Anatomy of a Hotel Audit
By Steven Klein Partner, Gerson, Preston, Klien, Lips, Eisenberg & Gelber | January 06, 2019
These are challenging times for the hotel industry. Due to skyrocketing operating costs, most U.S. hotel groups have still been unable to reach operating margins commensurate with the industry peak in 2007. Consumer preferences demand upgrades in technology and room renovations, cutting into the bottom line even as rising salaries, wages, benefits and staffing levels add to labor costs.
Historically, hotel management raised room rates in order the balance the books. But new challenges on several fronts are making that approach impractical.
Airbnb, the home-sharing platform going head-to-head with hotels, continues its phenomenal growth. Through 2014, hoteliers in cities such as New York, Los Angeles and San Francisco that offer significant inventories of Airbnb options saw variable profits shrink up to 3.7 percent, according to a recent report from the National Bureau of Economic Research. The greatest losses came during peak seasons in tight markets –– think Manhattan on New Year's Eve or Cambridge, Massachusetts at graduation –– when room rates soar and hotels traditionally post their highest margins.
According to the study, as of November 2016 Airbnb reported an inventory of just over 3 million listings worldwide –– nearly three times that of industry frontrunner Marriott International. Most recently, Airbnb announced a 2,500 percent growth in bookings in 2017.
A recent survey of generational travel patterns found that millennials, now aged 18-34, were the most active summer travelers in 2018. Hotels that want to capture this booming market sector may feel the need to add high-tech amenities such as high-speed connectivity or digital registration and room keys.
An enhanced internet presence is also becoming a necessity. But while online booking services such as TripAdvisor and Expedia expand market reach, they may also contribute to the drain on profit margins. Competitive listings limit room-rate hikes, and commission rates charged hotels are climbing.
In spite of these assaults, some forecasts project the U.S. hotel industry will wrap up 2018 with near 3 percent growth in revenue per available room (RevPAR). But the specter of oversupply haunts the immediate future. Nationwide, an 8 percent increase in hotel product is on track for delivery by 2020.
The financial Audit: A Pragmatic Approach
In the face of these challenges, even the most established global hotel brands may question how to remain profitable in today's complex hospitality frontier. There's a simple answer: get regular financial audits. From international resorts to smaller boutiques, financial audits should be understood as far more than just an occasional check-the-box requirement. When used correctly, an audit can be a powerful performance tool that will help hotel executives make better decisions across the board. It may uncover potential pitfalls before they cause havoc and embarrassment. It provides a practical assessment of financial procedures that can be used to create more efficiency. In so doing, it may even identify new opportunities for revenue growth.
What a Financial Auditor Does
Simply put, a financial auditor is an unbiased, outside expert who conducts an independent assessment of a business operation's financial reporting. This assessment is designed to find out whether the fiscal information gathered is fairly stated and accurate. In pursuit of this goal, a good financial auditor will cover quite a few bases for a hotel or hospitality group to compile information from as many sources as possible. He or she will examine a company's financial statements, documents, data and accounting entries, financial reporting systems, account balances, cash flow statements, income statements, balance sheets, tax returns and internal control systems.
Of course, most hotels already have their own internal financial and reporting processes in place. An independent, third-party audit should not be seen as suspicion of fraud or embezzlement. Executives from the top down should feel comfortable with opening the books to an independent third-party expert.
Inhouse accountants and financial officers help to assemble all the information needed to undertake an accurate assessment. More often than not, the errors auditors uncover aren't due to intentional misreporting. It's more likely to find careless mistakes or inadvertent omissions – small gaffes that can create serious problems down the line.
One example that comes to mind involves a series of errors that, if compounded, would have been catastrophic for a client's reputation. We were hired to audit a hotel operation consisting of pooled investor-owned hotel units. In the course of the audit, we discovered errors caused by a misunderstanding of how the operating agreement was meant to be applied. This had led to miscalculations of the revenue split between the hotel operator and the unit owners, as well as an inaccurate reckoning of the revenue net of the deductions that had been agreed upon. Simple mistakes, obviously unintentional – but unchecked, they would have become a ticking time bomb.
Nuts and Bolts
Properly conducted, a thorough audit is a comprehensive investigation of every aspect of a hotel's operations. The object is not to point fingers but to ferret out errors, miscalculations and areas of risk to the property's financial health. This includes a complete analysis of procedures for processing and recording transactions, financial reporting methods, and essential controls and systems.
Let's get down to the nitty-gritty. Here's a quick rundown of the risk-based measures that serves as a path toward completing a successful and thorough audit.
Reconcile the general ledger, which holds the complete accounting record of the entity's financial transactions from its inception – assets, liabilities, owners' equity, revenues, expenses. The general ledger is the source from which all financial statements are derived. Take a look at any sub-ledgers such as folio and guest ledgers, accounts payable and receivable, payroll and the like.
Perform in-depth audits of selected transactions by inspecting the source documents and contacting third parties to provide confirmation.
Review the hotel's compliance with significant contracts.
Then, apply detailed analytical procedures to determine how successfully the hotel is responding to trends in the hospitality business. Look at industry comparisons to see how it measures up in such areas as average daily rates (ADR); food & beverage revenue, including cost per cover; expense statistics; advance deposits; recorded revenue and so on.
Depending on the property, the whole process could take anywhere from one to three weeks. If this sounds tedious, remember that auditors are professionals.
A financial audit isn't a pass/fail test of a property's financial acumen. In fact, it can be an effective guide to greater efficiency and clarify previously under-recognized opportunities.
When an audit is complete, it's helpful to prepare a management letter that provides detailed information on findings. In addition to pointing out mandatory protocol changes and alerting hotel executives to any deficiencies unearthed during the audit, the management letter includes suggestions for improvement based on our observations. Then, provide a full financial statement consisting of a balance sheet, statement of operations (functional, divisional and summary), statement of cash flows and stakeholder equity. Findings are then further explained in extensive footnotes containing relevant information.
When to Conduct an Audit
A financial audit is only as reliable as the data it reports. It won't be useful as a decision-making tool unless it's kept up to date. For any number of reasons, financial statements from an audit conducted as little as two years ago may no longer be applicable.
Company executives need to be proactive. Ideally, every hotel or resort should be audited annually, timed to coincide with the end of its fiscal year. Don't wait until discrepancies and inconsistencies make it clear that something is wrong.
On occasion, an audit will identify egregious errors or serious omissions that could damage ownership's credibility. But even when it does not uncover any irregularities, it serves as an independent, unbiased validation to ownership as well as both internal and external users of the hotel management's financial reporting. Potential lenders, investors, partners or buyers may well require a recent audit. It is also a useful tool to identify recommendations or improvements to operating and financial reporting procedures.
Ultimately, the audit not only protects the hotel as an asset; it also helps prevent the hotel's executives from making unfortunate financial decisions based on faulty assumptions of financial health and performance. It serves to enhance the credibility of ownership, which can be critical to creditor or investor decision-making.
The hospitality industry has always been vulnerable to circumstances beyond its control, from changing trends to natural disasters to political upheavals anywhere on the globe. Timely financial audits can help hotel management and ownership find the resources to deal with the unexpected from a position of strength.
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