In the second of our series on the budget approval process, we are looking at specific areas to look at which can ease the approval process and ensure a more accurate budget and a profitable following year.
The most important consideration overall is to remember that hotels never have the same year twice. This feels particularly true now, as trading looks to even out after the lifting of Covid restrictions, but in fact, will have been true for the lifetime of the property. Factors outside your control, such as being in an in-demand location, hosting a sporting event, or even a change in weather, can mean that one year can look very different from another.
When taking guidance from the past year, it is important to set aside all the one-off events which took place in the current year and identify the one-off events in the budgeted year, then do a waterfall analysis to identify whether all the one-off events are isolated. This will give you a clear view of the actual revenue increase and how realistic it is. Do the same with the one-off costs.
Here, the Asset Manager should always review their monthly asset management reports of the past one or two years. We need to identify key events, challenging months, mistakes, and other events that impacted the P&L. Using this information is crucial to improve performance. For instance, if the executive team failed to rapidly lower their costs after the high seasons, we should warn the team to put a Profit Protection Plan in place before repeating the same mistake in the upcoming year.
Ask for a comparison per department where you will exclude the mandatory pay rise and the bonus effect. You have to isolate each case as this will help you to understand the cost structure better. For example, if you had three employees on sick leave last year and had to replace them with additional staff while their salaries were paid, you should present some savings in the new budget. On the other hand, if you budget for additional occupancy, you will need to book for higher maids.
An area which is often overlooked is the breakfast cost and allocation. It can have a significant impact because usually, the operators would rather allocate a small amount of the breakfast revenue to the F&B, keeping the rest in the ADR. This way, they inflate their RevPar and, consequently, the RGI, which is usually part of the performance test. Additionally, some of them have special fees on the Room Revenue, therefore, by including in the ADR a higher amount of the sold package (it is not only breakfast, but any package), they earn higher fees. Nevertheless, when one makes this calculation should also have in mind the VAT applied to the F&B, which in some countries is higher compared to the rooms; hence it might make sense to have a lower allocation. If the hotel sells on net rates, then the allocation should be done in a way to take into consideration all the above and guarantee the best profitability for the Owner. In any case, it doesn’t make sense to have low rates which don’t even cover the direct costs (F&B, payroll etc.), as it creates wrong alarms about the F&B profitability and, in case of a tax inspection, can end up with fines.
Do the same with the costs. For instance, if you had to make some special repairs in the kitchen last year due to a one-off problem, you should present some savings in the new budget. Nevertheless, if you present an occupancy increase, you will show an increase in variable costs, such as amenities and cleaning supplies, and semi-variable costs, such as utilities.
Before starting with the budget, ask for an accurate forecast for the current year and check it carefully. Ensure you identified all additional costs and over-accruals that need to be reversed by the year’s end.
Once incomings and outgoings are all accounted for, check your GOP and explain any variances versus the 10-year plan presented to the Owner, then identify areas for improvement in the cost structure. Use the bridge report commented in our previous article (link). You should calculate how much additional revenue you received through the rate increase, how much through the one-off events etc. Compare your GOP with the latest 5-year plan presented by the operator. You need to check his consistency and accuracy in his previsions.
Then check your flow through. ADR increase should give an additional 80%-85% profit, while the occupancy increase should give some 70%-75% more.
Prepare your cash flow for the next year and prepare the Capex requests and make sure their ROI has been included in the budget.
Identify clear goals for the next period and make sure they are S.M.A.R.T. This means that they must be: Specific, Measurable, Achievable, Relevant and Time-bound. Defining these parameters as they pertain to your goal helps ensure that your objectives are attainable within a certain time frame.
Once the Asset Manager has thoroughly reviewed and analysed the proposed budget, they will discuss it with the hotel management team.
Owners and Asset Managers will push for more difficult but attainable goals. Please keep in mind that budgets are also used as a base for executive bonuses, but not limited to. They should be achievable; otherwise, your employees will be quickly disappointed and will not do their utmost to achieve the goals you set. However, especially after the 2008 crisis, many operators have detached the annual bonus from the GOP achievement to keep their senior staff motivated and enable them to pay partially the bonus. The Asset Manager should think of the staff satisfaction related to the bonus payment when setting up the budget without ignoring the Owner’s interests.
The operator, however, is likely to defend their initial projections to make achieving their goals more attainable, ensuring that they meet their performance requirements. They will also try and justify past performance by finding logical arguments and reasonable justifications. While some may be a factor of an external or uncontrollable event, it is crucial to understand what really happened and locate the actual cause.
If the first budget is rejected, which is often the case, the operator will make the changes according to the points discussed during the initial meeting. Keep in mind that the first draft is the most time-consuming as everything is reviewed in detail.
The budget rejection should be formulated in an official letter drafted by the Asset Manager or the Owner. This letter should mention the top-line objective and expected GOP %. The letter shouldn’t go into the details discussed during the budget meetings. It is important that the executive team decides the line-by-line changes within their P&L as long as they intend to meet the ownership objectives.
Any necessary modifications should be made within two weeks (check also the deadlines set in the HMA), and the corporate team will again review the second draft before it is submitted to the Owner and Asset Manager.
All outstanding points of contention and remaining issues should be revised in the second budget meeting (usually, a call is sufficient). If rejected again, it will be followed by a 3rd budget version until a final submission which is approved ideally before the end of the year. Unfortunately, this can go on until a budget is agreed upon, and in some rare cases, a third-party advisor may be engaged.
We recommend sending a formal budget approval letter to the operators, with the exacted budget provided, the occupancy and ADR, and the exact G.O.P. in the local currency. This way, there is no confusion about which version was approved. Please also ensure that no correction to this budget takes place without prior ownership written approval. It is surprising, but if ownership doesn’t keep a pulse on the operation, some unscrupulous tricks take place just to secure executive team bonuses.
But an approved budget is by no means the final word, as you will find out in part three.
