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HOSP ITAL I TY
F I N A N C I A L
MANAGEMENT
HOSP I TAL I TY
F I N A N C I A L
MANAGEMENT
Agnes L. DeFranco & Thomas W. Latt in
J O H N W I L E Y & S O N S , I N C .
This book is printed on acid-free paper. ��
Copyright � 2007 by John Wiley & Sons, Inc. All rights reserved.
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Library of Congress Cataloging-in-Publication Data:
DeFranco, Agnes L., 1961–
Hospitality financial management / by Agnes DeFranco & Thomas Lattin.
p. cm.
Includes index.
ISBN-13: 978-0-471-69216-4 (cloth)
ISBN-10: 0-471-69216-6 (cloth)
1. Hospitality industry—Finance. I. Lattin, Thomas W. II. Title.
TX911.3.F5D44 2006
647.94068�1—dc22
2006007280
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
CONTENTS
Preface ix
Acknowledgments xi
1 Finance and the Hospitality Industry 1
Introduction 5
Hospitality Industry Financial Challenges 6
Chapter Structure 8
Chapter Topics 9
2 Financial Reporting 15
Financial Reporting 17
Accounting as the Language of Business 17
Financial Statements 21
Management Reports 25
Accounting System—CP 3 System 38
3 Analyzing Financial Statements 53
Analysis of Financial Statements 56
Readers of Financial Statements 56
Types of Analyses 57
Management Decision Making 74
Readers of Financial Statements Beware! 78
4 Managing Working Capital and Controlling Cash 91
Managing Working Capital and Controlling Cash 94
Working Capital 94
Cash 97
5 Growing the Business 112
The Need for Growth 115
Shareholder Value 115
Other Benefits of Growth 118
CONTENTSvi
Growth Strategies 120
Increase Sales and Productivity of Existing Properties 120
Expansion of Physical Facilities 122
Franchise Brand Rights 123
Secure Additional Management Contracts 124
Mergers and Acquisitions of Competitors 125
Going Public 125
6 Financing Growth 134
The Need for Capital 138
Capital 139
Loan Terminology 145
Types of Loans 147
Sources of Loans 150
Equity 153
Hotel Financing Trends and Schemes 158
The Golden Age of Hotel Financing 159
Savings and Loans 159
Investment Tax Credits 159
Influx of Foreign Capital 159
Accelerated Depreciation 160
Real Estate Tax Shelters 160
The Tax Reform Act of 1986 160
The Resolution Trust Corporation (RTC ) 160
New Financing Schemes 161
7 The Time Value of Money 177
Concept of Time Value of Money 179
Time Value of Money 179
Market Value 180
Calculating Time Value of Money 182
Time Period and Compounding 205
8 Investment Analysis 221
Investment Analysis 223
Weighted Average Cost of Capital (WACC ) 224
Discount Rate 225
Capitalization Method of Valuation 226
Investment Analysis Tools 227
Factors Affecting Tools of Investment Decisions 236
9 Hospitality Industry Applications of Time Value of Money
Concepts and Skills 247
Time Value of Money Applications 250
Loan Questions 250
Equity Questions 256
CONTENTS vii
Use of Sensitivity Analysis 258
Hospitality Applications 259
Using ROI, NPV, and IRR 271
10 The Investment Package 286
The Need for an Investment Package 289
Executive Summary 291
Fact Sheet 291
Business Plan 294
Source and Use of Funds 295
Photographs or Renderings 297
Third-party Confirmation 298
Project Budget 298
Qualifications of Project Team 301
Investment Analysis 302
Personal Financial Data 302
Evaluation of the Investment Package 302
Lenders: Debt 303
Owner/ Investor: Equity 304
11 Crafting and Negotiating the Deal 315
The New Business Venture 318
The Business Entity 319
The Debt and Equity Mix 325
Negotiating Loans with Lenders 325
Principal 327
Interest Rate 328
Points Charged 328
Additional Collateral 328
Personal Guarantees 329
Other Lender Issues 329
Deal Sponsor’s Goals 330
Negotiating the Equity Investment 331
Amount of Equity 332
Percentage of Ownership 332
Investor Hurdle Rates 333
Exit Strategy and Decision-making Power on When to Sell 333
Negotiating Skills 333
Be Prepared 333
Be Professional 334
Use Proven Selling Skills 334
12 Tying It All Together 345
Introduction 348
Hospitality Industry Financial Challenges 348
CONTENTSviii
Financial Reporting 349
Analysis of Financial Statements and Management Reports 350
Analysis of Financial Statements 350
Analysis of Industry Reports 351
Applications of Financial Analyses 351
Managing Working Capital 351
Growing the Business 352
Shareholder Value 352
Increasing Shareholder Value 352
Other Benefits of Growth 353
Growth Strategies 353
Financing Growth 356
Types of Capital 356
Cost of Capital 356
Mix of Capital 356
Investment Analysis 357
The Time Value of Money 357
Investment Analysis Methods 358
Favorable or Unfavorable? 358
Factors Impacting the Analysis 359
Hospitality Industry Applications 359
Debt and Equity Negotiations 359
The Investment Package 360
What Lenders Want to Know 360
What Equity Investors Want to Know 361
Crafting and Negotiating the Deal 362
Business Decisions to Make 363
Negotiating the Loan 363
Negotiating the Equity Investment 363
Negotiating Skills 363
Index 365
PREFACE
Our goal in writing this book is to present a practical approach to hos-
pitality financial management that provides students with a clear de-
scription of the financial management concepts, skills, and tools they
need to become successful managers or entrepreneurs in the hospitality indus-
try. The target audience for this applied finance book is undergraduate students
taking a hospitality financial management course. However, it can also be used
as a supplementary text in a graduate-level hospitality financial management
course. Hospitality Financial Management is entrepreneurial in nature and em-
phasizes that to succeed in the world of business, whether you work for a large
or small company, a public or private company, for others or yourself, you must
always think like an owner while acting like a manager. The more you assume
that the money you are spending, collecting, and investing is your own, the
better business decisions you will make and the more financial rewards you will
earn.
The unique and colorful image incorporated in the cover of this text is a
photograph of the Portland Head Light, a famous and historic lighthouse in
Cape Elizabeth, Maine, which was first lit in 1791. We chose this scenic land-
mark because it symbolizes the essence and entrepreneurial spirit of the hos-
pitality industry and small business.
Pedagogical Features That Help Students
F E AT U R E S T O RY: Each chapter begins with a Feature Story, based on a real-
world restaurant, hotel, or small business, that relates to the financial concepts
presented within the chapter. An additional Feature Story is also included
within the body of the chapter.
PREFACEx
L E A R N I N G O U T C O M E S : A list of Learning Outcomes follows each chapter’s Feature Story. This
list highlights the key concepts covered in the chapter.
P R E V I E W O F C H A P T E R : A Chapter Preview outlines the main topics and subtopics within each
chapter.
T H E R E A L D E A L : Boxed inserts in each chapter emphasize the relevance of the text content by
relating financial concepts to fun facts relating to situations students either have or will en-
counter in their everyday lives.
F I N A N C E I N A C T I O N : Finance in Action problems provide real-world scenarios where a particular
calculation or analysis relating to chapter-specific concepts is needed. A stepped-out solution is
provided for each problem to walk the student through the necessary financial calculations.
A P P L I C AT I O N E X E R C I S E S : Application Exercises at the end of each chapter reinforce student
comprehension of the key concepts presented in it.
C O N C E P T C H E C K S : Mini-cases with discussion questions based on real-world situations are in-
cluded at the end of each chapter to enhance student understanding.
W H E R E W E A R E G O I N G , W H E R E W E H AV E B E E N : This section summarizes what has been covered
in a particular chapter and what will be covered going forward in the text.
K E Y P O I N T S : A bulleted list of the key concepts related to each of the learning outcomes pre-
sented at the beginning of each chapter appears within the end-of-chapter material.
K E Y T E R M S : These are bolded when they first appear within the chapter and then listed at the
end of each chapter with their definitions.
Resources for Instructors
I N S T R U C T O R ’ S M A N U A L : Includes lecture outlines, quizzes, solutions to application exercises
and concept checks, and a test bank.
C O M PA N I O N W E B S I T E : Includes electronic files for the Instructor’s Manual with Test Questions
and PowerPoint slides containing lecture outlines for every chapter.
ACKNOWLEDGMENTS
Books are not written single handedly. We are grateful to Ms. Tanya Venegas and Ms. Jacqueline
Lee, both graduates of the Conrad N. Hilton College, for their very able assistance in researching
the feature stories that appear in each chapter and developing the exercises and concept checks
that appear at the end of each chapter. We also wish to thank the following individuals for
providing much of the material used for the numerous illustrations throughout the book: John
Bowen, Cathleen Baird, Alan Gallo, Brian Hanna, David Manglos, R. P. Rama, Albert Ramirez,
Arlene Ramirez, Michael Scott, and Rosa Tang.
Special thanks are also due to Randy Smith and Mark Lomanno of Smith Travel Research
and Frank Wolfe of the Hospitality Financial and Technology Professionals for their generosity
in sharing their knowledge and publications. We also wish to thank Joseph Jackson, Tom Latour,
and Chuck Warczak for their valuable contributions, insights, and, most of all, their time and
patience during our interviews. We also appreciate all the efforts Cindy Rhoads and Nigar Hale
of John Wiley and Sons have made to make this project a pleasure.
Also, we would not be able to ensure this book will meet the needs of our target audience
without the expertise and excellent suggestions provided by our reviewers. For this, our thanks
go to: Rhomi Kher, International College of Hospitality Management; Woody Kim, School of
Hotel and Restaurant Administration at Oklahoma State University; Don St. Hilaire, The Collins
School of Management at California State Polytechnic University at Pomona; and Jenny Staskey,
Northern Arizona University.
This book is dedicated to Dr. Gerald and Jean Lattin, who encouraged us to write it and
have served as role models to both of us throughout our careers in the world of business and
academics; to our spouses, Linda Lattin and John DeFranco, who have been so supportive and
understanding of the many hours it has taken to write this book; and to the professors, teachers,
and trainers who will, we trust, find this book a valuable and useful tool when preparing our
young people for a career in the exciting and financially rewarding hospitality industry.
AGNES DEFRANCO
THOMAS LATTIN
University of HoustonHouston, Texas