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Finance & Funding in Travel and Tourism - cost, volume & profit

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Costs, volume and profit for …

Costs, volume and profit for
management decision making
in travel and tourism

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  • 1. The International Travel College of New Zealand 1 Finance & Funding in the Travel and Tourism Sector Unit #2 – Learning Outcome 1 Costs, volume and profit for management decision making in travel and tourism
  • 2. The International Travel College of New Zealand 2 Types of Businesses Businesses are known generically as ‘business entities’ , each entity has a different kind of structure and its financial accounting and reporting has slightly different requirements
  • 3. The International Travel College of New Zealand 3 Sole Proprietor (Trader) • A single owner (Proprietor) – also known in New Zealand as sole trader • No separate legal entity – accounts are kept for the business but the owner is legally responsible as both the business owner and personally for any contracts, debts etc • ‘Unlimited liability’ with respect to the activities, obligations and debts of the business • No accounting, auditing or reporting requirements other than the need to keep accounts for the Inland Revenue Department • Limited access to investment or business funds – lenders reluctant to provide finance for sole traders to setup business • Costs to set up a business as a sole trader are much lower than for other entity structures. • All rewards flow directly to the owner. • Simple and timely decision making.
  • 4. The International Travel College of New Zealand 4 Partnership • A business entity structure representing the relationship between two or more individuals and focused on generating a financial profit. • May be established by a formal partnership agreement or an informal agreement between the parties. • No legal distinction between the business and the partners. • Unlimited liability with respect to the debts of the business. • In NZ partnerships are governed by the Partnership Act 1908, where it’s usual to have a formal written agreement between the parties. • Rights and responsibilities of each partner governed by the agreement rather than employment law. • A partnership can be either ‘special’, where some partners (not involved in the business) have limited liability, or ‘general’ , where all partners have unlimited liability. • The partnership assets are owned by the partners rather than individually. • The partnership profits belong to the partners equally unless otherwise agreed. • Some restrictions around how many people can constitute a partnership. Generally 20 is the max, exceptions being accounting practices.
  • 5. The International Travel College of New Zealand 5 Limited Company or Corporation • A business entity owned by people who have invested in the business. • Ownership interest broken down into shares • A company is a separate legal entity and can enter into contracts to buy sell, borrow, lend etc. • The life of a company is indefinite and not related to the life of the individuals who own it. • Ownership may change, shares can be bought and sold but the company is still the company. • The owners of a limited liability company are limited as to what they are financially responsible for if the business goes into debt. • A limited liability corporation protects a person's assets in the event of the company becoming insolvent. • A Company allows shareholders to limit their maximum possible liability for the debts of that company to the amount of the paid capital in the company.
  • 6. The International Travel College of New Zealand 6 Limited (Ltd) Company - NZ • In New Zealand, a limited company or corporation can be established under the Companies Act 1993, which makes no distinction between a public and a private limited company. • Directors can be held personally liable for the debts of their company if they’re found not to have carried out their duties properly. • Registration of a company is a simple procedure - costs less than $200 – by making an application to the New Zealand Companies Office giving details of the directors, the registered address and the company’s constitution. • Not necessary to have an individual constitution, as the Companies Act serves as a ready-made constitution for companies without their own. • Company profits belong to the shareholders and are either distributed or retained for the benefit of the shareholders. • Shareholders may be managers in the business, but large businesses employ managers to run the business on behalf of the shareholders. • Companies are often run by Directors who operate as a ‘Board’. • Directors are elected by the shareholders. • By law there must be at least one Director for a privately owned company and three Directors for a public company. • Directors do not need to be shareholders. • A company can raise capital/finance by issuing new shares or by offering the company as security (or collateral) for a mortgage or loan. • Arranging security for a loan can be both cheaper and easier for a company than an individual.
  • 7. The International Travel College of New Zealand 7 Public Companies • Public companies offer their shares for sale to the general public, and private (or proprietary) companies cannot. • Companies who offer their shares for sale to the general public are ‘listed’ on the stock exchange where shares in such companies are traded each day. • Shareholders can buy and sell shares in these public companies at the going market price. • Public companies are much more rigorously regulated than private companies. • In NZ currently (August 2013) there were 239 Public companies listed on the NZ stock exchange with such famous brands as Auckland Airport, Burger Fuel, Pumpkin Patch, Postie Plus, Sky City and The Warehouse.
  • 8. The International Travel College of New Zealand 8 Financial Investment/Capital • The amount of ‘capital’ invested in a company at startup is always shown on the balance’ sheet (now known as the statement of financial position) which forms part of the financial accounts for any business. • A statement of financial position sets out the things that are owned by the company, and deducts from this figure the amounts owed to outsiders. • The difference represents the wealth of the business. • Shareholders investment is also known as ‘shareholders equity’.
  • 9. The International Travel College of New Zealand 9 Directors Duties • 1. Management • The Board of Directors has primary responsibility for the financial performance and statutory compliance of the company. Where Directors have a role in the management of a company, the scope of their role should be explicit. • 2. Major Transactions • These should not be entered into without a special resolution or be conditional upon such a resolution. • 3. Good Faith/Best Interests • A Director must act in good faith and in what they believe is the best interests of the company. • 4. Proper Purpose • A Director must exercise a power for a proper purpose. • 5. Compliance with the Companies Act and Constitution • A Director must not act or agree to the company acting in a manner that contravenes the Act or the company’s constitution. • 6. Reckless and Insolvent Trading • A Director must not agree to the business being carried on in a way likely to cause substantial risk of serious loss to creditors or to cause or allow the business to be carried on in a way likely to create substantial risk of serious loss to company’s creditors. The Director must not agree to the company incurring an obligation unless he or she believes, on reasonable grounds, the company can meet that obligation when required. Directors should ensure that up to date financial records are kept and that they read and understand those records and reports. • 7. The Duty of Care, Diligence and Skill • A Director when exercising powers and performing duties must exercise care, diligence and skill that a reasonable director will exercise. A Director should understand the business, understand the financial statements and exercise informed independent judgment in every case. • 8. Directors Interested in Transactions • A Director must disclose any direct interests in other businesses or disclose information regarding close relatives who may get material benefits from related financial
  • 10. The International Travel College of New Zealand 10 Financial Reports A financial statement (or financial report) is a formal record of the financial activities of a business, person, or other entity. The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions.
  • 11. The International Travel College of New Zealand 11 Why do we need financial reports? • People need economic information to help them to make decisions and judgments about business. • Business owners/shareholders are also obliged to maintain accounts and produce financial statements to meet their governance requirements, to help secure additional finance, refinance or prepare the business for sale. • Some types of businesses, such as ‘public’ companies that are owned by shareholders and those in receipt of government funding are required to have their accounts externally verified and audited each year to confirm to the funding agencies or shareholders that the company has been run appropriately and that all funds are accounted for.
  • 12. The International Travel College of New Zealand 12 Accounting • Accounting is concerned with the collection, analysis and communication of economic information. Such information can be used as a tool of decision making, planning and control • The accounting system involves: o Identifying and capturing relevant economic information o Recording the information collected in a systematic manner o Analysing and interpreting the information collected o Reporting the information in a manner that suits the needs of users • This Unit focuses on the analysis and interpretation of the accounts rather than on the preparation of the accounts themselves.
  • 13. The International Travel College of New Zealand 13 Financial Accounts • Concerned with providing users (such as lenders, owners, government bodies) with information they will find useful. • Reports produced are general purpose reports showing a broad overview of the position, performance and cash flows of the business for a period. • Reports are presented in a standardized form. • Financial accounts are produced annually, although larger businesses may produce semi-annual reports and even quarterly reports. • Reflects the performance and position of the business to date and are therefore ‘backward’ looking • Concentrates on information that can be quantified in monetary terms.
  • 14. The International Travel College of New Zealand 14 Management Accounts • Concerned with providing managers with the information they require for the day-to-day running of the business. • Reports produced are for specific purposes, designed for a particular manager or use, and contain a lot of detail to help with decision making. • These reports are for internal use only and have no restrictions in the way are presented or produced. • Management accounts are produced as frequently as required by managers, which may be weekly or monthly, allowing them to keep a close check on business performance. • Reports include past performance as well as future performance projections or forecasts. • Reports include information quantified in monetary terms in addition to non-financial information such as measures of physical quantities of inventory/stock.
  • 15. The International Travel College of New Zealand 15 Costs and Volume The type and behaviour of costs and how this relates to the volume of activity in a business. Understanding this issue helps business managers/owners to make decisions and assess risks.
  • 16. The International Travel College of New Zealand 16 The Behaviour of Costs Costs may be classified as:  Fixed Costs: those that stay fixed (the same) when changes occur to the volume of activity.  Variable Costs: those that vary according to the volume of activity.
  • 17. The International Travel College of New Zealand 17 Fixed Costs • Fixed costs stay the same irrespective of the level of business activity but could still rise as a result of inflation. • They may also vary with ‘time’ eg rent for two months is twice as much as rent for one month. • Fixed costs are usually fixed for a range of output levels but if we increase output (eg increase sales) beyond that range we would need to increase some of our fixed costs to meet that new output level. • In the case of rent for a business, that is usually the most fixed cost of all, but if a business is very successful the business may expand to larger premises, and thus the fixed cost increases.
  • 18. The International Travel College of New Zealand 18 Variable Costs • These are costs that vary with the level of activity. eg if a tourism business sells more Harbour Cruises they will need to put on additional vessels, increase staff in order to operate those vessels, buy additional fuel for those vessels etc. • In some cases, higher levels of business activity may lead to better purchase pricing and thus improved economies of scale.
  • 19. The International Travel College of New Zealand 19 Economies of Scale • A reduction in cost per unit resulting from increased production, realized through operational efficiencies. • Economies of scale can be accomplished because as production increases, the cost of producing each additional unit falls. • Economies of scale applies equally in a service industry where buying services in ‘bulk’ is cheaper than buying them individually. • Higher levels of demand can also lead to higher costs: in order to meet demand, for example, operating additional harbour cruises, Fullers may need to pay staff overtime, making those cruises less profitable than others. • So…more output can lead to lower costs. But it can also lead to higher costs.
  • 20. The International Travel College of New Zealand 20 Semi Fixed/Variable Costs • Some costs have both a fixed and a variable element to them. • Good examples include power which might rarely vary until high levels of activity are experienced (busier than usual, open longer hours) when usage rises and thus power bill is higher. • Telecommunications is another one that is semi- fixed, with fixed monthly costs for the provision of lines, phone systems etc, but the actual usage varying depending on the output of the business.
  • 21. The International Travel College of New Zealand 21 Break-Even Point • Break-Even point is at a level of activity where revenue will exactly equal total cost, so there is neither profit nor loss. • With higher sales, the company makes a profit, and with lower sales, it suffers a loss. • Economists illustrate the break-even point with cost curve graphs, which plot a product's marginal cost, average total cost, price and quantity. • But you can more easily calculate the break-even point using simple arithmetic. • At break-even point, the level of sales revenue equals expenses.
  • 22. The International Travel College of New Zealand 22 Margin of Safety • The difference between the output of a business and the break-even volume is known as the ‘margin of safety • Most companies that continue to remain in business earn a profit and sell more than is required for their break even point. The actual sales minus the break even sales are the margin of safety. • An established business which has successfully traded beyond its break even point, will be interested in its margin of safety, that is to say, how much total revenue could fall before the business starts making a loss, i.e. expenditures are greater than revenue. • A business with a large margin of safety, is clearly in a much stronger business position.
  • 23. The International Travel College of New Zealand 23 ‘Contribution’ ‘Sales revenue per unit less variable costs per unit’ • If you sell a product for $100 and the variable costs in producing one unit are $60 your ‘contribution’ is $40. • This $40 can contribute to meeting the fixed costs of the business. • Any excess goes towards profit. • In this example, if our fixed costs are $25 per unit we have $15 left per unit to contribute towards profit.
  • 24. The International Travel College of New Zealand 24 Operational Gearing • The relationship between contribution and fixed costs is known as ‘operational gearing’. • A business with relatively high fixed costs compared with its variable costs is said to have high operating gearing.
  • 25. The International Travel College of New Zealand 25 Full Costing • In full costing all costs, whether fixed or variable are involved in calculating the costs of producing goods or services. • The costing system includes everything, including rent, wages and costs of production. • If a business is to achieve a profit, the owners must set a selling price that covers all costs. • The simples process of full costing is:  Add up all the costs of production incurred in the accounting period. (rent, wages, materials, power etc)  Divide those total costs by the total number of units of output for the period.
  • 26. The International Travel College of New Zealand 26 Segmenting the Overheads • Dividing the overheads into different areas or business units for costing purposes is a common accounting practice, and informs managers about the relative productivity and profitability of each area. • For example, a tourism business may be operating out of Auckland City and Rotorua. It makes perfect business sense to divide the overheads by business unit, so sales and costs associated to Rotorua are readily identified. • These segmented overheads might include wages of the staff, rent based on the space occupied, other direct costs such as advertising or communications costs if they can be separated out.
  • 27. The International Travel College of New Zealand 27 Direct & Indirect Costs • Direct costs – costs that can be identified to specific products or lines. Commonly this might be materials and labour. So all materials and labour used in production of one particular product or service can be attributed to the service. • Indirect costs (also known as overheads) are all the other costs that cannot be directly measured in respect of a particular unit of output. Commonly this might be rent, power etc. These costs may also be known as ‘common costs’ as they are common to all production of the product or service.
  • 28. The International Travel College of New Zealand 28 Job Costing • To work out the full cost of a particular unit or output all the direct costs of the job are attributed to it along with a share of the indirect costs. • This is known as job costing, common in product production such as factories, and generally not popular in service industries.
  • 29. The International Travel College of New Zealand 29 Activity Based Costing (ABC) •Also known as Activity Based Management (ABM) •This costing system has been popular in service industries such as tourism and hospitality, but it is expensive to operate and difficult to manage in small businesses. •Activity-based costing (ABC) identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. •This model assigns more indirect costs (overhead) into direct costs compared to conventional costing. •With ABC, a company can estimate the cost elements of entire products, activities and services. This may help inform a company's decision to either: o Identify and eliminate those products and services that are unprofitable and lower the prices of those that are overpriced (product and service portfolio aim) o Or identify and eliminate production or service processes that are ineffective and allocate processing concepts that lead to the very same product at a better yield •ABC is generally used as a tool for understanding product and customer cost and profitability based on the production or performing processes. •As such, ABC has predominantly been used to support strategic decisions such as pricing, outsourcing, identification and measurement of process improvement initiatives.
  • 30. The International Travel College of New Zealand 30 Mark-up Costing (Cost-Plus pricing) • Take the cost price and add the same percentage mark- up to all items (e.g. 50%). • Talk to suppliers, competitors or relevant business and industry associations to find an industry standard. • Useful when you have multiple products at different price points and other costing methods are too complex. • Adjust the mark-up depending on your strategy. • This method is simple but: o it takes no account of demand o there is no way of determining if potential customers will purchase the product at the calculated price.
  • 31. The International Travel College of New Zealand 31 Penetration Pricing • Penetration pricing is the pricing technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers. • The strategy works on the expectation that customers will switch to the new brand because of the lower price. • Penetration pricing is most commonly associated with a marketing objective of increasing market share or sales volume, rather than to make profit in the short term.
  • 32. The International Travel College of New Zealand 32 Penetration pricing is appropriate when: • Product demand is highly price elastic. • Substantial economies of scale are available. • The product is suitable for a mass market (i.e. enough demand). • The product will face vigorous competition soon after introduction. • There is not enough demand amongst consumers to make price skimming work. • In industries where standardization is important. The product that achieves high market penetration often becomes the industry standard (e.g. Microsoft Windows) and other products, whatever their merits, become marginalized.
  • 33. The International Travel College of New Zealand 33 Marginal Cost Pricing • Marginal cost is the change in the total cost that arises when the quantity produced changes by one unit. • That is, it is the cost of producing one more unit of a product. • In general terms, marginal cost at each level of production includes any additional costs required to produce the next unit. For example, if producing additional vehicles requires building a new factory, the marginal cost of the extra vehicles includes the cost of the new factory. • In practice, this analysis is segregated into short and long-run cases, so that over the longest run, all costs become marginal. • At each level of production and time period being considered, marginal costs include all costs that vary with the level of production, whereas other costs that do not vary with production are considered fixed.
  • 34. The International Travel College of New Zealand 34 Price Skimming • Price skimming is a pricing strategy in which a marketer sets a relatively high price for a product or service at first, then lowers the price over time. • It allows a company to recover its sunk costs quickly before competition steps in and lowers the market price. • The objective of a price skimming strategy is to capture the consumer surplus. • If this is done successfully, then theoretically no customer will pay less for the product than the maximum they are willing to pay. • In practice, it is almost impossible for a firm to capture all of this surplus. • The skimming strategy gets its name from skimming successive layers of "cream," or customer segments, as prices are lowered over time.
  • 35. The International Travel College of New Zealand 35 Other Pricing Strategies: Market-led Pricing • A company accepts the price which competitors are charging for a product and then prices its product at the same level or slightly lower in order to gain some advantage over its competitors Cost-plus Pricing • Popular in travel and tourism – particularly in small to medium sized businesses as it is relatively easy to introduce and manage. Add up the costs then add on a markup as a profit margin. Absorption pricing • Method of pricing in which all costs are recovered. The price of the product includes the variable cost of each item plus a proportionate amount of the fixed costs.
  • 36. The International Travel College of New Zealand 36 Economies of Scale • ‘Doing things more efficiently with increasing size of operation’ • Economies of scale are the cost advantages that enterprises obtain due to size, with cost per unit of output generally decreasing with increasing scale as fixed costs are spread out over more units of output. • Often operational efficiency is also greater with increasing scale, leading to lower variable cost as well. • Economies of scale apply to a variety of organizational and business situations and at various levels, such as a business or manufacturing unit, plant or an entire enterprise. For example, a large manufacturing facility would be expected to have a lower cost per unit of output than a smaller facility, all other factors being equal, while a company with many facilities should have a cost advantage over a competitor with fewer. • Economies of scale often have limits, such as passing the optimum design point where costs per additional unit begin to increase. • Common limits include exceeding the nearby raw material supply, such as wood in the lumber, pulp and paper industry. • A common limit for low cost per unit weight commodities is saturating the regional market, thus having to ship product uneconomical distances. • Other limits include using energy less efficiently or having a higher defect rate.
  • 37. The International Travel College of New Zealand 37 Diseconomies of Scale • An economic concept referring to a situation in which economies of scale no longer function for a business. • Rather than experiencing continued decreasing costs per increase in output, firms see an increase in marginal cost when output is increased. • The concept is the opposite of economies of scale • These terms are highly relevant to the travel and tourism industries. • Many tour operators gain significant economies of scale by purchasing travel components in ‘bulk’, such as airline seats, hotel accommodation. • Diseconomies of scale operates,. for example, when selling more of a product (flight seats to Sydney) results in the need to charter or operate a larger aircraft which carries significant additional costs and actually may increase the cost per seat rather than reduce it • Another example: tour operators introduce new specialized products, such as intrepid journeys, safaris, treks, to isolated places and buying the components of the package may produce a profit when customers are travelling in small groups, but the moment the group becomes larger the transport type has to be changed to something much more substantial, causing costs to escalate and profit to reduce. So the more of these tours are sold, the less profit is made.
  • 38. The International Travel College of New Zealand 38 Profit • Profit is a very important concept for any business – particularly a start-up • Profit is the financial return or reward that entrepreneurs aim to achieve to reflect the risk that they take. • Given that most entrepreneurs invest in order to make a return, the profit earned by a business can be used to measure the success of that investment. • Profit is also an important signal to other providers of finance to a business. Banks, suppliers and other lenders are more likely to provide finance to a business that can demonstrate that it makes a profit (or is very likely to do so in the near future) and that it can pay debts as they fall due. • Profit is also an important source of finance for a business. Profits earned which are kept in the business (i.e. not distributed to the owners via dividends or other payments) are known as retained profits. • Retained profits are an important source of finance for any business, but especially start-up or small businesses. • The moment a product is sold for more than it cost to produce, then a profit is earned which can be reinvested. • Profit can be measured and calculated. • Profit is the difference between the purchase and the component costs of delivered goods and/or services and any operating or other expenses.
  • 39. The International Travel College of New Zealand 39 Factors Influencing Profit - Manufacturing • Production efficiency – the number of units produced per hour • Losses – such as losses in production, health & safety losses, loss of materials, loss of market reputation • Costs – such as investment costs, operating costs, maintenance costs • These factors influence on each other and must be optimised together to achieve maximum profit for a production company. • The product manufactured in the production company could be any tangible item, such as a newspaper, diet coke, pair of shoes or Toyota car. • For a business to be successful a profit must be achieved during the production lifetime. • Interestingly, reducing costs does not always result in increased profit as the cost reduction measures may affect sales adversely or even have no effect at all.
  • 40. The International Travel College of New Zealand 40 Factors Influencing Profit - Retail • COGS is the industry standard abbreviation for "cost of goods sold." A company's COGS is determined by adding up all the money spent to buy and ship the needed materials to produce the retail product. • This may be the money spent on wholesale products that are put on the shelf and sold as is, or it could mean the amount of money spent on various products that are combined to create a new product to sell. • A company's COGS directly affects the gross profit since the money used to produce the retail items is ultimately deducted from the money taken in from sales. • Therefore, it is important for a business to shop around for the best deal on wholesale products in order to reduce the COGS and make more profit. • In businesses that do a high volume of sales, even a small savings on some items or cheaper shipping methods can add up to a considerably higher gross profit in the long run.
  • 41. The International Travel College of New Zealand 41 Markup Influences Profit • Markup is the amount above the cost of goods/services that the business sells its products or services for. • It is not uncommon for some retailers to charge three times the cost of goods to its customers. • This considerable markup may sound like a lot, but the markup must not only cover the goods themselves, but all of the costs associated with the business. • Markup directly affects gross profit because the higher the markup, the more gross profit there is. • However, setting a price too high will actually reduce gross profit if consumers decide the product/service isn't good value and refuses to buy. • When this happens the cost of goods remains the same, but the money taken in from sales is reduced. • Similarly, a selling price that is too low may result in more sales, but the amount of gross profit may be too low to operate the business adequately.
  • 42. The International Travel College of New Zealand 42 Stock/Inventory Levels • Maintaining sensible stock levels can indirectly affect gross profit in many businesses. • If a company stocks too much of a product, selling just a small percentage of the total purchased in a given time period, the cost of goods may outweigh the total sales. • On the other hand, ordering too few of an item could mean that you reduced the cost of holding stocks but missed out on sales that could have been made. This too will reduce the gross profit, even though less money was spent up front. • The ideal situation is to develop a re-ordering schedule that will have just the right amount of items arriving just in time for sale.
  • 43. The International Travel College of New Zealand 43 Factors influencing Tourism Sector Profits • Tour operating business performance is largely determined by the skill of the company in buying its product components (eg aircraft seats, accommodation and transfers) at a competitive price and reselling at a price that is lower than that for which a consumer could assemble the same product.
  • 44. The International Travel College of New Zealand 44 Negotiating low prices • Large tour operators will contract with suppliers to provide services (flights, accommodation and transport) well in advance of an operating season. This will secure them an advantageous price per service unit achieving valuable economies of scale. • The suppliers (also called principals) also benefit through having advance sales guarantees enabling them to fix their costs in advance. The advantageous price can be used to sell cheaper packages to customers who cannot obtain these contracted rates directly.
  • 45. The International Travel College of New Zealand 45 Managing Seasonality • Tourism is a seasonal business in almost all areas of the world, and presents some unique challenges both in operational terms and in the financial management of a tourism business. • Peaks and troughs of cash flow are difficult to manage and tricky to forecast. • The off-season periods can adversely affect profit levels with resources and facilities under-utilised or even not utilized at all. • An operators’ fixed costs remain ‘fixed’ even in the off-season. Ie rent and rates on premises. • In high season operators may struggle to finance additional staffing/equipment or services in order to meet the peaks of demand, and therefore lose potential business. (this is known as an opportunity cost). • Even if operators could fund additional services in high season they may not be able to find the staff and resources to increase their operation and meet demand. • Some tourism operators/accommodation providers operate differential pricing to encourage people to travel during the ‘off’ season. (ie cheaper prices in low season, high prices in peak season). This is designed to spread demand and helps to recover fixed costs during the off-peak season and minimizes effects on staff. • Addressing issues of seasonality in NZ requires flexible and creative marketing strategies including: o Greater segmentation of the market and targeting those segments with a predisposition to travel in the low season o The ongoing development of seasonal product and packages o The development of innovative promotional campaigns o Flexible pricing strategies that recognize the relationship between supply and demand
  • 46. The International Travel College of New Zealand 46 Managing Periodicity • Periodicity refers a similar concept as seasonality but within a shorter time frame, usually a week. • Hotels which cater to the business traveller usually experience peak demand from Monday to Thursday and often experience empty hotels over the weekend. • Dramatic price reductions for these nights are designed to lift occupancy rates and assist in meeting fixed costs.
  • 47. The International Travel College of New Zealand 47 Profit Enhancing Strategies Maximising use of resources • Tour operators with integrated tourism companies (horizontal integration) may achieve lower operational costs by increasing the capacity or usage of resources such as aircraft. Eg increasing the number of flights over a given period or reducing seat sizes can increase the number of passengers carried and thus achieve higher sales leading to improved profit levels. Reducing profit margins • Some tourism operators will reduce their profit margins in order to remain competitive or to gain a market advantage, relying on sales volumes to make up for lack of profit on individual sales. This is a risky strategy but is often one which is used to halt falling sales. Cutting cost structures • The cost of producing a product or service is a key component in establishing profit levels. If it costs more to produce a service than you can sell it for then the business will fail. Businesses can easily become very cost-heavy, with layers of administration and support services that may provide useful functions but erode profit levels. Many businesses seek to cut costs in order to improve their profit levels. This is not always successful however as reduced support services may lead to lower satisfaction levels and thus reduced sales.
  • 48. The International Travel College of New Zealand 48 Economic Factors Impact on Profit • Economic factors affecting businesses are regulation, access to credit, demand for goods and/or services and technological advancement. • Local and national regulations influence how well a business can take advantage of economic opportunities and adapt to the changing economic landscape. Regulation standards affect the ability of smaller businesses to create jobs and revenue. • Businesses grow when they experience low interest rates because a low rate ensures that it will cost less to get the needed financial resources to start or expand a business, or stave off bankruptcy. • Businesses are influenced by the interest rates, wage rates and rates of inflation, all of which measure the general cost of doing business. • If these rates rise, so does the cost of maintaining a business, which in turn necessitates higher prices for products and services. • The interest rate affects retail sales, as lower rates indicate that people have more disposable income to spend. • When the demand for a product or service declines, so does growth. This can result in pricing pressures and lost customers. • The profitability of a business depends upon consumer spending reflected in the demand for products and services. • High interest rates, bankruptcies and unemployment undermine consumer spending as both businesses and individuals juggle the increasing cost of business with decreasing demand for their goods and services. • Technology has improved customer service and demand, and this is especially true of modern communication technology, because online databases enable vast quantities of information to be shared easily and quickly between businesses and their customers. • Digital technology positively impacts the distribution of goods and services via the Internet, improving the speed and efficiency with which goods and services are accessed by consumers and then delivered via online businesses. • Consumers are able to purchase goods and services online, then review their satisfaction levels online, sharing their experience with millions of users via review sites such as TripAdvisor or social media sites such as Facebook.
  • 49. The International Travel College of New Zealand 49 Political Factors Impact on Profit • A government that is pro-tourism can dramatically impact the economic success of the industry as it can use its influence and funding to leverage the sector both at home and overseas. • NZ is a classic case with the Prime Minister as Tourism Minister. • This ensures a high profile for tourism leading to greater demand for the tourism product. • This can also influence the regulations and legislation surrounding tourism operations, with the sector being better able to lobby and make representations more easily. • Similarly, a government that is anti-tourism may make it more difficult for tourism to take place, placing immigration barriers at borders or introducing legislation that is not ‘user-friendly’ to tourism. • Governments can also impose taxes and charges at airports and other entry points, or impose levies or duties on purchases by overseas visitors. • Governments may introduce schemes to save visitors money, such as GST exemption schemes designed to encourage tourists to shop locally. • Governments may also use their powers to fund or support tourism initiatives or infrastructure projects that can progress and develop, or block, tourism development. • The shifting tides of governments can change the financial plans of any tourism business as policy or planning changes take effect.
  • 50. The International Travel College of New Zealand 50 Debt Management Impact on Profits • Bad debts appear as an expense on the company's income statement, thus reducing net income. • In general, companies make an estimate of bad debt expenses that might be incurred in the current time period based on past records as part of the process of estimating earnings. • Most companies make a bad debt allowance since it is unlikely that all of their debtors will pay them in full. • This ‘expense’ affects a business’s profit. • Accounting functions within a business include the collection of monies owed, known as ‘accounts receivable.’ • The objective for managing accounts receivable is to collect accounts receivable as quickly as possible • The longer an account remains unpaid, the greater the cost to the business as they do not have use of those funds while they are owed to them. • Businesses seek to avoid bad debts by offering inducements to settle invoices ‘up front’ or through partial settlement. • Cash discounts are also offered as inducement to pay promptly. • Changes in the credit period, the number of days after the beginning of the credit period until full payment of the account is due, also affect a firm’s profitability • Credit monitoring is the ongoing review of a firm’s accounts receivable to determine whether customers are paying according to the stated credit terms. • Slow payments are costly to a business because they lengthen the average collection period and thus increase the firm’s investment in accounts receivable
  • 51. The International Travel College of New Zealand 51 Smart Financial Management Impact on Profits • Working capital management focuses on managing each of the firm’s current assets and current liabilities in a manner that positively contributes to the firm’s value. • Financial managers seek to turn over inventory as quickly as possible, collect accounts receivable as quickly as possible, manage mail, processing, and clearing time, and pay accounts payable as slowly as possible. • A commonly used technique for effectively managing inventory to keep its level low is the economic order quantity (EOQ) model and the just-in-time (JIT) system. • Efficient use of inventory management systems can make a significant difference to the financial performance of a business. Carrying high stock levels ties up resources that could be being used elsewhere. • For businesses operating on an invoice basis ie selling a product or service and then invoicing a customer, providing credit is an important part of the financial operation of the business. • Credit selection techniques determine which customers’ creditworthiness is consistent with the firm’s credit standards. • Changes in credit standards can be evaluated by assessing the effects of a proposed change on profits from sales, the cost of accounts receivable investment, and bad- debt costs. • Changes in credit terms—the cash discount, the cash discount period, and the credit period—can be quantified similarly to changes in credit standards.
  • 52. The International Travel College of New Zealand 52

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