Capital Budgeting in the Hotel Industry

This assignment delves into the realm of capital budgeting within the hotel industry. It examines various methods employed by hotels to evaluate potential investments and make informed financial decisions. The focus is on understanding how hotels utilize these techniques to optimize resource allocation and enhance profitability in a dynamic and competitive market.

MANAGEMENT ACCOUNTING

Table of Contents
INTRODUCTION......................................................................................................................1
TASK 1 .....................................................................................................................................1
TASK 2......................................................................................................................................2
a) Preparation of cash budget................................................................................................2
b) Preparation of budgeted income statements......................................................................3
c) Budgeted statement of financial position..........................................................................4
TASK 3......................................................................................................................................5
CONCLUSION..........................................................................................................................8
REFERENCES.........................................................................................................................10

INTRODUCTION
There is a significant difference between financial and management accounting.
Financial accounting is the process of recording all the business transactions in an appropriate
manner. However, management accounting is concerned with the process of using financial
information by the managers so that they can perform efficient planning and control business
operations. The present project report will discuss the use of budgeted statement and various
capital budgeting techniques for the success of hotel business.
TASK 1
Budget: It is a financial tool that summarizes all the potential business incomes and
spending. In every corporation, managers analyse future operating activities and estimate
revenues and payments for constructing budget. In other words, it is the process of preparing
monetary plan that define business objectives which all the divisions or departments are
required to achieve (Warren, 2015). Moreover, it helps to determine variances through
comparing actual and budgeted targets and give advice to take corrective actions to remove
negative variances. Each and every firm whether small or large scale is required to draft
budget on the continuous basis. Need for budget preparation arises for maximizing revenues,
controlling spending and maintaining sufficient cash available to support daily functions
(Turner, 2013). Moreover, it assists the managers to optimally utilize of resources and
accomplish set business targets in an effective manner.
Process of budget preparation: Budget can be prepared easily in an ongoing
corporation while it will be very difficult task to construct budget for a new organization. The
reason behind this is that, the historical budget provides an idea about future operations as
without this it will not be possible to prepare budget for the new hotel.. Forecasting is the
initial requirement for budget preparation (Brooks and Mukherjee, 2013). Firm managers
have to forecast cash revenues and spending that will incur in the future period. As per the
scenario, hotel managers will estimate sales through determining room occupancy level and
multiply it with the total room rent (Sonawane, 2014). However, payments can be estimated
through determining payments for purchasing food, drink and laundry material. Moreover,
they have to assess labour and overhead payments which will be incurred in the upcoming
period. Thereafter, net cash balance will be determined through identifying difference
between actual and budgeted yields. It may be of two kinds, which are surplus and deficit.
Surplus indicates that potential earnings will be higher than payments however; deficit
balance implies that payments will be higher than hotel's operational incomes (Turner, 2016).
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It is the liability of the hotel manager to ensure optimum utilization of business resources so
as to avail adequate surplus balance. Otherwise, hotel cannot survive effectively in the
market. Moreover, it assist the managers to ensure hazard free operations and smooth
business functioning. After this, , cash balance at the end of budgeting period can be
determined through adding opening cash balance to the net cash flow of the period (Stephen,
Randolph and Bradford, 2016).
Limitations: One of the most important limitations is that it is based on the estimation
which may be inaccurate with reference to future period. Changing the market conditions
may change the predictions and it might be possible that actual cost will be significantly
different from set budgeted targets. Moreover, in case of new hotel, zero base budgeting
technique will be used for drafting budget. Henceforth, its limitation is that it takes lot of time
and money of the organization (de Souza and Lunkes, 2015). Another limitation is that, after
preparing budget, all the business strategies and decisions of the senior management focus on
accomplishing their budgeted targets. No changes will be made by the mangers if the market
conditions change.. Conflict of interest may arise regarding methods used by the senior
management to allocate resources in different divisions or departments (Chand, n.d.).
Another limitation is that it is a quantitative approach which focuses on maximizing
profitability henceforth, excludes all the qualitative aspects. For instance, it eliminates
various stakeholders’ interest such as customer demand, product quality, and shareholders
wealth and employee satisfaction.
TASK 2
a) Preparation of cash budget
It is a summarized statement of future earnings and payments (Noordzy and
Whitfield, 2015). As per the scenario, cash budget has been prepared here for six months
period ending on 30th September, 2016.
cash budget for the time period of six months
Particular April May June July August Sept. Total Oct.
Cash sales 12150 16200 28350 36450 36450 28350 157950
Credit sales 28350 37800 66150 85050 85050 302400 66150
Total current
year sales 40500 54000 94500 121500 121500 94500 526500
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Total cash
revenues 12150 44550 66150 102600 121500 113400 460350
Cash purchase
of food, drink
and laundry 1620 2160 3780 4860 4860 3780 21060
Credit purchase 6480 8640 15120 19440 19440 69120 15120
Labour cost 8100 10800 18900 24300 24300 18900 105300
Overhead cost 10125 13500 23625 30375 30375 108000 23625
Total Cash
expenses 9720 29565 44820 67905 78975 72495 303480
NCF 2430 14985 21330 34695 42525 40905 156870
Opening
balance 125000 127430 142415 163745 198440 240965 281870
Ending cash
balance 127430 142415 163745 198440 240965 281870 438740
On the basis of prepared cash budget, it can be interpreted that in all the subsequent
months, John's hotel business will generate surplus cash balance. In the month of April, NCF
was £2430 which went up to £40905 in the month ending. Thus, it indicates that sufficient
cash will be available to the hotel for operational purpose. Moreover, the above cash budget
states the amount of creditors and debtors for the month of October.
b) Preparation of budgeted income statements
It is a summarized statement of all the incomes and revenues which measure
operational performance in terms of gross profit and net profit. The difference between cash
budget and income statement is that it involves all the cash and non cash affecting
transactions. Increasing business profit indicates that hotel is performing well in the market
whilst decreased trade signify worst business performance. The purpose of this statement is to
determine hotel operational result in the way of profit or loss. For the given scenario, income
statement has been prepared here which is as under:
Budgeted Income statement for the year ended on 30th September, 2016
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Total sales 526500
Closing inventory
Consumption of material (See working note) 110300
Gross profit 416200
Less: operating expenses
Labour cost 105300
other overheads 131625
Depreciation on lease hold property 16000
Depreciation on furniture and fittings 7500
Depreciation on kitchen equipment 2500
Depreciation on laundry equipment 2500
Depreciation on gym equipment 750
Bad linen and towels 10000
Total operating expenses 276175
Net profit 140025
Working note
Material consumed
Opening stock of material 15000
Add: purchase of material 105300
Less: Closing stock 10000
Cost of material consumed 110300
c) Budgeted statement of financial position
It summarizes all the assets and liabilities of the hotel. Assets comprise of fixed as
well as current assets. Fixed assets are the assets which will be retained and it will be used by
the hotel for a long time period. For instance, lease hold property, furniture and fittings,
kitchen equipment, laundry equipment, gym equipment and china, glass and cutlery are the
type of fixed assets. On the contrary, current assets include all the hotel assets which will be
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converted into cash within the short term period of one year. In context to given scenario,
debtors, inventory and closing cash balance at the end of September will be included in CA.
However, liabilities involve capital contribution made by John hopes and all the current
liabilities. Capital indicate the proportion of total assets which have been owned by the
owner’s fund while current liabilities includes creditors which hotel has to repay within one
year. The purpose of preparing balance sheet is to determine financial status of the hotel. It
has been prepared as under:
Budgeted statement of financial position of Hotel as on 30th September, 2016
Fixed assets
Lease hold property 1600000
Less: depreciation 16000 1584000
Funriture and fittings 150000
Less: depreciation 7500 142500
Kitchen equipment 50000
Less: depreciation 2500 47500
Laundry equipment 25000
Less: depreciation 2500 22500
Gym equipment 15000
Less: depreciation 750 14250
China, glass and cutlery 10000 10000
Total fixed assets 1820750
Current assets
Debtors 66150
Inventory 10000
Cash 281870
Total current assets 358020
Total assets 2178770
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Capital contrinution 2000000
Add: Net profit 140025
Total capital 2140025
Current liability
Creditors for material 15120
Creditors for overheads 23625
Total creditors 38745
Total liabilities 2178770
TASK 3
Capital budgeting: Hotel is required to invest in land, property, building and other
fixed assets. Capital budgeting techniques provide huge assistance to determine most viable
project which render greater yields to the hotel (Gamsakhurdia and Maisuradze, 2016). Both
the discounted and undiscounted cash flow investment appraisal techniques are available for
the investment purpose. As per the scenario, NCF has been increased by 3% every year.
Pay-back period: The time period in which project will generate its initial investment
of 200000£ is known as payback period. The decision rule of this method says that project
which gets back its initial outlay earlier will be better for the hotel (Armstrong, 2015). On the
contrary, it is not a good method because it does not consider the time value of the money
and avoids post pay back profitability.
Calculation of Payback period
Year Net cash flow (NCF) Cumulative cash flows (CCF)
0 -4500 -4500
1 1000 -3500
2 1030 -2470
3 1060.9 -1409.1
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4 1092.727 -316.373
5 1125.50881 809.13581
6 1159.2740743 1968.4098843
7 1194.052296529 3162.462180829
8 1229.8738654249 4392.3360462539
9 1266.7700813876 5659.1061276415
10 1304.7731838293 6963.8793114707
Residual value of the
hotel 3200 10163.8793114707
Payback period = 4 year + (£316.373/1125.50881)
= 4 year + .2811 year
= 4.2811 year
Discounted pay-back period: It overcome one limitation of payback period
method because this method uses discounted cash flow to determine recovery period
(Dzhandzhugazova and et.al., 2015). In the context to given scenario, 7% cost of capital
will be used for discounting purpose. The selection criteria say that hotel should invest
their funds in the project whose discounted payback period is earlier.
Calculation of Discounted payback period method
Year Net cash flows
Discount rate of
£1 @ 7%
Discount
factor up
to four
decimals
Discounted
cash flows
Cumulative
cash flows
0 -4500 1 1 -4500 -4500
1 1000 0.9345794393 0.9346 934.6 -3565.4
2 1030 0.8734387283 0.8734 899.602 -2665.798
3 1060.9 0.8162978769 0.8163 866.01267 -1799.78533
4 1092.727 0.762895212 0.7629 833.6414283 -966.1439017
5 1125.50881 0.7129861795 0.713 802.4877815 -
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3 163.65612017
6 1159.2740743 0.6663422238 0.6663
772.4243157
061
608.76819553
61
7 1194.052296529 0.6227497419 0.6227
743.5363650
486
1352.3045605
847
8
1229.873865424
9 0.5820091046 0.582
715.7865896
773
2068.0911502
62
9
1266.770081387
6 0.5439337426 0.5439
688.9962472
667
2757.0873975
287
10
1304.773183829
3 0.5083492921 0.5083
663.2162093
404
3420.3036068
691
Residual
value of
the hotel 3200 0.5083492921 0.5083 1626.56
5046.8636068
691
Discounted payback period = 5 year + (£163.65612017/£0.6663422238) year
= 5 year + 0.21187 year
= 5.21187 year
Net present value: It is comparatively very superior method than other techniques.
As per this technique, hotel managers have to determine future values of all the net cash
flows (Götze, Northcott and Schuster, 2015). However, the difference between total of DCF
and initial project investment is known as NPV. In context to given scenario, 7% discount
rate has been assumed to predict future values of NCF. The decisions rule of this method says
that John Hopes has to make investment in project whose NPV is higher.
Calculation of Net present value
Year Net cash flows
Discount factor of £1
@ 7%
Discounted cash
flows
1 1000 0.9346 934.6
2 1030 0.8734 899.602
3 1060.9 0.8163 866.01267
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4 1092.727 0.7629 833.6414283
5 1125.50881 0.713 802.48778153
6 1159.2740743 0.6663 772.4243157061
7 1194.052296529 0.6227 743.5363650486
8 1229.8738654249 0.582 715.7865896773
9 1266.7700813876 0.5439 688.9962472667
10 1304.7731838293 0.5083 663.2162093404
Residual value of
the hotel 3200 0.5083 1626.56
Total discounted
value of cash
inflows 9546.8636068691
Less: Initial
investment 4500
Net present value 5046.8636068691
Interpretation: Above calculation indicate that hotel project will take 4.28 year to re-
earn its initial investment of £4500. However, DPP is a little bit higher to 5.21187 year
because NCF has been discounted by using 7% DF. On the other hand, NPV method implies
that this project will posses positive NPV of £5046.86. This in turn, it can be said that this
project will be profitable for the hotel business.
CONCLUSION
The prepared project report concluded that management accounting helps in
managing business functions efficiently. Budgeting is a tool that assists in maximizing
company’s revenues and minimizing expenditure so as to attain high profitability. Moreover,
it assists the managers in strategic business planning, monitoring, controlling and taking
qualified decisions. It provides huge assistance to allocate firm resources in various operating
activities in an efficient manner. Along with it, the report described that capital budgeting
tools provide aid to hotel to identify most beneficial project for investment purpose. Thus, it
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became clear that both the tools help in accomplishing organizational short-term and long
term objectives and ensure high potential growth.
REFERENCES
Books and journals
Armstrong, V.S., 2015. Using real option analysis to improve capital budgeting decisions
when project cash flows are subject to capacity constraints. Academy of Accounting and
Financial Studies Journal. 19(2). pp. 19.
Brooks, R. and Mukherjee, A.K., 2013. Financial management: core concepts. Pearson.
de Souza, P. and Lunkes, R.J., 2015. Budgeting practices: a study on Brazilian hotel
companies. Revista Brasileira de Pesquisa em Turismo. 9(3).
Dzhandzhugazova, E.A. and et.al., 2015. The Russian Hotel Market: condition and
development under the crisis. Mediterranean Journal of Social Sciences. 6(3). p. 289.
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