The hospitality industry is a large field within the service industry that includes smaller fields such as hotels and lodging, event planning, theme parks, transportation, cruise lines and other fields within the tourism industry.
With the hospitality industry being a general one, it is extremely important to define a set of financial ratios that can be used to analyze companies across the entire industry, regardless of operations. The hospitality industry is heavy in fixed and tangible assets, and therefore requires a very specific set of financial ratios to accurately analyze the industry and come to conclusions based on performance of individual companies. The following are key financial ratios a stakeholder can use to analyze companies within the hospitality industry.
1. Liquidity Ratios
Liquidity ratios provide stakeholders with information regarding a company’s ability to meet its short-term financial obligations. The hospitality industry needs a high amount of working capital and has a lot of short-term financial obligations to cover, making liquidity ratios an integral part of the industry’s analysis.
Current ratio = (current assets / current liabilities)
The current ratio is a liquidity measure that shows how a company is able to meet all its short-term liabilities with the short-term assets on hand. These assets are anything considered short-term such as inventory, and do not include long-term assets such as property, plant and equipment.
For the hospitality industry, companies have a lot of current liabilities in the form of salaries and wages, short-term equipment leasing and other short-term liabilities. Additionally, it is a cyclical industry, making it imperative that companies have enough current assets to cover current liabilities, even in an economic downturn. Stakeholders want to see a high current ratio above 1 to determine a company within the hospitality industry is strong.
2. Financial Leverage Ratios
Financial leverage ratios give stakeholders an understanding of the long-term solvency of a firm in the hospitality industry. These ratios measure a company’s ability to meet its long-term debt obligations.
Debt ratio = (total debt / total assets)
Companies within the hospitality industry have a lot of long-term liabilities in the form of debt, along with current liabilities. This debt is used to finance large properties such as hotels and large bus fleets for transportation companies. A lot of long-term assets are needed to successfully run a hospitality company, and therefore long-term debt financing is also normally needed.
The debt ratio measures a company’s ability to meet its long-term debt obligations. For companies within the hospitality industry, it is important to have low debt ratios, meaning long-term assets greatly outweigh the debt used to purchase them.
3. Profitability Ratios
Profitability ratios measure a company’s level of profitability, at the gross profit, operating profit and net profit levels. For companies in the hospitality industry, billions of dollars are generated, and many companies are long-established, meaning high profit margins should be generated at all levels.
Gross profit margin = (sales – cost of goods sold) / (sales)
Gross profit margin measures a company’s gross profit earned on the revenue it generates. For companies in the hospitality industry, most of the costs come from operations and not cost of goods sold, and the gross profit margin should be high for those businesses that operate within the hospitality industry.
Net profit margin = (net profit) / (total sales)
The net profit margin is similar to the gross profit margin except it measures the amount of net profit earned on the revenue a company generates. For the companies in the hospitality industry, profits are actually not very high, as there are high associated operating costs to run a company in this industry. However, a stakeholder should always look at a company’s net profit margin and compare it to industry averages to ensure it meets or exceeds the benchmark.