How to Measure Your 2022 Hotel Profitability

As a hotelier, you know that generating profitable revenue is key to running a successful hotel. However, understanding your profitability metrics is not always easy as you may not have all the information you need to understand your hotel’s ROI or ROE. Other profitability metrics can give you the insights you need to make the biggest profits. Read on to discover the critical revenue management practice that drives hotel profits.

Here’s how to analyze three profitability metrics
Whether you’re a hotel owner, GM, or revenue manager, it’s helpful to understand how profitability metrics work. They can provide insights into the hotel’s overall performance, which is particularly important for bank loans.

There are three primary profitability metrics; ROI, ROE and ROS. However, a fourth, EBITDA, provides the best framework for assessing your hotel’s profitability using percentages.

Profitability Metrics: The Big Three

Return on Investment (ROI)
Every entrepreneur is familiar with the concept of ROI. The general overview is to divide your operating income by the capital invested and multiply by 100.

ROI = (Operating Income / Invested Capital) x 100

However, ROI is often subjective and based on the expectations of the owner or shareholders. Revenue managers focus on market demand and how it affects room rental rates.

Return on Equity (ROE)
Return on Equity measures your risk; For example, is your ROE higher than government bond yields?

ROE = (Annual Net Income / Net Equity) x 100

This is another profitability metric you may come across; Again, it’s rather subjective.

If you want to analyze your hotel’s ROI or ROE, you need a thorough understanding of the hotel’s financial position. You need to know how much capital the hotel has invested to achieve the optimal ROI percentage and you need to know the net equity for ROE. Not everyone has unique access to these types of numbers.

In addition, such figures are object-specific and do not provide accurate insight when extrapolated across the industry.

Return on Sales (ROS)
Return on Sales measures the hotel’s performance and can compare it to competitors of a similar size within the same sector.

ROS = (Operating Profit / Net Sales) x 100

The ROS is a useful comparison tool as it averages your hotel’s typical profit margin. When hoteliers review profit margin, they get basic insights into how the business operates when they compare it to similar hotels.

Consider if your industry has an average profit margin of 10% but your hotel has an ROS rate of 4%. This raises red flags that there are gaps in your hotel operations and room for improvement. You could review product pricing, distribution channels, or production costs to discover these gaps from a revenue management perspective.

As Revenue Managers, the Franco Grasso Revenue Team (FGRT) recognizes that ROS (Return on Sale) accurately measures your hotel’s profitability. ROS focuses on maximizing sales by maximizing sales and profits. However, better representation is another metric hoteliers can use to analyze profitability.

ROS vs. EBITDAR/EBITDA

Compare ROS to EBITDAR (Earnings Before Interest, Taxes, Depreciation, Amortization, Restructuring or Rent Costs), better known as Gross Operating Profit (GOP), and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), the same as EBITDAR, however, after deducting rental costs (if the property is not owned and pays a rent).

It’s a mouthful, but the complexity of this ratio paints a more detailed picture of the property’s financial health.

EBITDA indicates how much money is available to handle costs like interest, taxes, etc. and still leave a profit margin. In general, the healthiest companies have higher EBITDA, while low or negative EBITDA indicates that operating expenses are higher than revenue, which is unsustainable.

EBITDA is critical as it provides an overall view of a company’s health through day-to-day operations rather than clever accounting practices that can obscure the reality of operations.

In summary: EBITDA = Revenue – Expenses (excluding taxes, interest, depreciation and amortization)

Hoteliers can forecast EBITDA or calculate it using a hotel’s balance sheet.

Of course, in the hospitality industry, many discrete areas can impact revenue. For example, target restaurants and spas can be segmented separately. As a simple example, let’s apply the EBITDA ratio to a hotel that uses only rooms as its cost and revenue center.

How revenue management increases your hotel’s profitability

In a hypothetical property where rooms are your only consideration, several factors still play into EBITDA:

• Room revenue (revenue management)
• Variable costs* ideally, these are about 30% of the total turnover
• Fixed costs* are less easy to generalize as they depend on many factors. They should not exceed 40/45% of total sales.

*Cost Optimization is a delicate balancing act between reducing overall costs without compromising quality of service with a view to increasing profits.

A strong revenue management strategy aims to maximize room revenue by using factors that consider your property’s location, your brand reputation and market conditions.

When revenue management is well implemented, the result is always higher EBITDA for more profit on an absolute basis.

Revenue management at work

Imagine that the annual turnover of your property amounts to 1 million euros without revenue management. This property has typical variable costs (cleaning products, linen, utilities, sales commissions, etc.) of 30% of the room turnover of 300,000 euros and fixed costs (mainly staff) of 40%. Subtract operating expenses from income and you have gross operating profit or EBITDAR (Earnings Before Interest, Taxes, Depreciation, Amortisation, Restructuring, or Rent Costs) of $300,000. After deducting restructuring or rental costs (if any), you get the EBITDA.

However, statistics show that such a property can increase sales by 20% in the first year if proper strategies are implemented with the help of revenue management. Revenue management helps hotels offset increased variable costs with a higher profit percentage.

There is a myth that revenue management increases variable costs due to higher utilization and decreases operating margins. In reality, intelligent revenue management can increase variable costs and revenue at the same time, so profits grow.

For example, imagine a property without revenue management. This hypothetical property earns 500.00 euros per year with variable costs of 150,000 euros (30% of the total income). The fixed costs are 200,000 euros (40% of the income).

By implementing revenue management, the property increases occupancy and revenue by 25%, bringing the property in for €625,000. Fixed costs remain the same and variable costs increase by 35% (from 150,000 to 202,500). However, the increase in variable costs is largely offset by the incremental increase in sales (52,500 to 125,000). This leads to higher EBITDA and higher earnings.

Revenue management always puts profit percentages in perspective, which means your hotel may be increasing variable costs by a larger percentage than revenue. However, they still result in higher EBITDA in absolute value, which means an increase in overall profitability. This principle also applies in the face of recent increases in energy costs and inflation.

Hotels that practice revenue management increase their revenues and profits annually (except during pandemics and other unforeseen crises).

This begs the question: What about crises? How does revenue management work in a global crisis? The answers may surprise you.

How revenue management maintained profitability during the pandemic

As you know, the hotel industry has been struggling as the world shut down due to the pandemic. However, the FGRT study with over 400 hotels has shown how important revenue management is in global crises. Some of these hotels were still showing growth and positioned themselves to maximize results when demand returned.

Revenue management helped these hotels stay on track and minimize losses during the lockdown. During the 2020 and 2021 closures, many city hotels maintained their revenue strategies and have broken even or remained profitable despite the pandemic.

In this free e-book you will discover ten revenue management principles that successful revenue managers implement. Hotel Revenue Management is more than technology.