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Although the indications are that the hotel sector is recovering after several difficult years, the sector continues to be highly challenging for all involved.
From the major international hotel groups to privately owned businesses, key financial objectives for hotel management remain to maximise occupancy and revenues, to keep costs under close control and to ensure that their business continues to attract customers.
In a market where customers are becoming more and more discerning and alternatives are increasingly accessible through the Internet, ongoing investment in the hotel infrastructure and effective facility programming is needed to maintain the flow of customers. This is especially the case for the premium and business/conference sectors of the market where there is overcapacity.
With profits down, it makes it even more important to ensure that the capital is invested wisely. An effective investment appraisal process is essential to support the decisions taken by management and to demonstrate this to investors.
Traditionally the investment appraisal tools most commonly used within the hotel sector have been to prioritise between potentially beneficial options using payback calculations, return on investment and discounted cash flows.
If the decision taken proves to be wrong, the financial impact on the business can be significant in terms of unforeseen costs and lost opportunities. Considerable senior management time and effort may also be required to put it right.
Typical causes of wrong decisions
- Impact on other businessobjectives/activities not fully considered
- Unforeseen increases in costs/ Lower than anticipated revenues
- Insufficient consideration of planning or legal issues.
However, risk management techniques are increasingly being used to improve these processes.
Using risk management
A structured approach to the consideration of the risks associated with a decision will enable management to ensure that its impact upon other business activities is clear, unforeseen issues do not arise after the decision has been taken and that the assumptions behind financial forecasts are realistic.
The key steps of the decision making process are illustrated below.
Risk management has a significant role to play in this process.
Before making any investment it is important to understand where the organisation is today, what it is trying to achieve and what its risk exposures are. Then, by setting out the options together with the various risks associated with these, management can make a more balanced and informed judgement of the most appropriate course of action.
The affordability, economic gain and pay-back are all still relevant but this puts more emphasis on the other implications of the decision. For example an option that will to contribute to the objectives overall and meet the financial criteria without making the overall risk exposure unacceptable is likely to be a winner.
Options that increase risk to unacceptable levels need not be rejected immediately. Instead the additional remedial actions needed to reduce the risk to acceptable levels should be taken into account in the financial analysis. If no such remediation is possible then the option should be rejected.
In developing each option, management will need to make assumptions, particularly in relation to forecast additional revenues and the implementation timescale. Where there is uncertainty, a range of scenarios should be developed setting out for example, the various levels of revenue that may be achieved. Management should then apply their understanding of the risks associated with the option, to select the most likely level of revenue.
Once the preferred option has been selected, an assessment should be made of the sensitivity of the decision to changes to the assumptions which underpin the option. Where the risk of change is high and such change would result in an alternative option being selected, the viability of the preferred option should be reconsidered carefully.
This article was first published in Control matters , a PKF newsletter on internal control developments
By Jon Dee, director business risk services for hotels at PKF.
Theodore is the Co-Founder and Managing Editor of TravelDailyNews Media Network; his responsibilities include business development and planning for TravelDailyNews long-term opportunities.
