In this article we will be discussing how an increase in hotels rooms revenue impacts on gross operating profit by illustrating the flow through from revenue to profit.
When hotel occupancy and revenues exceed forecast it is still critical to closely monitor the flow through or conversion of each monetary unit of revenue to gross operating profit (GOP). The GOP is a key level of profit for hotel operators because it represents the level of profit in the P&L which is impacted most by the operational teams. The Uniform System of Accounts for the Lodging Industry (USALI) defines GOP as the profit achieved from all the property revenues less the departmental operating costs and the operational overheads known as the Undistributed Operating Expenses (UOE). The UOE include costs such as Administration and General, Sales and Marketing, IT and Communications, and Utilities.
Gross operating profit is a good measure of the overall potential of the business to generate an income for the owner as well as providing the basis for operating company management fees. Measuring and monitoring GOP can be done using a range of measures, the cash value, the percentage to total revenue and as an asset usage ratio such as GOPPAR (Gross Operating Profit per Available Room) and GOPPOR (Gross Operating Profit per Occupied Room).
The level of conversion of revenue to GOP is measured via the Flow Through and Flex techniques defined by the USALI as the difference between the actual GOP achieved versus budget or forecast divided by the difference in actual total revenue and the budget or forecast values. Typically, comparison to the forecast provides the greatest insight when analysing the monthly management reports.
Actual Gross Operating Profit – Forecasted Gross Operating Profit
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Actual Revenue – Forecasted Revenue
This calculation provides an overall percentage measure of the conversion of the additional revenue to GOP which can be tracked when revenue both increases and declines. Clearly when revenue falls against the forecast the challenge is to salvage as much GOP as possible from that decline.
When both revenue and GOP has dropped, the USALI recommends that the Flex calculation be used.
1 – Actual Gross Operating Profit – Budgeted Gross Operating Profit
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Actual Revenue – Budget Revenue
This is an excellent start to monitoring the GOP conversion. The next step is to understand how the source of revenue impacts on the conversion. The conversion rate of rooms revenue is quite different to food and beverage revenue for example because of the proportion of marginal or variable costs involved for restaurant revenue, in particular the product cost which are typically 30% of the net selling price.
Within the category of room sales, the additional revenue could arise through an increase in the Average Room Rate (ARR) or through an increase in occupancy or a combination of both. Additional rooms revenue arising from an increase in rate does not require additional cost to service the room giving a better flow through to GOP.
Using standard costing techniques, it is possible to both split the revenue to determine the source of the change in revenues as well as calculating the additional cost likely to be incurred. We can start with the Sales Volume Variance which is the difference between the actual and expected occupancy, i.e. the number of rooms sold and then multiplied by the forecasted average room rate.
The purpose of this variance is to separate out the change in GOP arising from the number of rooms sold. Then if we consider the Selling Price Variance, this is the difference between the actual and forecasted average room rate, multiplied by the actual number of rooms sold. The following steps illustrate how this can be achieved in practice.
| Actual | Forecast | |
| Rooms available | 750 | 750 |
| Rooms occupied | 645 | 615 |
| Occupancy percentage | 86% | 82% |
| ARR | £177.00 | £163.00 |
| Rooms Revenue | £114,165 | £100,245 |
From the above table we can see that the additional total rooms revenue generated is £13,920. We can then split the increase in revenue into the two sources. The additional revenue due to the rooms occupied is:
30 X 163.00 = 4,890
And the additional revenue due to the average room rate is:
£14 x 645 = 9,030
We then need to consider what is the conversion rate of each of these sources of revenue to GOP. When additional rooms are sold there will be additional variable costs incurred to clean the rooms for example. Whereas an increase in room sales due to the rate change will have a higher conversion to GOP.
As in all analysis there are various assumptions to be made throughout the calculations which some might argue renders the review less useful. However, I would support the view that increased scrutiny provides increased insight and the process of completing the steps above provides a much-improved understanding of the true costs involved and the impact on the overall profitability of the business.
To find out more – why not sign up for our next course for Finance for Non-Financial Managers in Hospitality or join our finance4hospitality academy.
