Table of Contents
- Research Question
- Identification and Assessment of the Appropriate Sources of Finance
- Evaluation of the Appropriate Sources of Finance for the Expansion Plan of the City Hotel
- Analysis of the Cost of Funding the Project
- The Importance of Financial Planning and Assessment of the Necessary Information
- Importance of Budgeting and Analysis of the Budgets for Variation
- Calculation of the Unit Cost
- Assessment of the Viability of the Hotel Expansion Project Using Investment Appraisal Techniques
- Discussion, Interpretation and Analysis of Financial Statements
- Comparison of the Formats of Financial Statements
- Related Research essays
The current research paper describes the procedure of making managerial decision concerning the source of financing of the City Hotel for acquiring new buildings. Both positive and negative sides of different source of financing are thoroughly analysed and evaluated. Particular attention is paid to necessity of budgeting and planning of financial activity of the hotel that can be performed on the basis of different financial statements.
The research paper is based on the understanding of the considerable growth of the hospitality industry. Hotels require funding for acquiring new buildings, development and realisation of new projects in order to remain competitive. Finances can be obtained from different sources. Administration and operation managers of the company should thoroughly analyse and evaluate advantages and disadvantages of different sources of financing for making the most beneficial commercial decision.
The current research project will provide description of different sources of long-term financing for acquiring new buildings for lease. The City Hotel requires at least £ 25 million for the initiative. Both advantages and disadvantages of the different sources will be shown below. The research goal of the work is determination of the investment decision that will be the most suitable for the financing project of the City Hotel.
Identification and Assessment of the Appropriate Sources of Finance
The City Hotel can obtain financing to acquire new buildings from different sources of investment. Two of them include bank loans and insurance companies, and will be analysed in the scope of the paper. The choice is based on the understanding that the two sources can provide necessary sum in a short period of time. Moreover, the money can be returned during relatively long time frame.
Banks can provide long-term financing. Hence, the City Hotel has an ability to generate sufficient cash flow for acquisition of new buildings on lease. Bank that will finance the organisation will require an assurance of repayment. The assurance can be presented in a form of personal guarantees or secured interest on personal or organisational assets (for example, a mortgage) (Rao 2010). Thus, bank analytics will perform thorough analysis of organisation’s performance before approving for a loan in order to assess the possibility of return of their money, and organisation’s health. The great benefit of the identified source of financing is that bank can provide some flexibility in the terms of loan payment: “you can pay off your loan early and terminate the agreement” (Rao 2010). It should be noted that bank is more interested in giving loans to big business because they bring higher profit than small enterprises. The interest rate depends greatly on different factors: amount of loan, terms of pay-off, existing guarantees, risks of non-return, political and financial climate in the country, etc. Terms of loan contract should be thoroughly discussed by bank authorities and financial managers of the hotel.
The next source of financing is shared capital. The project provides funds invested by shareholders. They can be individuals or institutions (like pension funds). Shared capital is a long-term source of financing. Shareholders will gain a share of the ownership of the hotel. At the same time their personal capital remains protected. Shareholders are only liable for the invested sum (Ireland, 2008). Also, shareholders can use different personal sources for financing the hotel (for example, personal investments). The return on investment can be provided in a form of dividends. Shareholders buy or sell shares through stockbrokers or directly from the organisation. Each investor can observe the performance of the company through the Annual Report, Income Statements, and other financial documents, which the brokers or organisation provides. Moreover, they can take an active part in performance of the corporation, in which they invested, through voting on main issues.
Evaluation of the Appropriate Sources of Finance for the Expansion Plan of the City Hotel
Evaluation of the mentioned sources of finance will be based on both advantages and disadvantages of each source. The administration of the City Hotel should ground its financing decision on the understanding of how the hotel will return obtained funds, the methodology of pay-off and the extent of control, which administration intends to keep in its hands.
Bank loan is a recommended source of financing for the situation, when the administration of the City Hotel has a definite vision that hotel has a possibility to return the loan within a certain period of time. Moreover, some guarantees should be provided to the bank. Moreover, the liability financing will not provide any limits on the managerial decisions.
Shared capital will be more beneficial choice, when the organisation has some reservations about the terms of returning the money. Owner’s equity financing implies that the administration of the hotel is not obliged of return the whole sum of money within certain period of time. Shareholders just obtain their dividends. However, shareholders receive the control over the performance of the hotel and can take an active part in making and realisation of managerial decisions.
Analysis of the Cost of Funding the Project
Analysis of the cost of the project financing will be performed by application of equity versus debt finance.
Equity financing is an approach based on issuance of shares. Selling of additional shares of the company leads to the decreasing percentage of ownership for previous stockholders. However, the cost of financing the project by using an equity investment will be lower than by employing debt financing. The reason is that stockholders obtain only the certain part of organisation’s income in a form of dividends. However, the corporation will be obliged to pay dividends for an indefinite period of time. George Deeb (2014) in his article stated the following: “most professional investors will be seeking equity in the form of preferred stock, not common stock, where they get a 6% to 8% interest”. Hence, the City Hotel will be required to repay stockholders the certain interest rate that is set by initial agreement between the investor and the hotel. The cost of equity depends on the following factors: dividends per share, current market value stock and growth rate of dividends.
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Debt financing is based on borrowing money from other person or institution without surrendering ownership right. The form of financing usually includes stricter conditions and limitations. The example of debt financing is bank loans. The cost of financing is clearly defined by the terms of the loan agreement. In many cases, the contract included into the loan agreement between the bank and the City Hotel is mutually binding. For instance, the bank will provide a loan in a £ 25 million; the City Hotel will begin payment of the loan from the January 1, 2016; the interest rate is 9 per cent annually; payments should be performed till the last day of every quarter; the final day of repayment will be January 1, 2018. Hence, the City Hotel will be obliged to return £ 25 million together with the annual rate of interest that can vary depending on the terms of loan agreement. The cost of debt financing is estimated by rules of the contract between the hotel and the bank.
The Importance of Financial Planning and Assessment of the Necessary Information
Financial planning enables the administration of the hotel to perform grounded decisions concerning the amount and the time of spending funds. The strategy should be based on the amount of funds available at administration’s disposal. Financial planning “estimates the precise requirement of funds which means to avoid wastage and over-capitalization situation” (Pujari 2015). It projects allocating necessary financial sources in due time. Financial planning enables precise assessment of available budget for investing in the most beneficial projects, thorough control of financial activities based on comparison of estimated and actual financial results. Utilization of finance and minimization of possibilities of commercial shocks and surprises leads to improvement of financial health. Additionally, Saritha Pujari stated that financial planning “helps in deciding debt/equity ratio and by deciding where to invest this fund” (Pujari 2015).
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Grounded assessment based on financial information and available data provides effective and efficient coordination of financial functions of the organization. Examples of such information are the following: balance sheets, income statements, cash flow statements, change in owners and financial ratios (Zager K & Zager L 2015). The aforementioned statements and calculations reflect financial position, business performance, cash receipts and expenditures, as well as company’s transactions (Zager K & Zager L 2015). Decision makers should focus their attention on the most significant part of the organisation’s cost accounting, managerial accounting and financial accounting (Zager K & Zager L 2015).
Financial operations of the organisation form the background for its statement. Any changes, like operating and financial leases, have a considerable effect on financial activity and statements. The research paper will provide a description of impact of financial lease on financial statement based on the decisions of the administration of the City Hotel. Financial lease forms interest expense and depreciation expense. The net income will become lower because the company will cover expenses for the lease (Feroz et al 2003). At the same time, EBIT will increase (Feroz et al 2003). Also, financial lease will lead to the growth of amount of long-term assets and long-term liabilities stated in the Balance sheet (Feroz et al 2003). Moreover, the percentage of increased assets will be lower than the percentage of increased liabilities (Feroz et al 2003). Financial lease leads to decreasing of the current ratio (Feroz et al 2003). It should be noted that the amount of total after-tax cash flow will be higher in the early years.
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Importance of Budgeting and Analysis of the Budgets for Variation
Budgeting is planning of expenses for determination of the effectiveness and efficiency of the current and projected expenses in the future. It provides numerous advantages to the organisation. Firstly, budgeting leads to elimination of wasting the capital on unessential projects. Secondly, it creates the background for building financial roadmap for analysis of both positive and negative business variations and environment changes. Thirdly, the organisation can plan its future development and make capital reserves. Finally, budgeting enables estimation of revenues and expenses, development of effective plans of actions and performance control methods for assessment of actual results.
Budgets are analysed for variations in order to provide the administration more information concerning the causes of the difference between estimated and actual results. There are two types of variance, which are quantity variance and cost variance. The differences create background for revenue variance analysis and cost variance analysis. Both of them can be used for analysis of revenues and expenses.
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The administration of the City Hotel should perform precise planning for acquisition of new buildings on lease. Debt financing by using bank loan is considered to be the most suitable decision for acquiring the new building. The decision is based on the understanding that definite loan agreement eliminates any negative consequences of market fluctuation. Terms of the contract enable administration to build clear budgeting plans and reserve the management decisions over the hotels for current administration. However, some collateralized property should be given at bank’s disposal (for example, in the form of buildings which currently are in the property of the City Hotel).
Calculation of the Unit Cost
The unit cost will be represented by the revenue from one unit. It will estimate the average daily rate and coverage expenses. Average daily rate is the regular rental income that is obtained for one occupied room within a certain period of time. Property occupancy can be derived from the official statistics. The unit cost will cover the following expenses: wages to employees, taxes, managerial fees, supply (equipment, food, flowers, machineries, software, and household goods), telephone and Internet connection, and part of loan interest. The administration should consider the following characteristics for calculation of unit costs: the amount of rooms of different types (single, double, triple, and family rooms), fixed and variable costs, season, and occupancy.
According to the assignment, the City Hotel needs at least £ 25 million to acquire new buildings on lease. The current research analysis will be based on assumption that the administration of the hotel decided to pursue a loan agreement with the bank on the time period of 25 years with the rate of interest of 0.2 per cent annually. Hence, each year, the City Hotel will be obliged to pay to the bank £ 2.35 million. The amount of expenses that should be covered (except loan interest) is £ 3 million. Consequently, total annual expenses will be £ 5.35 million. The average rate of occupancy of UK hotels is 75 per cent (Hyatt Hotel Corporation 2015). The amount of units will be 200. The average revenue per unit is £ 100. Total revenue will be £ 5475000. Finally, total annual profit will be £ 125000.
Assessment of the Viability of the Hotel Expansion Project Using Investment Appraisal Techniques
The viability of expansion of the City Hotel should be assessed by using the following investment appraisal techniques: net present value (NPV), cost benefit analysis (CBA), Internal Rate of Return (IRR), and Return on capital employed (ROCE) (Capital Investment 2015). The NPV represents a methodology based on estimation, discount and comparison of the revenues and the costs of initial investments into expansion project. Cost benefit analysis calculates the summary of all the incomes and subtraction of the associated costs. Internal Return Rate is calculated as a function of NPV of the rate of return. Return on capital employed is defined as average annual profit before interest and tax divided on initial capital costs. The use of appraisal techniques in the current research paper is considered to be unvalued, because of indefinite amount of taxes, as well as fixed and variable costs. The above calculations show that even after covering all expenses the hotel will obtain the considerable profit. Consequently, the hotel expansion project is considered to be successful.
Discussion, Interpretation and Analysis of Financial Statements
The discussion of the Income Statement, Statement of Cash Flow and the Statement of Financial Position (Balance Sheet) of Hyatt Hotels Corporation and Sirona Dental will be provided below (Hyatt Hotel Corporation 2015). Total current assets of the first company are $1,709,000; total current liabilities are $730,000 (Hyatt Hotel Corporation 2015). Hyatt Hotels Corporation has strong market liquidity because total current assets are more than twice higher than the total current liabilities. Most probably, banks would like to invest into the company, because it will be able to meet its current obligations. Total current assets of the business ($1,709,000) are mostly based on cash and cash equivalents ($1,044,000) (Hyatt Hotel Corporation 2015). Consequently, Hyatt Hotels Corporation can quickly correspond to changeable market conditions. Debt ratio is calculated as total liabilities ($3,516,000) divided on total stockholder equity ($4,627,000) (Hyatt Hotel Corporation 2015). Currently, it is at 0.75. The ratio means that the creditors have supplied $0.75 for each $1.00 supplied by stockholders. Time interest earned is calculated by dividing of earnings before interest and taxes ($596,000) on interest expense for the year ($71,000) (Hyatt Hotel Corporation 2015). Time interest earned is 8.39. It means that the company is earning 8.29 times the amount it is required to pay its lenders as interest. Free cash flow is difference between cash flow provided by operational activities ($473,000) and capital expenditures of the company ($253,000) (Hyatt Hotel Corporation 2015). It is $220,000, which shows that after paying all its expenditures, the corporation has $220,000.
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Total current assets of Sirona Dental are $687,100; total current liabilities are $ 237,300 (Hyatt Hotel Corporation 2015). Market liquidity is less strong, but still attractive for investing. Total current assets of the company ($687,100) are also mostly based on cash and cash equivalents ($383,600) (Hyatt Hotel Corporation 2015). Consequently, Sirona Dental also can provide timely response to market fluctuation. Debt ratio of the organisation is much stronger than debt ration of Hyatt Hotels Corporation. It is calculated as dividing of total liabilities ($552,200) on total stockholder equity ($1,258,800) (Hyatt Hotel Corporation 2015). It is 0.036. The number means that the creditors have supplied $0.036 for each $1.00 supplied by stockholders. Free cash flow is calculated as difference between cash flow provided by operational activities ($248,400) and capital expenditures of the company ($93,700) (Hyatt Hotel Corporation 2015). It is $154,700. Thus, Sirona Dental has lower free cash flow than Hyatt Hotels Corporation.
Comparison of the Formats of Financial Statements
Formats of Financial Statements of Sirona Dental and Hyatt Hotels Corporation are compared below. Income statement of Hyatt Hotels Corporation does not contain research development. At the same time, there is no interest expense in the income statement of Sirona Dental. Both reports do not contain non-recurring events. Balance Sheets are also different. Short-term investments are not included in balance sheet presented by Sirona Dental. Hyatt Hotels Corporation has no deferred long-term liabilities. Both balance sheets do not report accumulated amortization, miscellaneous stocks options warrants, redeemable preferred stock, and preferred stock. There are also some differences in cash flows. Cash flow of Hyatt Hotels Corporation does not provide information on dividends paid, while cash flow of Sirona Dental does not contain investments and other cash from financing activities.
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Current work provided deep understanding of the methodology of determination the most suitable source of financing. Bank loans are considered to be the most beneficial source for financing the property acquisition by the City Hotel, because it will not limit rights of the current management and will provide definite terms of repayment. The administration should perform thorough budgeting for effective and efficient work of the hotel. The process is based on analysis of financial information described in balance sheet, cash flow and income statement.