Financial and Non-Financial Risks in the Hospitality Industry

This study discusses the financial and non-financial risks faced by the hospitality industry, specifically in the hotel sector. It explores the challenges associated with changing regulations, guest demands, sharing economy, and scarcity of skilled staff. The study emphasizes the importance of risk evaluation and management in the hotel industry.

Financial and Non-Financial Risks
Hospitality industry is flanked between unprecedented growth on one side and challenges of
seasonality and rapidly changing customer demands and guest-facing connected technologies
boom on the other side. For rapidly changing hotel industry, risk management has high
significance. In this study, I shall discuss the various risks associated with my hotel and elaborate
on the challenges faced. The financial challenges faced by the hotel industry are high financial
costs, multiple taxes, licensing and legal complications, working capital issues and lowering
margins.
Let’s take a look at the risks associated with running our All Seasons Hotel in the current
technology savvy world with millenials having different expectations and demands. Firstly, we
shall enumerate the financial risks which hotels are to deal with:-
Ever changing Regulations and Trends
A riskier and tough challenge in hotel industry arises with the effect of the standard levied from
1st July, 2019 for the maximum number of employees wherein they are mandated to assess the
worksite in an organisational way with the help of certain housekeepers. For this inspection, the
personnels should be formally trained which again attracts financial expenses. (Simpson & Wall,
2014)
Frequent changes in Guest Demands
In the 21st century, customer expectations are changing day and night . Technologies have
captured the minds of every individual in such a manner that they are accustomed to a well
organised shopping experiences, be it online or offline . Nevertheless they do not want to settle
for less or compromise since they are paying for the best. Hence for hotels, only providing the

guests with well decorated deluxe suites is of no help. Demands are increasing so there should be
extra activities also correlated with the rooms such as games room for the adults, gym , pool
facilities, wifi,personal fun parks for children etc.
Getting inclined towards boutique kind of decorated hotel with all the present –day amenities
might also mitigate such risks of losing momentum. (Donovan, 2019)
Economic Twin Sharing
Sharing economy can be observed as a partial threat to the hotel industry.The travellers have
started hunting for the inexpensive accomodation options while they on vacay mode . There are
many homeowners or dwellers who own houses in the tourist region and also tend to offer their
property or rooms on rent to the tourists. By staying in such property , tourists feel more safe ,
secured and also feel at home even when they are on vacations. Such options of stay at tourist
regions are also pocket saving and user friendly as compared to the hotels.
Scarcity of skilled staff and personnels
In this cut throat competitive world, hotels need to win the rat race by employing highly skilled
employees. Staff in respect to the hotel industry categorised as Chefs, Bartenders, Managers,
Room maintenance employees, Front Desk Clerks, etc should be well trained in order to avoid
the mounting risk of declining morale.
Customer Risks Evaluation

Human demands are never ending. In order to decide on the associated risks with the consumer
demand, we need to marginalise the segments wise in this industry which is becoming
increasingly competitive especially in the cases related to international tourists so correlated to
the hotels. The hotels which are low star graded hotels do not tend segment the market and are
assumed to increase their star rating which might in turn help to gain momentum. Any hotel
industry should prioritize the needs of the customers first . Doing so will help the hotel keepers
to empower their knowledge and also adapt within its marketing spectrum. Subsequent study and
understanding of the market segment might increase the chances of the market success.
Coming to the other side of risk, that is non- financial risks associated with the hotels in general.
Such risks could not be directly associated with the financial transactions. These are the risks of
events or actions which might affect the operational management of the hotel industry. Non
financial strategic risk might affect our All Seasons Hotel’s competitive internal factors which
generally downgrades the chances of achieving success. With the advent of the modern, well
equipped amenities, apartment hotels are out showing the not so modern hotel. Non- Financial
Risks also include Operational, compliance and conduct risks . Let's discuss the aforementioned
type of risks in details.
Operational Risk
Operations risks are the risk often shown as the outcome of the day to day activities of any
normal organization which are directly linked to its internal resources, employees, process of
conducting the work, etc. It is basically loss rooting from an issue arising due to the
aforementioned factors. To illustrate better, let's assume that All Seasons Hotel hires
inexperienced employees as certain cost-saving measure and such inexperienced employees
commit minor mistakes , then we shall experience loss. (Rachbini, 2018)

Similarly suppose if we hire inexperienced contractors for the renovation of our hotel, who end
up fumbling with their job, then we might have to face mechanical breakdowns or delay in
outcome.
Compliance Risk
This type of risk arises when the management of the industry does not follow or violates the
standard laws, rules , ethical practices and regulations incident to the organization. Such
compliance also includes Governmental laws and the policies laid down in accordance with the
law of the country where the organization is.
Failure in abiding by the regulations might also attract fines and in some cases imprisonment too.
Enumerating below the key areas which should be checked and abided by for the smooth running
of the hotel:
Electrical Systems
Gas Emulsions
Air conditioning including al the checks of the indoor and outdoor units
Hygiene
Fire Safety
Water Supply
Conduct Risk

Conduct as the word suggests is the way an organization associates with its staff, customers and
all the other related parties. Good conduct or behaviour of the in-house management team might
help the hotel make greater profits in the long run.
In this context , to avoid the conduct risk, the hotel must train its personnels keeping in mind the
key formula to success , that is good behaviour.Bad conduct can be a challenging tool for all the
organization and also might lead to a damage reputation in the market.
Dealing with conduct risk is nothing but all about the sustained corporate practices and also
enhancing the behaviours with high values and morales in order to escape harmful comments
from the guests increased profitability ratios. (HOSPITALITY RISK SOLUTIONS, 2019)
Capital investment proposal analysis through capital budgeting techniques
As the hospitality industry is booming and is constantly strengthening with current markets still
growing, emerging marketing showing hyper-growth and new markets being introduced
regularly, there is a continuous need for investment upgrades and updates. In keeping up with the
current requirements, my “All Seasons” hotel has an investment opportunity which needs to be
analyzed before arriving at a decision to take up the project or not. The project requires hotel to
start an in house café serving approximately 20 guests together, so that hotel can cater to the
need of the millenials and attract them more. One of the renowned organizations has already
been consulted and the property owners have agreed that architectural and engineering projects
are approved on the land. Hence, the legal requirements shall be taken care of, so we need to take
a close look at the other aspects such as budgeting and cost-benefit analysis for the same. First,
let’s look at the proposed budget figures below:-

Initial investment=$255, 000
Expected first year cash flow=$180, 000
For the purpose of budgeting, we need to understand first why it is important to analyse the
Capital decisions which are growing edge for a business:-
Such decisions influence organization's long term existence and have considerable impact on
what it can do in future (Net, 2019)
It is extremely difficult to reverse such investment decisions and so they are the game changers
even risk wise
They involve substantial outlays
We need to employ the capital budgeting techniques to decide on the viability of the water theme
park project before making any investments. There are basically 2 types of techniques that are
adopted for the purpose, traditional and non-traditional. Let us begin with the analysis with the
traditional methods, which are payback method and accounting rate of return method.
Payback method-in this method, calculations are made to arrive at the time within which the
investment/outlay Will be able to generate cash flows. Through this method selection of a
proposal is based on the earning capacity of the project. The shorter the payback period, the
sooner the company recovers its cash investment. Whether a cash payback period is good or poor
depends on the company's criteria for evaluating projects. A project can be selected or rejected
based off a simple calculation, with results that will help gauge risks. In the present proposal, the
payback period shall be:-
Payback period = total investment/annual cash flow = 255,000/180, 000=1.416 years

Accounting rate of return method-method-to overcome the deficits of payback method, a
superior method, accounting rate of return method can also be adopted to analyze the proposal.
The rate of return is expressed as a percentage of the earnings of the investment in a particular
project. It takes care of disadvantage of absolute and induces relativity in analysis. It considers
the entire economic life of the project in the calculations and works on the criteria that any
project having ARR higher than the minimum rate established by the management will be
considered and those below the predetermined rate are rejected. Although this method is also not
free from limitations as it ignores time value of money and doesn’t consider the length of life of
the projects. The calculations involved are:-
ARE=Average income/Average investment
Apart from the above traditional methods for capital budgeting, there are few non-traditional
methods which consider time value of money as well into the calculations. In the following
paragraphs we shall look at them in details:-
Discounted cash flow method is one of the non-traditional method which involves cash inflows
and outflows both during throughout the life of the project, which are discounted through a
discounting factor. This technique adopts the interest rates and the return after the payback
period. However, if economists expect inflation to rise 30 percent annually, as per our prior
calculations the payback period of 10 years actually changes. As the present value of $ 200,000
is actually worth $153,846 when accounted for inflation ($200, 000/1.3 equals $153, 846approx.)
(Rachbini, 2018)

Net Present Value method is one of the most widely used methods, considering the cash
inflows and outflows with the time value of money. It is the difference between present value of
the future cash inflows and present value of future cash outflows.
Net present value=present value of future cash inflows-present value of cash outflows
Present value of cash flow=cash flow ((1-discount rate%)n, where n is the no. Of years.
In the café proposal ,there is initial investment of $ 255,000 and expected profit of $ 15,000 in the first
year while $ 25,000 in the second year. There should also be discount rate which is assumed to be 10%
which reflects the minimum return that is expected from the business. The business should provide the
return more than that 10% otherwise it is not beneficial one.
cash flows taking place at various time periods which are figured as $ 180,000 in the first year and $
300,000 in the second year.
Here, n=2 years,
NPV = -255,000+180,000/(1+0.10)+300,000/(1+0.10)2
NPV = -$156, 569
Internal Rate of Return method is quite complicated method which considers time value of
money however has limitations of producing multiple rates which are quite confusing. On the
similar lines of NPV method, it takes into account the entire cash inflows and outflows. It tries to
arrive to a rate of interest at which funds invested in the project could be repaid out of the cash
inflows, it is called internal rate because it depends solely on the outlay and proceeds associated
with the project and not any rate determined outside the investment. For calculating IRR, NPV is
kept at zero and then value of “i” is calculated. The IRR of the project that value of “i” where

NPV is equal to zero. So, to calculate IRR in our case, let’s assume high rate of IRR at 50% as
10% discount rate calculates NPV to be $156,569, which is quite high.
NPV, when discount rate=50%
NPV= = -255,000 + 180,000/(1+0.494) + 300,000/(1+0.494)2
The answer of above equation is equal to -113 which is less than zero, so the rate of IRR need to be kept
slightly lower than 50%. By considering IRR equal to 49.4% the NPV is -113, which is quite near to zero
and therefore IRR of the café project is 49.4% approximately.
Profitability index calculates the ratio at which present value of future cash benefits for the required rate
of return to the initial cash outflow of the investment.
Profitability index = PV of future cash benefits/initial cash outlay. If PI is above zero, then the proposal is
acceptable.
For café proposal, as for expected budget already provided:-
PI= 180,000/(1+1.0)]+[300,000/(1+0.10)2] / 255,000
=163,636 + 247,933 / 255,000=1.61
As PI = 1.61>1, the project seems to be favourable.
With the help of the techniques explained above, we can decide on whether “All Seasons “hotel
should consider the investment proposal or not. Hence, we can conclude on the basis of the
calculations that the café project seems to be quite viable and the hotel should adopt it.
Capital budgeting is an attempt to decide future with the use of numbers. It helps in providing a
wide scope for financial managers to evaluate different proposals and projects and also exposes
the risks and uncertainty of the projects. The management is provided with an effective control

on cost of capital expenditure projects. Having said that, there are few other determinants such as
how effectively and optimally the resources are utilized.
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