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[Financial risk in hospitality industry] Page 1

Table of content

7-8

1. LITERATURE REVIEW

1.1. Overview of the theme

Running a business naturally entails taking risks—it is what business activity is about.
In this literature review, I will focus on the financial risk impact on the hospitality
industry, and the topic will consistent of general definition of financial risks, what

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factors cause financial risk in hospitality industry, how does financial risk effect
hospitality industry and how to control financial risk in hospitality industry.

1.2. Definition of financial risk

 Financial risk is only the inability of the hospitality project to generate enough
cash to support the debt the service. Due to the riskiness of certain hotel
projects. (John 1991, p.100)

 Financial risk is the additional variability in returns to shareholders that arises

because the financial structure contains debt.(Glen 2002,p.813)

 Financial risk is the additional risk placed on the common stockholders as a

result of the decision to finance with debt. (Stanley & Geoffrey 2005, p.272)

 Financial risk is a part of the total risk to shareholders’ returns that arises from
the method of financing the business. The more highly capital(financially)
geared, the higher the level of financial risk. (Eddie2006,p.500)

1.3. What factors cause Financial risk in hospitality industry

There are many factors that make the hospitality industry to meet with financial risk.
Jude, William and Hazel claim that Staff behaviour will cause financial risk. All hotel
staff have their stories to tell of stolen items. The assets used in a hotel business are
ones which are also commonly used in the home. For example, some hotels in the
USA screw their televisions into the furniture. Moreover, some of the internal risks in
hotels result from minor frauds carried out by staff. There is often an understanding
between management and staff that this goes on and is difficult to stop. Sometimes a
certain level of ‘wastage’ will be built into budgeted results in the knowledge that this

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is the case and cannot be prevented. (Jude, William & Hazel 1995, p.83) However,
Berry and Jarvis refer that financial structures cause financial risks, it means the way
that deciding to finance the assets will directly influence the financial risk. The mix of
debt finance and equity finance is known as gearing, and it affects the financial risk of
an enterprise. (Berry & Jarvis 1997, p.168) As a result, it is important that the way of
managers select to finance should be appropriate for the business, by way of
decrease the financial risk. On the other hand, Eugene and Michael consider that
financial risk is risk that result from financial transactions. For example, if a firm plans
to issue new bonds, it faces the risk that interest rates will rise before the bonds can
be brought to market. Similarly, if the firm enters into contracts with foreign customers
to suppliers, it faces the risk that fluctuations in exchange rates will result in
unanticipated losses. (Eugene & Michael 2005, p.798)At the same time, Robert and
Michael advance that financial risk results from fixed cost increasing. Financial risk is
the risk which arising from hospitality industry use of fixed cost sources of financing.
Fixed cost sources of financing include two kinds of stocks, debt and preferred. Debt
and preferred stock create risk because of fixed financial costs such as interest
expense and preferred dividend payment. (Robert & Michael 2005, p.266) If the hotel
cannot afford to pay these fixed financial costs, the use of debt and preferred stock
will increases, at the same time, the fixed costs will increases ,and then a firm must
pay regardless of its level of sales and profitability. Consequently, the financial risk will
be increase quickly.

In a word, financial risk is the risk that the hospitality industry will be unable to meet its
financial obligations. This risk is primarily a function of the relative amount of debt that
the hotel uses to finance its assets. There are many items will result in financial risks
including employee behaviour, financial structure ,financial transaction and fixed cost
increasing.

1.4. How does financial risk effect in hospitality industry

Financial risks are risks which impact on business success in hospitality industry.
William and Raymond consider that financial risk influence investment. Financial risk

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and business risk contribute to the overall risk of the investment and hence the
investment’s risk premium. Financial risk relates to the inability of the firm to meet its
debt obligations. Business risk relates to the company achievement which express
the firm is unable to hold its competitive position, maintain stability, and growth in its
earning. Moreover, the risk premium will be greater or less for different types of
investments. (William & Raymond 1993, p.103) Besides, Alan claims that financial
risk is generally associated with decision-making when talking about the topics like
investments, credit and buying and selling shares. (Alan 2002, p.41) Consequently,
shareholders need to use risk premium to determine if the hotel or business is worth
to invest or not. However, Atkinson, Berry and Jarvis claim that financial risk is related
to the capital structure of a business, i.e. the way in which it finances its assets, and
by adjusting the type of finance or the mix of equity finance to debt finance the
financial risk can be altered. Choosing various sources of finance ,a business needs
to bear in mind the use of the finance ,the limitations of the source of finance ,the
cost, the repayment terms and timing, and the availability of alternatives.( Atkinson,
Berry & Jarvis 1995, p.153) Meanwhile, they also refer that financial risk influence
shareholders return. Ordinary shareholders of high risk are getting a better return than
the shareholders of low risk. (Atkinson, Berry & Jarvis 1995, p.166) It means high risk
investments of shareholder may be getting a greatest return, but shareholders also
burden a high risk of loose all the investments. From Ruth and Keith point of view,
they deem that financial risk effect financial strategies. The concept of financial risk
can be combined with the business risk profile, in order to develop logical alternative
financial strategies for different types of hotels. For example, high risk businesses
should adopt low risk financing structures, primarily equity based. Similarly, low risk
businesses can improve shareholders’ return by taking on debt, increasing their
financing risk. (Ruth & Keith 2002, p.38)As a result, hotels should select the financial
strategies according to their actual situation.

In a summary, financial risk is crucial for hotel decision makers as well as hotel
investors. Financial risk will help decision makers to do the financial strategic
according to the real hotel situation. On the other hand, hotel investors can use
financial risk to balance how many benefits they will make as a return, the higher risk
they have ,the higher return they maybe receive. Moreover, financial risk plays an
important role in making financial strategy, making investment decision, influencing
capital structure and investors returns.

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1.5. How to control financial risk in hospitality industry

The management and control of risks is a key function of all hotel management .
Closely related to risk monitoring is risk control ,or the actions a hotel takes to keep its
actual risk profile at or below its risk tolerance. Risk management products like
position-keeping and monitoring systems are often essential support systems for a
sound system of internal controls on financial risk.(Christopher,2001,p212) Once all
the risks have been identified it is then necessary to identify the controls which cover
each risk that has financial implications and then ensure that these controls are
operating effectively. However, there are two different levels of controlling which are
detailed controls and high level controls.1)Detailed controls are operated by the staff
of the hotel, ensuring that the information systems accurately record the individual
transactions of the business and summarises them into the financial management
information.2) High level controls are those which look at the business as a whole and
are operated by the more senior managers of the business.

All hotel financial information systems have the same some key objectives of control
which are:

 To provide an accurate billing system—this will ensure that the revenues

reports by each department of the hotel are accurate;

 To monitor performance of the hotel;

 To safeguard assets—the risk of assets in a hotel being misappropriated is

relatively high given the nature of assets: cash and goods which are used in
domestic situations(and can therefore be used outside the hotel) (Jude,
William & Hazel 1995, p.83)

As in all industries, controls can be classified into those which are preventive and
those which are detective. Preventive controls are used to ensure that the main
objectives of controls identified above ate actually achieved. However, such controls
are not infallible and detective controls are used to indentify instances where

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preventive controls have not operated satisfactorily and where accounting records
need to be altered so that they accurately reflect what has happened in the hotel.

2. CONCLUSION

Any hotel will face a number of risks which will have a significant impact on the
business. Financial risk relates to the inability of company to support the debt service
which regard as an added risk bore by shareholders. Moreover, financial risk is being
viewed on a comprehensive basis. It is associated with the whole organizational
structures, processes, management procedures, and human resources decision-
making process. (Alan 2002, p.41) It is vital that business should be able to identify all
significant risks faced by the hotel. Without a rigorous risk analysis it is not possible to
assess the controls which are necessary. Failure to identify a significant risk and
therefore, not control it may have serious consequences for the business.

3. REFERENCE LIST

Atkinson, H., Berry, A.& Jarvis, R.,1995, Business Accounting for Hospitality and
Tourism, Chapman & Hall, 2-6 Boundary Row, London, UK.

Alan, W. & Lan, R. G., 2002, Managing Risk critical issues for survival and success
into the 21st century, Thomson learning.

Berry, A. & Jarvis, R. ,1997, Accounting in a Business Context, 3rd edition , Thomson
Learning.

Christopher,L.C.,2001,The Risk Management Process, published simultaneously in

Canada.

Debra, A., 2006, Management Accounting for the Hospitality Tourism and Leisure
Industries, Thomson learning.

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Eugene, F. & Michael, E., 2005, Financial Management theory and practice, 11th
edition, Thomson South-Western.

Glen, A. ,2002, Corporate Financial Management,2nd edition, Pearson education

Limited, Edinburgh Gate, Harlow, England.

John M. T.,1991, a practical guide to Hospitality Finance, Van Nostrand Reinhold,

New York.

Jude, C., William, B. & Hazel, O., 1995, Hotels an industry accounting and auditing
guide, Accountancy Books the Institute’s Publisher.

Mclaney, E. ,2006, Business Finance Theory and practice, 6th edition, Prentice Hall,
England.

Robert, E.C. & Michael, C.D., 2005, hospitality financial management, Pearson
Prentice Education, Inc., Upper Saddle River, New Jersey.

Ruth, B. & Keith, W. ,2002, Corporate Financial Strategy, 2th edition, Butterworth-
Heinemann, Britain.

Stanley, B.B. & Geoffrey, A.H., 2005, foundations of financial management, 10th
edition, McGraw-Hill/ Irwin, Americas, New York.

William, P. & Raymond, S., 1993, Financial Management for the Hospitality Industry,
Educational institute of the American hotel & motel association.

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