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  1. 1. THE FINANCIAL FEASIBILITY OF YOUR TOURISM BUSINESS CONTENTS The Financial Feasibility of your Tourism Business ......................................................2 Pre-Feasibility ...............................................................................................................2 Financial Analysis......................................................................................................3 Market Analysis .........................................................................................................3 Technical Constraints ................................................................................................3 The Financial ‘Quick Test’.............................................................................................3 Profit Projections .......................................................................................................4 Business Costs........................................................................................................10 Profitability Forecasts ..............................................................................................11 Cash Flow Projections.............................................................................................11
  2. 2. The Financial Feasibility of your Tourism Business A business can be defined as any scheme or activity in which financial resources are to be invested with the expectation of a return and which lends itself to reasonable analysis and evaluation. What, then, makes a business feasible? Being feasible implies that a business is sustainable in the long term, it is practicable, and it will meet your objectives. Depending on the size, complexity and financial risks involved you will be well advised to prepare a business feasibility study. There are many professionals who are well equipped to assist and there is a lot you can do yourself, however you are strongly advised to seek advice from your accountant. For a business to be proven feasible, it is accepted practice for two studies to be carried out: • The preliminary feasibility, or pre-feasibility, which examines: - whether the business meets minimum financial requirements - whether there is a market for the finished product - whether it is technically feasible This stage is sometimes referred to as the ‘pre-investment study’. • The full feasibility is a more detailed analysis of: - the technical aspects - capital costs - operating revenues, expenses and cash flows - marketability - the social and environmental impacts. Pre-Feasibility There is no standard method or technique for doing a pre-feasibility. The suggestions provided here should be used as a guide only. There are many other approaches that can be taken. In the final analysis it will be your decision as to which approach is best suited to your needs. A pre-feasibility is undertaken in the very early stages of a business to determine whether it is worth further consideration. This is where some ‘ball park’ figures are generated. At the very least there are three key elements you will need to look at: • Financial Analysis • Market Analysis • Technical Constraints
  3. 3. Financial Analysis The purpose of this part of your pre-feasibility is to determine the start-up cost of the business, how it will be financed, what price will be charged to the customer and what the likely return will be to you. Market Analysis The purpose of a market analysis is to determine if there is a market for the product. It is strongly recommended that you speak to Tourism Western Australia staff when undertaking your market analysis. We may be able to provide some insights you have not yet considered. Learn as much as you can about your potential customers. For starters, try to find out: • What they buy? • Where your customers can be found? Are they mostly in Perth, interstate, overseas or some mix of all? • When do they purchase? Do they have long lead times or make spontaneous/impulse decisions? • Why they buy? What really motivates them? • What are your potential competitors saying about your prospects? Technical Constraints There is a real need to identify potential government planning regulations that may need to be complied with, preliminary engineering and design issues where applicable, and potential social and environmental impacts. The Financial ‘Quick Test’ Here is a very simple approach to ascertain whether you have the financial capability to consider doing a pre-feasibility. The Business Hurdles What will be the total What is your equity in Amount to be cost of the project? the project? borrowed - = Work out your expected revenue Revenue Interest payments The interest rate hurdle - = The interest rate hurdle All other costs The business cost - hurdle = Business cost hurdle Principal repayments The repayments hurdle - = Repayments hurdle Desired Profit Is there anything left = for me? -
  4. 4. The primary aim of your financial analysis at the pre-feasibility stage is to determine whether: • The revenue generated from the business will cover expenses • The rate of return on your funds invested in the business is equal to or better than established benchmarks. At a minimum you should include the following: • An assessment of the required capital investment and proposed capital structure • Proposed financing arrangements • A depreciation schedule • Profit and loss forecasts • Cash flow forecasts • An evaluation of cash flow projections. Profit Projections Profit is measured as Revenue - Expenses = Profit The first step is to determine the revenue potential of your proposed business. For most tourism businesses there is a standard way to determine revenue. Many newcomers to tourism significantly overestimate revenues. Once you have worked out the revenue capabilities of your business proposal the next step is to look at the expected costs. Many newcomers substantially underestimate costs. It is then possible to examine the liquidity side of your business, that is, cash flow. Revenue Determination Three factors need to be known before a revenue stream for a tourism business can be determined. These are: • Capacity • Utilisation • Price Capacity This is the basic number of saleable units of the product you intend having on the market at any one time. For a hotel it is rooms. For a coach, boat or aircraft it is seats. Many accommodation operators prefer to talk in terms of ‘room nights’. The formula used to calculate available room nights is: Available Room Nights = Rooms Available x Nights Open for Business
  5. 5. Capacity is fixed unless of course you have an expansionary development program. Capacity is in effect the supply side of your business. You will be investing in capacity. Throughout this section we will use an example –‘Anywhere Motel’- to illustrate the main points. Worked Example Anywhere Motel Anywhere Motel has 100 rooms. The owners want to express the motel's capacity in terms of room nights. They also want to work out the revenue potential of the property. Firstly, let's work out the annual number of rooms nights available. This is given as follows: Annual Room Nights Available = 100 Rooms X 365 Nights = 36,500 Room Nights Utilisation Because unused units of capacity can not be stored, you need to have a good idea of capacity utilisation over any given period. Utilisation refers to how much capacity was actually sold. Rarely will total capacity be sold every day of the year. Tourism operators refer to utilisation in terms of ‘occupancy rates’ (accommodation) and ‘load factors’ (coaches, boats and aircraft). The room occupancy rate for an accommodation establishment is given by the following: Occupancy Rate (%) = Rooms Occupied x 100 Rooms Available Hence, the occupancy rate of an accommodation establishment is a ratio of the number of rooms occupied to the total number available. Worked Example Anywhere Motel If an average of 50 rooms is occupied each night by paying guests, then the annual room occupancy rate for Anywhere Motel is: Occupancy Rate = Rooms Occupied x 100 Rooms Available = 50 x 100 100
  6. 6. = 50% Anywhere Motel has an annual average room occupancy rate of 50% It is useful to also work out the room nights occupied. For an accommodation business, once the occupancy rate and capacity are known it is a simple task to determine the rooms night occupied. It is given by the formula:- Room Nights Occupied = Rooms Available x Occupancy Rate This figure is very important. It can be considered as the level of ‘consumption’. Worked Example Anywhere Motel The annual number of room nights occupied generated at Anywhere Motel will be: Room Nights Occupied = 36,500 X 50% = 18,250 Room Nights The proprietors of Anywhere Motel ‘produced’ and sold 18,250 room nights. The remaining 18,250 room nights were, in a sense, wasted. They can not be stored. Their capacity to generate revenue for the business has gone forever. A room or a seat is said to be a highly perishable product. It will be noted from the above that while the occupancy rate provides a basic measure of market demand it does not tell exactly how many guests you can expect at a given occupancy. Annual occupancy rates and load factors rarely reach 100% and must be built over time. Capacity utilisation is usually lower in the early few years of a business than once it is established in the marketplace. There are several problems associated with using occupancy rate as the sole measure of performance or productivity. Artificial price decreases can ‘boost’ occupancies and consequently given an inflated view. This issue is particularly important if you are considering buying an existing business. Price Pricing is the only marketing decision that will impact on revenue. All other marketing decisions will impact on expenses. The average price you sell your product at can be varied - it is the only element of revenue you do have direct control over.
  7. 7. One of the more important factors you will need to consider when pricing your product is that of travel agent's commission. In particular you need to be aware of the tourism industry practices for marking up a price. When working out the annual expected revenue flow you will be interested in the average price (or tariff). However, the average price does not necessarily mean the selling price. The actual selling price can vary quite considerably. For example, high season, shoulder and low season pricing, corporate, travel industry and group rates, and so on. Annual Revenue Three factors combine to determine revenue, as follows: Revenue = Capacity x Utilisation x Price Depending on the nature of the business, for example, a coach tour or tourist attraction, there are some subtle differences in the method of calculation. It is important to keep in mind at this early stage that the revenue generated by the business will not alone determine whether the investment is worthwhile. Worked Example Anywhere Motel The average room tariff is $120.00. The annual room revenue will be: Rooms Revenue = Rooms available X 365 X Occupancy % X Tariff = 100 X 365 X 50% X $120 = $2,190,000 How to Work Out Your ‘Fair Share’ One of the first issues that will confront you is to work out an estimated occupancy rate. There are several ways you can do this. One method is known as the ‘fair share’ calculation. Essentially, this method says that, all other things being equal, you can expect to gain a share of demand that is proportional to that of existing competitors. For accommodation businesses it is the ratio of the proposed new capacity your business will bring onto the market to the total (competitive) capacity that is already available. Fair share can be calculated as follows: Fair Share (%) = Your New Capacity x 100 Existing Capacity + Your New Capacity
  8. 8. The fair share is the starting point for further analysis. The new business may be able to get more than this depending on its competitive characteristics. Worked Example Anywhere Motel The proprietors of Anywhere know that there are six other competitive hotels and motels in town with a total capacity of 900 rooms. They want to work out their likely fair share of the market. Fair Share (%) = 100 Rooms x 100 900 Rooms + 100 Rooms = 10% The proprietors can expect to get 10% of the market. If the existing accommodation operators are experiencing an average of 60% occupancy, the new average once your business becomes established will be 54%. How to Work Out the Required Number of Customers In order to determine the potential revenue, you must make assumptions about occupancy either in the form of a room occupancy rate, coach load factor or some other measure. In doing so you are, in fact, making assumptions about the number of customers the business will attract. Ultimately, you will need to know the actual number of customers required to make the business profitable. It is possible to make these estimates in a systematic manner particularly with respect to accommodation businesses. The key variables are the number of guest nights, guests per room and average length of stay. Guest Nights Paying guests generate guest nights. However, guest nights and room nights are not the same thing because more than one guest can be accommodated by one room. Therefore, in order to find the required number of guests, you need to know the number of guests per room. The formula for calculating guest nights is: Guest Nights = Room Nights x Guests per room Guests Per Occupied Room The average number of guests per room will need to be estimated. It is rare for this figure to be greater than 2.0 (unless the business operates exclusively in the family market). Guests per occupied room for a locality can often be found for a locality in the Australian Bureau of Statistics Tourist Accommodation Survey.
  9. 9. Average Length of Stay The second variable that needs to be known before guest arrivals can be calculated is the average length of stay. Average length of stay can often be found from industry averages through the Australian Bureau of Statistics Tourist Accommodation Survey. Where statistics are not available, you will need to make a best guess. Guest Arrivals These two variables, guest nights and average length of stay, can be divided to find guest arrivals: Guest Arrivals = Guest nights Average Length of Stay Guest arrivals can often be found for a locality in the Australian Bureau of Statistics Tourist Accommodation Survey. Worked Example Anywhere Motel On average guests stay two nights at the motel and the average number of guests per room is 1.2. Therefore: Guest Nights = 18,250 occupied room nights X 1.2 guests per room = 21,900 guest nights and Guest Arrivals = 21,900 guest nights 2 nights = 10,950 guest arrivals The proprietors of Anywhere Motel need to find a market of at least 10,950 guests, that is, 30 guests per day, in order to satisfy their revenue requirements. Travel Agents’ Commission Paying commission is a standard way of life in the tourism industry and it is a concept that tourism operators need to understand to take advantage of the distribution channels available. There are two ways of reaching potential clients:
  10. 10. • Directly – advertising, brochure distribution, website • Indirectly – using retail travel agents, wholesalers and inbound tour operators There is a cost attached to both methods that needs to be considered in your financial feasibility assessment and the cost of tourism products. Tourism operators do find difficulty in justifying the commission required by some agents, yet the costs in accessing these markets are generally way beyond the reach of small operators and the cost of paying commission is often balanced out by the number of bookings received direct by the business, which do not incur a commission. The normal commission rate to retail travel agencies is 10 per cent. When you have determined your net rate, that is, the rate that includes your costs and allows for some return as profit, you need to mark it up by 11.1 per cent (or one ninth) to provide for the 10 per cent commission charged on the retail rate. For example, a tour with a net rate of $180 that relies on travel agents for all of its bookings will need to charge $200 for the tour ($180 plus 11.1 per cent, or $20). If the tour operator only receives 25 per cent of bookings from travel agents, a markup of only $5 is required to achieve the required net rate of $180. Wholesale agents charge higher rates of commission – sometimes up to 30 per cent - because they are responsible for funding the brochures that contain your business’s details. A similar calculation is necessary to determine the required selling price for the tour. It is therefore important to keep accurate sales records that show the source of bookings – wholesale agents, retail agents and bookings direct from customers. Tourism WA has prepared a publication on commission rates. Business Costs Business costs can be divided into two groups - fixed costs and variable costs such that: Total Cost = Fixed Costs + Variable Costs Fixed Costs Fixed costs tend to remain relatively stable over a given occupancy range. Examples are • Depreciation • Lease payments • Rates and Taxes • Office expenses • Insurances • Interest on borrowed funds • Salaries of the general manager and key personnel
  11. 11. If loan funds are to be sought, a major expense item will be interest payments. The use of loan funds also means that you intend to introduce debt into the capital structure of your business. Your business will then be described as ‘geared’. Gearing will be discussed further in a later section. Variable Costs Variable costs, on the other hand, tend to change in direct proportion to changes in occupancy. • Consumable items in rooms • Laundry costs • Room cleaners’ labour costs • Food and beverage costs • Agents’ Commissions • Advertising • Credit card charges. Some costs, such as advertising, have both a fixed and variable component. For example, some base level of advertising will be maintained regardless of the level of sales. Profitability Forecasts Once you have an idea of revenues and expenses it is possible to start making some profitability forecasts. This can best be achieved through computer spreadsheet analysis. An example of a typical spreadsheet for several businesses is available from Tourism WA. Take special note of the presentation and not the actual figures themselves. It is common to provide projections for the first five years of the business and, for the first year, monthly figures. Cash Flow Projections The net cash flows of a business and the profit generated in a given year are not the same thing. Many businesses have in the past failed despite rapid profit growth. Profit can increase without a corresponding increase in net cash flow. For example, depreciation does not involve any cash outflow although it is charged as an expense against income. Furthermore, principal payments on borrowings do not feature in the profit and loss statement. These and other adjustments must be made when determining cash flow. The business spreadsheet examples provide both profitability and net cash flow projections and reconciliation between both.
  12. 12. © Tourism Western Australia 2009 DISCLAIMER This document has been prepared by Tourism Western Australia predominantly from information and data gathered in the course of its activities. No person or organisation should act on the basis of any matter contained in this document without considering and, if necessary, taking appropriate professional advice. Neither Tourism Western Australia, nor any of its employees, undertakes responsibility to any person or organisation in respect of this document.