out of inventory (bad). It could also mean that the food and beverage manager decided to buy more inventory each time (thus, making purchases fewer times) because of discount prices due to larger (bulk) purchases (good). 5  A high turnover could occur because sales are higher than expected, thus causing food to move faster out of inventory (good). It could also mean that significant wastage, pilferage, and spoilage might have occurred causing food to move out of inventory faster, but not due to higher sales (bad). Property and Equipment (Fixed Asset) Turnover     The property and equipment (fixed asset) turnover ratio is concerned with fixed asset usage. Fixed assets consist of the property, building(s) and equipment actually owned by the business. A simple example will explain how to interpret this ratio. Assume that there is a fryer in the kitchen which generates $50,000 worth of revenue per year. A new fryer is purchased that generates revenues of $100,000 per year. The new fryer would have a fixed asset turnover ratio two times higher than that of the old fryer. The new fryer is more effective at generating revenues than the old fryer. The term “net” in any calculation generally means that something has been subtracted. When calculating the net property and equipment turnover ratio, “net” refers to the subtraction of accumulated depreciation. Creditors, owners, and managers like to see this ratio as high as possible because it measures how effectively net fixed assets are used to generate revenue. Total Asset Turnover    The total asset turnover ratio is concerned with total asset usage. Total assets consist of the current and fixed assets owned by the business. Restaurants may have higher ratios than hotels because hotels typically have more fixed assets (thus making the denominator larger and the ratio smaller). Creditors, owners, and managers like to see this ratio as high as possible because it measures how effectively total assets are used to generate revenue. Profitability Ratios    It is the job of management to generate profits for the company’s owners, and profitability ratios measure how well management has accomplished this task. Profits must also be evaluated in terms of the size of investment in the business that has been made by the company’s owners. There are a variety of profitability ratios used by managerial accountants:  Profit Margin  Gross Operating Profit Margin (Operating Efficiency)  Return on Assets  Return on Owner’s Equity Profit Margin  Profit margin is the term managerial accountants use to describe the ability of management to provide a profit for the company’s owners. This ratio compares 6 the amount of net income generated by a business to the revenue it generated in the same time period. Gross Operating Profit Margin  The gross operating profit margin is also known as the operating efficiency ratio. In the opinion of most managerial accountants, it is a better measure of actual management effectiveness than is profit margin. Return on Assets    The original investment and profits paid back to owners are called returns. When developing profitability ratios, managerial accountants want to examine the size of an investor’s return. Return on assets (ROA) is one such ratio. The importance of this ratio is easy to understand if you analyze it using a comparison of two companies (see Go Figure! in the text). Managerial accountants carefully review the ROA achieved in a business and compare it to industry averages, the business owner’s own investment goals, and other valid benchmarks. Return on Owner’s Equity   Return on equity (ROE) is a ratio developed to evaluate the rate of return on the personal funds actually invested by the owners (and/or shareholders) of the business. Even for individual business owners, the greatest interest is in determining the total amount they have personally invested and the total amount (after taxes) that investment will actually yield (return back to them). Investor Ratios   Investor ratios assess the performance of earnings and stocks of a company. Investors use these ratios to choose new stocks to buy and to monitor stocks they already own. Investors are interested in two types of returns from their stock investments: money that can be earned from the sale of stocks at higher prices than originally paid, and money that can be earned through the distribution of dividends. 7  Investors use many different ratios to make decisions on investments:  Earnings per Share  Price/Earnings Ratio  Dividend Payout Ratio  Dividend Yield Ratio Earnings Per Share   Earnings per share (EPS) is of most interest to those who buy and sell stocks in publicly traded companies, and to those managers who operate these companies. This ratio is strongly affected by both the amount of money a company earns and the number of shares of stock its board of directors elects to issue to the public. Price/Earnings Ratio    For investors, the question of a stock’s “value” is assessed, in part, by computing its price/earnings (P/E) ratio. The price/earnings ratio compares market price per share to earnings per share. Neither the numerator nor denominator of this ratio is located directly on the company’s financial statements, although the calculation for earnings per share does use information from the income statement. Price/earnings ratios for hospitality industry stocks vary greatly. The question of whether a specific P/E ratio is a “good” one or a “bad” one is dependent upon the goals of the investor as well as that specific investor’s view of the company’s profitability and growth potential. Dividend Payout Ratio  The dividend payout ratio compares dividends to be paid to stockholders with earnings per share. This ratio is determined annually by the company’s board of directors based on the desired amount to pay stockholders (dividends) and the amount to be reinvested (retained) in the company. Dividend Yield   Dividend yield ratio compares the dividends per share to the market price per share. The dividend yield ratio can be used by investors who wish to find stocks that will supplement their income with dividends. Hospitality Specific Ratios  The numbers used to create these ratios are often found on daily, weekly, monthly or yearly operating reports that managers design to fit their operational needs. Hotel Ratios 8  The hotel-specific ratios in this section are:  Occupancy Percentage  Average Daily Rate (ADR)  Revenue Per Available Room (RevPAR)  Revenue Per Available Customer (RevPAC)  Cost Per Occupied Room (CPOR) Occupancy Percentage      Hotel managers and owners are interested in the occupancy percentage (percentage of rooms sold in relation to rooms available for sale) because occupancy percentage is one measure of a hotel’s effectiveness in selling rooms. Most hotels will have rooms, floors, or entire wings at various times of the year that are out of order (OOO), meaning that repairs, renovation, or construction is being done and the rooms are not sellable. When calculating occupancy percentage, adjustments (subtractions) should be made to the denominator to account for rooms that are out of order. Complimentary occupancy (percentage of rooms provided on a complimentary (comp) basis or free of charge), average occupancy per room (average number of guests occupying each room), and multiple occupancy (percentage of rooms occupied by two or more people) are all variations of room occupancy. Occupancy percentage can used to compare a hotel’s performance to previous accounting periods, to forecasted or budgeted results, to similar hotels, and to published industry averages or standards. Industry averages and other hotel statistics are readily available through companies such as Smith Travel Research (STR). Smith Travel Research is a compiler and distributor of hotel industry data. Average Daily Rate (ADR)   Hoteliers are interested in the average daily rate (ADR) they achieve during an accounting period. ADR is the average amount for which a hotel sells its rooms. Most hotels offer their guests the choice of several different room types. Each specific room type will likely sell at a different nightly rate. When a hotel reports its total nightly revenue, however, its overall average daily rate is computed. Revenue Per Available Room (RevPAR)   High occupancy percentages can be achieved by selling rooms inexpensively, and high ADRs can be achieved at the sacrifice of significantly lowered occupancy percentages. Hoteliers have developed a measure of performance that combines these two ratios to compute revenue per available room (RevPAR). For an illustration of how RevPAR can be used to compare two hotels, see Go Figure! in the text. Revenue Per Available Customer (RevPAC) 9   Hotel managers are interested in the revenue per available customer (RevPAC) (revenues generated by each customer) because guests spend money on many products in a hotel in addition to rooms. RevPAC is especially helpful when comparing two groups of guests. Groups that generate a high RevPAC are preferable to groups that generate a lower RevPAC. Cost Per Occupied Room (CPOR)   Cost per occupied room (CPOR) is a ratio that compares specific costs in relation to number of occupied rooms. CPOR is computed for guest amenity costs, housekeeping costs, laundry costs, in-room entertainment costs, security costs, and a variety of other costs. CPOR can be used to compare one type of cost in a hotel to other hotels within a chain, a company, a region of the country, or to any other standard deemed appropriate by the hotel’s managers or owners. Restaurant Ratios  The restaurant-specific ratios in this section are:  Cost of Food Sold (Cost of Sales: Food)  Cost of Beverage Sold (Cost of Sales: Beverage)  Food Cost Percentage  Beverage Cost Percentage  Average Sales per Guest (Check Average)  Seat Turnover Cost of Food Sold (Cost of Sales: Food)   Cost of food sold (cost of sales: food) is the dollar amount of all food expenses incurred during the accounting period. Cost of goods sold is a general term for cost of any products sold. For restaurants, cost of goods sold as referenced in the inventory turnover section of this chapter refers to cost of food sold and cost of beverage sold. The formula for cost of food sold follows: Beginning Inventory + Purchases = Food Available for Sale - Ending Inventory = Cost of Food Consumed - Employee Meals = Cost of Food Sold  Beginning inventory is the dollar value of all food on hand at the beginning of the accounting period. This inventory may be referred to by its synonymous term, 10        opening inventory. Beginning inventory is determined by completing an actual count and valuation of the products on hand. Purchases, as used in this formula, are the sum costs of all food purchased during the accounting period. Food available for sale is the sum of the beginning inventory plus the value of all purchases. Ending inventory refers to the dollar value of all food on hand at the end of the accounting period. This inventory may be referred to by its synonym, closing inventory. It also is determined by completing a physical inventory. The cost of food consumed is the actual dollar value of all food used, or consumed, by the operation. This is not merely the value of all food sold, but rather the value of all food no longer in the establishment. This includes the value of any meals eaten by employees and also food that is lost due to wastage, pilferage, and spoilage. Cost of goods consumed is a general term for cost of any products consumed. For restaurants, cost of goods consumed refers to cost of food consumed and cost of beverage consumed. Employee meals are a labor-related expense. The cost of this benefit, if provided, should be accounted for in the Employee Benefits line item of the Operating Expenses section of the income statement. Since this expense belongs under Employee Benefits, it is subtracted from cost of food consumed to yield the cost of food sold (cost of sales) on the income statement. Transfers out are items that have been transferred out of one unit to another, and transfers in are items that have been transferred in to one unit from another. The formula for cost of food sold in this situation would be as follows: Beginning Inventory + Purchases = Food Available for Sale - Ending Inventory = Cost of Food Consumed - Value of Transfers Out + Value of Transfers In - Employee Meals = Cost of Food Sold  See Go Figure! in the text for an example of the computation of Cost of Food Sold (Cost of Sales: Food). Cost of Beverage Sold (Cost of Sales: Beverage)   Cost of beverage sold (cost of sales: beverage) is the dollar amount of all beverage expenses incurred during the accounting period. The cost of beverage sold is calculated in the same way as cost of food sold except that the products are alcoholic beverages (beer, wine, and spirits). Employee meals are not subtracted because employees are not drinking alcoholic beverages. The computation of cost of beverage sold is as follows: 11 Beginning Inventory + Purchases = Beverage Available for Sale - Ending Inventory = Cost of Beverage Sold  The cost of beverage sold formula is amended for transfers as follows: Beginning Inventory + Purchases = Beverage Available for Sale - Ending Inventory - Value of Transfers Out + Value of Transfers In = Cost of Beverage Sold   See Go Figure! in the text for an example of the computation of Cost of Beverage Sold (Cost of Sales: Beverage). Accurate beginning and ending inventory figures must be maintained if an operation’s true food and beverage cost data are to be computed. Ending inventory for one accounting period becomes beginning inventory for the next period. Food Cost Percentage   A restaurant’s food cost percentage is the ratio of the restaurant’s cost of food sold (cost of sales: food) and its food revenue (sales). Thus, food cost percentage represents the portion of food sales that was spent on food expenses. The calculation for food cost percentage is: Beverage Cost Percentage   A restaurant’s beverage cost percentage is the ratio of the restaurant’s cost of beverage sold (cost of sales: beverage) and its beverage revenue (sales). Thus, beverage cost percentage represents the portion of beverage sales that was spent on beverage expenses. For most restaurants, the beverage cost percentage, its management, and its control are extremely important because alcoholic beverages represent an expensive cost and a serious security problem. 12 Labor Cost Percentage    Restaurateurs are very interested in the labor cost percentage, which is the portion of total sales that was spent on labor expenses. Labor costs include salaries and wages and other labor-related expenses such as employee benefits. Increasing total sales (the denominator in the formula) will help decrease the labor cost percentage even as total dollars spent on labor increases, assuming some of the labor costs represent fixed expenses such as salaries. It is typically not in the best interest of restaurant operators to reduce the total amount they spend on labor. In most foodservice situations, managers want to serve more guests, and that typically requires additional staff. The labor cost percentage is important because it helps managers relate the amount of products they sell to the cost of the staff needed to sell them. Many managers feel it is more important to control labor costs than product costs because, for many of them, labor and labor-related costs comprise a larger portion of their operating budgets than do the food and beverage products they sell. Average Sales per Guest (Check Average)     Average sales per guest is the average amount of money spent per customer during a given accounting period. Average sales per guest is also commonly known as check average. Most point of sale (POS) systems (computer systems used for tracking sales data) will tell you the amount of revenue you have generated in a selected time period, the number of guests you have served, and the average sales per guest. This measure of “sales per guest” is important because it carries information needed to monitor menu item popularity, estimate staffing requirements, and even determine purchasing procedures. It also allows a financial analyst to measure a chain’s effectiveness in increasing sales to its current guests, rather than increasing sales simply by opening additional restaurants. The check average ratio can be used to compare a restaurant’s performance to previous accounting periods, to forecasted or budgeted results, to similar restaurants, and to published industry averages or standards. Industry averages and other restaurant statistics are readily available through publications such as the Restaurant Industry Operations Report published by the National Restaurant Association. Seat Turnover   To evaluate a restaurant’s effectiveness in “turning tables” the seat turnover ratio is a popular one. Seat turnover measures the number of times seats change from the current diner to the next diner in a given accounting period. This ratio does not use information from the income statement, the balance sheet, or the statement of cash flows. It is one of the many financial ratios used by managers in the hospitality industry for which the data is generated completely internally. 13    The interpretation of this ratio must be carefully undertaken because its value is so greatly determined by the “covers served” that comprises this ratio’s numerator. Often, management must make decisions about the definition of a cover, such as:  Is a guest who accompanies another diner but does not eat considered a cover?  Must a cover purchase a minimum number of menu items or dollar value of items to be considered a cover?  Should the definition of a cover change from breakfast, lunch, and dinner? Managers want to see this ratio as high as reasonably possible because the seat turnover ratio is an important indication of a restaurant’s ability to effectively utilize its “seats” to sell it products. See Figure 6.7 for a summary of the ratios used by managers. Comparative Analysis of Ratios  Like many other types of financial data, a company’s financial ratios are often compared to previous accounting periods, to forecasted or budgeted results, or to published industry averages or standards (see Figure 6.8 and 6.9). Ratio Analysis Limitations   One weakness inherent in an over-dependency on financial ratios is that ratios, by themselves, may be less meaningful unless compared to those of previous accounting periods, budgeted results, industry averages, or similar properties. Another limitation is that financial ratios do not measure a company’s intellectual capital assets such as brand name, potential for growth, and intellectual or human capital when assessing a company’s true worth. See Figure 6.10 for a list of some of the intellectual capital assets that should be analyzed in addition to financial ratios to assess the health and worth of a company. 14 Liquidity Ratio Summary Table Ratio Name Definition Source of Data Formula Current Ratio Current ratio shows the firm’s ability to cover its current liabilities with its current assets. Quick ratio shows the firm’s ability to cover its current liabilities with its most liquid current assets. Numerator: Balance Sheet Denominator: Balance Sheet Current Assets Current Liabilities Numerator: Balance Sheet Denominator: Balance Sheet Operating cash flows to current liabilities ratio shows the firm’s ability to cover its current liabilities with its operating cash flows. Working capital is the difference between current assets and current liabilities. Numerator: Statement of cash flows Denominator: Balance sheet Cash + marketable securities + accounts receivable Current liabilities or Current assets – (inventories + prepaid expenses) Current liabilities Operating cash flows Current liabilities Quick (AcidTest) Ratio Operating Cash Flows to Current Liabilities Ratio Working Capital Numerator: Balance Sheet Denominator: Balance Sheet Current assets – Current liabilities Solvency Ratio Summary Table Ratio Name Definition Source of Data Formula Solvency Ratio Solvency ratio shows the firms ability to cover its total liabilities with its total assets. Numerator: Balance Sheet Denominator: Balance Sheet Total assets Total liabilities 15 Ratio Name Definition Source of Data Formula Debt to Equity Ratio Debt to equity ratio compares total liabilities to owners’ equity. Debt to assets ratio shows the percentage of assets financed through debt. Numerator: Balance Sheet Denominator: Balance Sheet Total liabilities Total owner's equity Numerator: Balance Sheet Denominator: Balance Sheet Total liabilities Total assets Operating Cash Flows to Total Liabilities Ratio Operating cash flows to total liabilities ratio shows the firm’s ability to cover its total liabilities with its operating cash flows. Numerator: Statement of cash flows Denominator: Balance sheet Operating cash flows Total liabilities Times Interest Earned Ratio Times interest earned shows the firm’s ability to cover interest expenses with earnings before interest and taxes. Numerator: Income statement Denominator: Income statement Earnings Before Interest and Taxes (EBIT) Interest Expense Debt to Assets Ratio Activity Ratio Summary Table Ratio Name Definition Source of Data Formula Food Inventory Turnover Ratio Food inventory turnover shows the speed (# of times) that food inventory is replaced (turned) during a year Numerator: Income statement Denominator: Balance sheet Cost of food consumed Average food inventory* *(Beginning food inventory + ending food inventory)/2 16 Ratio Name Definition Source of Data Formula Beverage Inventory Turnover Ratio Beverage inventory turnover shows the speed (# of times) that beverage inventory is replaced (turned) during a year Property and equipment turnover ratio shows management’s ability to effectively use net property and equipment to generate revenues. Total asset turnover shows management’s ability to effectively use total assets to generate revenues. Numerator: Income statement Denominator: Balance sheet Cost of beverage consumed Average beverage inventory* Numerator: Income statement Denominator: Balance sheet *(Beginning beverage inventory + ending beverage inventory)/2 Total Revenue Net Property and Equipment Numerator: Income statement Denominator: Balance sheet Total Revenue Total Assets Property and Equipment (Fixed Asset) Turnover Ratio Total Asset Turnover Ratio Profitability Ratio Summary Table Ratio Name Definition Source of Data Formula Profit Margin Profit margin shows management’s ability to generate sales, control expenses, and provide a profit. Gross operating profit margin shows management’s ability to generate sales, control expenses, and provide a gross operating profit. Numerator: Income statement Denominator: Income statement Net income Total revenue Numerator: Income statement Denominator: Income statement Gross operating profit Total revenue Gross Operating Profit Margin (Operating Efficiency Ratio) 17 Ratio Name Definition Source of Data Formula Return on Assets Ratio Return on assets shows the firm’s ability to use total assets to generate net income. Return on equity shows the firm’s ability to use owner’s equity to generate net income. Earnings per share compares net income to common shares. Numerator: Income statement Denominator: Balance sheet Net income Total assets Numerator: Income statement Denominator: Balance sheet Net income Total owners’ equity Numerator: Income statement Denominator: Statement of Retained Earnings and Investor Information Numerator: Statement of Retained Earnings and Investor Information Denominator: Statement of Retained Earnings and Investor Information Numerator: Statement of Retained Earnings and Investor Information Denominator: Statement of Retained Earnings and Investor Information Numerator: Statement of Retained Earnings and Investor Information Denominator: Statement of Retained Earnings and Investor Information Net income Total number of common shares outstanding Return on Equity Ratio Earnings Per Share Ratio Price/Earnings (P/E) Ratio Price/earnings ratio shows the perception of the firm in the market about future earnings growth of the company. Dividend Payout Ratio Dividend payout ratio shows the percentage of net income that is to be paid out in dividends. Dividend Yield Ratio Dividend yield shows the stockholders’ return on investment paid in dividends. 18 Market price per share Earnings per share Dividends per share Earnings per share Dividends per share Market price per share Hospitality Ratio Summary Table Ratio Name Definition Source of Data Formula Occupancy Percentage Occupancy % shows percentage of rooms sold in relation to rooms available for sale Average daily rate shows average amount for which a hotel sells its rooms RevPar shows revenues generated by each available room Numerator: Operating Reports Denominator: Operating Reports Rooms Sold Rooms Available for Sale Numerator: Operating Reports Denominator: Operating Reports Numerator: Operating Reports Denominator: Operating Reports Total Rooms Revenue Total Number of Rooms Sold Cost per Occupied Room (CPOR) Cost per occupied room compares specific costs in relation to number of occupied rooms Numerator: Operating Reports Denominator: Operating Reports Food Cost Percentage Food Cost Percentage represents portion of food sales spent on food expenses Beverage Cost Percentage represents portion of Beverage sales spent on Beverage expenses Labor Cost Percentage represents portion of total sales spent on labor expenses Numerator: Operating Reports Denominator: Operating Reports Cost of Food Sold Food Sales Numerator: Operating Reports Denominator: Operating Reports Cost of Beverage Sold Beverage Sales Numerator: Operating Reports Denominator: Operating Reports Cost of Labor* Total Sales * Cost of labor = salaries + wages + employee benefits Average Daily Rate (ADR) Revenue per Available room (RevPAR) Beverage Cost Percentage Labor Cost Percentage 19 Occupancy % x ADR or Total Rooms Revenue Rooms Available for Sale Cost Under Examination Rooms Occupied Ratio Name Definition Source of Data Formula Average Sales Per Guest (Check Average) Average sales per guest is average amount of money spent per customer during given accounting period Numerator: Operating Reports Denominator: Operating Reports Total Sales Number of Guests Served Seat Turnover Seat turnover shows number of times seats change from current diner to another diner in given accounting period Numerator: Operating Reports Denominator: Operating Reports Covers Served Number of Seats x Number of Operating Days in Period 20 21