Maximizing Profits By Calculating Your Hotel’s Break-Even Point

By James Downey Professor, Program Coordinator MBA Hospitality & Event Management, Lynn University | January 21, 2018

The notion behind break-even analysis or more formally known as cost-volume-profit (CVP) analysis centers around calculating your operations fixed and variable costs. One can catagorize fixed costs as a hotel general manager’s enemy and variable costs as a financial friend.

This is so because a salaried employee’s pay does not vary typically over one year offering no ability to lower its impact on the bottom line while a wage earners pay can be adjusted up or down depending upon the hours worked

Fixed Costs 

Fixed costs are the hotel manager’s nemesis because they do not change in the short run. (under one year) Why are they considered a nemesis? Because they do not change regardless of increases or decreases with actual sales revenue or volume. A primary example of a fixed cost is a manager’s salary at any level. Other fixed costs may include insurance, depreciation, rent, property taxes and income taxes, among others.

Variable Costs

Unlike a fixed cost, a variable cost is the hotel manager’s friend because it changes in relation to sales revenue or volume. A primary example of a variable cost is cost of sales for the food and beverage department. If food and beverage sales go up, more costs increase proportional to purchase those food and beverage items. Another example is the wage a worker receives. These workers are “on the clock” and can be a taken off the clock at any time. Unlike salaried personnel who earn an amount the entire year whether they work short or long hours, wage earners can save the operation money simply by utilizing them on a need only basis.

Break-Even Calculations 

Once you’ve separated your fixed costs from your variable expenses, it’s just a matter of applying a set and determined formulae to calculate the break-even point for your operation. Break-even calculations are broken down into three separate categories using the income statement. You can calculate your break-even point three of the following ways:

  1.   Break-even sales revenue
  2.   Break-even level in number of rooms for a hotel or seats for a restaurant, and 
  3.  Break-even occupancy percentage for a lodging operation. 

It must be stated here that the farther away your break even results are from your actual numbers, the more favorable your financial position. If the break-even percentage is 30 percent or less than actual sales revenue, seats sold or rooms sold, this would provide a favorable financial position for the operation.

Break-Even Sales Revenue (B.E.S.R.) 

First we will calculate the break-even revenue level for a lodging operation. The break-even sales revenue formula is as follows:

B.E.S.R. (Break-Even Sales Revenue) =
Fixed Costs
1 – (VC/SR)

As can be seen in figure 1, the break-even sales revenue is calculated by separating fixed costs from variable costs for the entire income statement. The Dew Drop Inn had a B.E.S.R of $1,195,112 which is below the actual sales volume of $1,753,000. In this case, the B.E.S.R is 68% of actual sales revenue which is not a favorable financial position. B.E.S.R is best when it is less than 30% of actual revenue. A general manager who knows his/her break even figure for sales is well equipped to make a profit providing B.E.S.R. is much lower than actual sales revenue.

Break-Even Calculations for Guest Rooms and Restaurant Seats

Guest Rooms

Using a lodging operation as an example, we can assume the following annual data for a 200-room hotel:

Fixed Costs= $1,900,000
Selling price of a room (ADR) = $150.00
Variable cost per room=$45.00

$1,900,000    

150.00 -45.00 =

$1,900,000    

$105.00 = 18,095 rooms at break-even

In summary, this hotel would have 73,000 rooms available annually (200 X 365) where 18,095 rooms must be sold just to break-even which amounts to a 24.8 % break-even occupancy. (18,095 divided by 73,000 available rooms) Moreover, this property needs to sell just 49 rooms per day just to break-even (.248 X 200 rooms) This is a favorable financial position since it is below the preferred break-even percentage of 30% for all lodging operations.   

Restaurant Seats 

A hotel general manger has a distinct advantage when he/she knows how many seats must be sold in order to break-even in restaurant facilities. In order to arrive at the break-even point for restaurant seats, another formula must be used that will reveal the exact number of seats to be sold just to break-even. This formula is as follows: 

Fixed Costs
Selling Price (SP) – Variable Costs(VC)

Using an example for a restaurant operation open all year with 100 seats, we’ll assume it has the following annual sales, fixed costs, per meal selling price and variable costs:  

Restaurant actual sales= $600,000  
Restaurant fixed costs= 100,000
Per meal selling price=$25.00
Variable costs per seat=$5.00

$100,000
$25.00 -5.00 =

$100,000
$20.00 = 5,000 seats at break even

To further explain, 5,000 seats need to be sold to break-even or put another way $125,000 must be earned in sales (5,000 X $25.00 per meal selling price) just to do the same.

Moreover, the restaurant has achieved a 13.6 % break-even level when the 5,000 seats sold at break even are divided by the 36,500 (100 seats X 365 days) actual seats available. This is well below the 30% favorable break-even level for all restaurant operations. Furthermore, a restaurant manager would only have to sell 14 seats per day just to break-even. (.13 6 X 100 seats = 14 rounded) 

Conclusion 

It should be noted that the results of the formulas used in your hotel facility will only be as accurate as the data supplied. In other words, you must avoid the “garbage in, garbage out” dilemma. 

It is also vital that the exact figures for fixed costs and variable costs be reliable and calculated correctly. I suggest your consult with your controller to identify specifically what costs are fixed and variable for your operation.

Once the break-even figures are achieved accurately, a general manager knows what he or she is up against when it comes to making a profit. Corrective action can be applied quickly when figures are out of the expected profitability range. Managers should therefore set expected profitability ranges when incorporating break-even applications. 

References:

1. Bragg, S. Hospitality Accounting: A Financial and Managerial Accounting Reference. Accounting Tools publishing. 2015.

2. Schmidgall, R.,Damitio, J. Hospitality Financial Accounting. 3rd edition. American Hotel and Lodging Association publishing. 2012.

3. Weygandt, J., Kieso, D. Hospitality Financial Accounting. John Wiley & Sons publishing. 2009.

Dr. Downey James Downey began teaching at Lynn in 1994 as an associate professor in the former School of Hospitality, Tourism and Recreation Management. Prior to that, his educational positions include Department Chairman of Hotel, Restaurant and Institutional Management at Drexel University in Philadelphia, Pennsylvania and he served as Dean of the School of Hotel, Restaurant and Tourism Administration at the University of New Haven, in New Haven, Connecticut. He also served as the Associate Dean in the College of Hospitality Management from 2002 until 2009 at Lynn. Mr. Downey's teaching philosophy has been and continues to be predicated on sound instructional techniques that provide successful student learning outcomes. He has maintained this philosophy since he came to Lynn. Below is a chronicle of how he adapted this teaching philosophy. Mr. Downey did not choose the hospitality industry, the hospitality industry chose him. His family managed a small hotel in eastern Pennsylvania where he began as a front desk clerk at the age of 13. From that experience, he developed a love of the hospitality industry that eventually drew him into the fields of accounting and lodging development. James Downey can be contacted at 561-237-7858 or jdowney@lynn.edu Extended Biography

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