degree of operating leverage as an indicator of economic readiness of selected hotels in cebu

DEGREE OF OPERATING

LEVERAGEAS AN

INDICATOR OF ECONOMIC READINESS OF

SELECTED HOTELS IN CEBU

DEGREE OF OPERATING LEVERAGE AS AN INDICATOR OF ECONOMIC READINESS OF

SELECTED HOTELS IN CEBU

Chapter 1

Chapter 2

Chapter 3

Chapter 4

Chapter 5

DEGREE OF OPERATING

LEVERAGEAS AN

INDICATOR OF ECONOMIC READINESS OF

SELECTED HOTELS IN CEBU

Chapter 1

Introduction

Chapter 1 - RATIONALE

•Tourism → hotel industry → comfortable lodging establishment

•The study is aimed to obtain data on the relationship of a hotel’s operating leverage with its financial stability measured through sustained profits

•Operating leverage → analysis of fixed costs and variable costs

•High DOL growth

recession

dramatic improvement

steeper erosion of income

Chapter 1 - PROBLEM

The research is aimed to establish DOL as an indicator of economic readiness of selected hotels operating in Cebu. 

Specifically, the researchers desire to answer:1.How do the selected hotels classify their expenses as to either fixed or variable?

2.Based on the conducted survey, how can hotel expenses be generally classified as to either fixed or variable?

Chapter 1 - PROBLEM

3. What are the break-even points (BEPs), margins of safety (MOSs), and degrees of operating leverage (DOLs) of the selected hotels from 2004 to 2010?

4. What is the relationship among the computed Cost-Volume-Profit Analysis tools?

5. Can the degree of operating leverage be used as an indicator of economic readiness?

Chapter 1 - ASSUMPTIONS

The researchers deem the following assumptions reasonable and necessary:

1.In the absence of Philippine-specific data regarding economic periods and events, international and/or United States-setting data shall be presumed to be applicable in the Philippines.

Chapter 1 - ASSUMPTIONS

2. The recession began on December 2007 and started recovering at the beginning of 2010.

3. The researchers are primarily dealing with secondary data. Having no means of ascertaining that these data are free of misstatements, they are presumed to be true and correct at their face value.

Chapter 1 - HYPOTHESES

The researchers present the following hypotheses:

1.The ↓ BEP, ↑ MOS, ↑ amount by which sales can drop before the hotel incurs financial losses

2.The MOS is inversely related with DOL

3.The DOL can be used as an indicator of the hotel’s economic readiness by citing the DOL’s relationship with the hotel’s BEP and MOS

Chapter 1 – SIGNIFICANCE OF THE STUDY

This study may be beneficial to the following stakeholders:

1.Hotels

2.Hotel Associations and Department of Tourism

3.National Economy

4.Academic Researchers

Chapter 1 – SCOPE AND LIMITATIONS

1. Criteria for selection of hotels:• must be operating in Cebu.• must be a member of the Hotel, Resort, and

Restaurant Association of Cebu (HRRAC).• must be registered with the Department of Tourism

(DOT).• must have filed their annual financial reports to the

SEC Cebu for the period 2004 – 2010

2. Limitated to secondary information, cost classification being internal in nature

Chapter 1 – DEFINITION OF TERMS

1. Break-even Point•the point where total contribution margin equals total fixed costs• the level of sales at which profit is zero

2. Degree of operating leverage:• is a measure, at a given level of sales of how a percentage change in sales volume will effect profits

Chapter 1 – DEFINITION OF TERMS

3. Economic Readiness•a hotel’s ability to profit, and sustain the same, despite fluctuations in room demand, pricing strategies, and operating costs

4. Fixed Costs•a periodic cost that remains more or less unchanged irrespective of the output level or sales revenue, such as depreciation, insurance, interest, rent, salaries, and wages

Chapter 1 – DEFINITION OF TERMS

5. Margin of Safety•the excess of budgeted (or actual) sales dollars (pesos) over the break-even volume of sales dollars (pesos)

6. Variable Costs•a cost that changes in proportion to a change in a company's output level or sales revenue.

Chapter 2

Theoretical Background

Chapter 2 – REVIEW OF RELATED LITERATURE

• Tourism - an integral part of the Philippine economy

Iris Ng, 2004

• 136 hotels listed nationally, 19 are in Cebuwww. dot.gov.ph

• Hotel, Resort & Restaurant Association of Cebu (HRRAC) - the umbrella organization that speaks or the hospitality industry in Cebu

www.hrrac.net

Chapter 2 – REVIEW OF RELATED LITERATURE

Chapter 2 – REVIEW OF RELATED LITERATURE

Chapter 2 – REVIEW OF RELATED LITERATURE

Chapter 2 – REVIEW OF RELATED LITERATURE

Chapter 2 – THEORETICAL FRAMEWORK

Chapter 2 – THEORETICAL FRAMEWORK

Chapter 2 – THEORETICAL FRAMEWORK

Decreased economic readiness

Decreased economic readiness

Decreased economic readiness

Decreased economic readiness

Chapter 2 – CONCEPTUAL FRAMEWORK

• Management philosophy Gov’t Intervention HRRAC practices

InterveningVariables

Economic Boom

Economic Recession

 Sales Fixed Cost Variable Cost

Independent Variables

DOL

 Economic Readiness

Economic Readiness

DOL

Chapter 3

Research Methodology

Chapter 3 – RESEARCH DESIGN

Chapter 3 – RESEARCH ENVIRONMENT

Chapter 3 – RESEARCH RESPONDENTS

Chapter 3 – RESEARCH INSTRUMENTS

Chapter 3 – RESEARCH PROCEDURES

• Gathering of Data

- two researchers were assigned to obtain the selected hotels’ FS from the year 2004 to 2009

- from the statement of comprehensive income, a listing of expense accounts was drawn.- survey was conducted after sending a request

letter

Chapter 3 – RESEARCH PROCEDURES

• Treatment of Data

- each hotel’s treatment of variable and fixed costs were tabulated

- Using the FS, the researchers computed the DOL, BEP, and MOS of the selected hotels• The following formulae were used:

BEP = MOS = Sales − BEP

DOL =

Fixed CostsContribution Margin

Contribution MarginNet Operating Income

or EBIT

Chapter 4

Presentation, Analysis, and Interpretation of Data

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA • Survey Results

- of the six hotels selected, only four responded: Cebu Grand Hotel, Century Plaza Hotel, Golden Valley Hotel, and Montebello Villa Hotel.

Fixed Costs Variable Costs - audit professional fees - bedroom supplies - cable TV services - food and beverages - directors’ fees - laundry services - employee retirement - light, power and water, expenses - office supplies

- repairs and maintenance- representation expense

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Table 4.1 Classification of Hotel Costs (by the selected hotels)

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA • Researchers’ classification of costs based on academic theory

Fixed Costs Variable Costs - Cable TV services - Bedroom supplies - Depreciation expense - Food and beverage - Employee retirement expense - Fuel and oil - Employee SSS, PHIC, HDMF - Bank charges - Janitorial service - Laundry services - Medical expense - Advertising expense - Rent expense - Office supplies - Salaries and wages - Repairs and maintenance

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA Difference of Treatments

1.Light, power, and water - usually semi-variable, in practice, entirely variable costs.

2.Insurance •property liability - fixed cost•health and accident insurance - semi-variable costs, in practice, entirely fixed costs.

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Table 4.2 Break-even Points of Selected Hotels

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Fixed CostsContribution MarginBEP =

Break-even Point Formula:

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Figure 4.1 Break-even Point Graph

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Sales − BEP in salesMOS =

Margin of Safety Formula:

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Table 4.3 Margin of Safety

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Figure 4.2 Margin of safety graph

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Degree of Operating Leverage Formula:

DOL = Net Operating Income or EBIT

Contribution Margin

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Table 4.4 Degree of Operating Leverage

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Figure 4.3 Degree of Operating Leverage Graph

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Relationship among BEP, MOS and DOL

- the higher the BEP, the lower the MOS, the greater the DOL

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Figure 4.10 Cebu Grand Hotel’s BEP and MOS (expressed as a percentage of sales); and DOL (expressed in tenths)

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Figure 4.11 Century Plaza Hotel’s BEP and MOS (expressed as a percentage of sales); and DOL (expressed in tenths)

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Figure 4.12 Golden Valley Hotel’s BEP and MOS (expressed as a percentage of sales); and DOL (expressed in tenths)

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Figure 4.13 Cebu City Marriott Hotel’s BEP and MOS (expressed as a percentage of sales); and DOL (expressed in tenths)

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Figure 4.14 Montebello Villa Hotel’s BEP and MOS (expressed as a percentage of sales); and DOL (expressed in tenths)

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Figure 4.15 Waterfront Cebu City Hotel and Casino’s BEP and MOS (expressed as a percentage of sales); and DOL (expressed in tenths)

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

From figures 4.9 – 4.14, it could readily be seen that DOL is inversely related to MOS; while DOL is directly related to BEP.

Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

Table 4.5 Coefficient of Correlation between MOS (as a percentage of sales) and DOL

DOL is negatively correlated with MOS, with an exceptions. This means that, if DOL increases, one can anticipate for a decrease in MOS.

Chapter 5

Summary of Findings, Conclusion, and Recommendation

Chapter 5 – SUMMARY OF FINDINGS, CONCLUSION, AND RECOMMENDATION

• Summary of Findings

1. DOL is inversely related to MOS.2.DOL is directly related to BEP, though at varying degrees, with some exceptions. 3.The higher the BEP, the lower the MOS, and the greater the DOL, with one exception4.DOL was highly negatively correlated with MOS.5.DOL was positively correlated with BEP.

Chapter 5 – SUMMARY OF FINDINGS, CONCLUSION, AND RECOMMENDATION

Conclusion

• The classification of expenses, as to fixed and variable is not constant among hotels, depending on the nature of the expense and the viewpoint of hotel management.•Hotels with higher BEP’s have the tendency to increase their BEP’s in the years to come.•Hotels with lower BEP’s tend to demonstrate relatively static BEP’s

Chapter 5 – SUMMARY OF FINDINGS, CONCLUSION, AND RECOMMENDATION

Conclusion

The higher the BEP, the lower the MOS, the greater the DOL. However, such relationship is not linear; the degree of change in one does not result to a proportional change in another.Moreover, DOL is highly negatively correlated with MOS, and is positively correlated with BEP.

Chapter 5 – SUMMARY OF FINDINGS, CONCLUSION, AND RECOMMENDATION

Conclusion

A high DOL indicates low MOS and lesser ability to handle and survive drastic falls in sales. Thus, the researchers conclude that DOL can be used as an indicator of economic readiness of hotels.

Chapter 5 – SUMMARY OF FINDINGS, CONCLUSION, AND RECOMMENDATION Recommendations

1. Future researchers - conduct further study on DOL as an indicator of economic readiness of industries other than the hotel industry.2.Hotel managers and executives - use this study to design a cost strategy responsive to business cycle fluctuations3.Accounting students – use this study to help future employers manage company costs4.All stakeholders – conduct further readings on DOL

Thank you.

DEGREE OF OPERATING LEVERAGE AS AN INDICATOR OF ECONOMIC

READINESS OF SELECTED HOTELS IN CEBU

Mr. Jun Alipe

Ms. Jovelyn Q. Yu, CPA, MBA

Mrs. Concepcion Rasalan-Racaza, CPA, MSA