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Introduction

Analyzing financial statements, is a process of evaluating the relationship between


component parts of financial statements to obtain better understanding of a firm’s
position and performance - Metcalf and Titard.

The hotel financial statements provide a lot of information to the users. According to Anand
Iyengar, it is necessary that the users of financial statements be able to read between the lines
to have a better understanding of the financial position of the hotel. Financial analyses
depend on the financial statements to assess the financial performance of a firm for the
following reasons:

• Momentous inference can be drawn by examining trends in raw data and financial
ratios.

• Comparison between various firms in similar industry can provide conclusive results.

The purpose of evaluation of financial statements differs among various groups (creditors,
shareholders, potential investors, management government, labour leaders and so on)
interested in the results and relationships reported in the financial statements.

Short-term creditors are primarily interested in judging the firm’s ability to pay its currently-
maturing obligations. The relevant information for them is the composition of the short-term
assets and short-term liabilities. The debenture-holders or financial institutions granting long-
term loans would be interested with examining the capital structure, past and projected
earnings and changes in financial position. The share holders as well as potential investors
would naturally be interested in the earnings per share dividend pay-out ratio which are likely
to have a significant bearing on the market prices of shares. The management of the firm, in
contrast, looks to the financial statements from various angles. For one thing, these
statements are required for management’s own evaluation and decision-making. Moreover, it
is the responsible for the over-all performance of the firm - maintaining its solvency so as to
be able to meet short-term and long-term obligations to the creditors and at the same time
enduring an adequate rate of return, consistent with safety of funds to its owners.
(Khan & Jain, 1992)
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This project seeks to explain the tools and techniques of key financial ratios that are
employed for the analysis and interpretation of financial data of hotel companies and to
obtain better view of their financial performance.

What are Financial Ratios?

A ratio expresses a numerical relationship between two numbers. The study of the relation
between items or groups, expressed as a ratio, is called financial ratio analysis. A meaningful
analysis must satisfy two requirements. First, it should be able to track progress over a period
of time, say three to five years. Second it should be able to bench mark against the most
recent result with appropriate competitors. Finding a perfect benchmark may be difficult due
to many factors, like variation in scale of operations, product mix, brand image, and financial
structure. (Iyengar, 2008)

Types of Financial Ratios

There are two types of ratios that are used widely in financial analysis. The first kind, the
balance sheet ratios, summarizes and highlights the financial performance of the hotel
company at a point in time-the point at which the balance sheet is prepared. Balance sheet
ratios imply that the numerator and the denominator in each ratio came directly from the
balance sheet. The second kind, income statement or the income statement balance sheet ratio
compares two items from the income statement, or one item from the income statement and
the other from the balance sheet. (Iyengar, 2008)

Further, for the sake of better understanding, we can sub-divide our financial ratios into five
distinct types: liquidity, financial leverage, activity, profitability, and operating ratios.

Liquidity ratios relate current assets or cash flows to liabilities or expenses to show a firm's
ability to meet its financial obligations. Activity ratios measure firm productivity, as in the
management’s ability to use assets. Financial leverage ratios relate firm liabilities to equity
and assets to indicate the degree to which the firm relies on debt to finance its operations,
while profitability ratios depict the operational efficiency in terms of return on investment.
Finally, operating ratios provide help in analyzing operations of the firm. (Pearce II & Doh,
2002)
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It is not possible to assess the financial position of the firm by referring to one ratio, or even
to one class of ratios. Reasonable assessment can only be made after referring to several
ratios and the economic, business, and other environmental factors that will affect the
financial performance of the hotel. Liquidity ratios highlight the ability of the firm to fulfil
short-term obligations. (Iyengar, 2008)

Purpose of Financial Ratios

Ratio analysis can facilitate two types of comparison. The first is internal comparison, where
the comparison can be carried out within all departments of a unit or the different units of the
company, or the performance of the unit or company over a period of time. A comparison
over a period of time enables an analyst to determine if the financial condition has improved
or worsened over the period of comparison.

The second type of comparison involves comparison between the firms in the industry. This
is referred to as external comparison. External comparison provides an insight into the
relative performance of the firm as regards other firms. It also helps in identifying any
deviation from the applicable industry average. External comparison can also be applied to
benchmark the hotels performance against competition. (Iyengar, 2008)

If the performance of a business, as measured by its ratios is compared with industry’s


average over a long period of time, it will show a trend. This may be a divergence from the
industry’s average indicating areas worthy of attention by the managers of the company.
(Langford, Iyagba, & Komba, 1997)

After having known the meaning, types and purpose, of financial ratios, we now turn to a
discussion on the calculation, formula, and the purpose of individual ratios. To facilitate
discussion on key financial balance sheet ratios, we shall refer to the balance sheet of the
Marriott International Inc and Hyatt Hotels Corporation. Using the figures from the exhibits
1.1and 1.2, we calculate key balance sheet ratios.
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Marriott International, Inc. Balance Sheet as at December 31st 2009

Amount in million Dollars


Balance Sheet - Assets
Cash and Equivalents 115,000
Accounts Receivable 838,000
Inventories 1,444,000
Current Deferred Income Taxes 255,000
Other Current Assets 199,000
Total Current Assets 2,851,000
Land & Improvements 454,000
Building & Improvements 935,000
Machinery, Furniture & Equipment 996,000
Construction in Progress 163,000
Total Fixed Assets 2,548,000
Accumulated Depreciation & Depletion 1,186,000
Net Fixed Assets (Net PP&E) 1,362,000
Intangibles 731,000
Cost in Excess 875,000
Non-Current Deferred Income Taxes 1,020,000
Other Non-Current Assets 1,094,000
Total Non-Current Assets 5,082,000
Total Assets 7,933,000
Balance Sheet - Liabilities, Stockholders Equity
Accounts Payable 562,000
Short Term Debt 64,000
Accrued Liabilities 519,000
Other Current Liabilities 1,142,000
Total Current Liabilities 2,287,000
Long Term Debt 2,234,000
Other Non-Current Liabilities 2,270,000
Total Non-Current Liabilities 4,504,000
Total Liabilities 6,791,000
Common Stock Equity 1,142,000
Common Par 5,000
Additional Paid In Capital 3,585,000
Retained Earnings 3,103,000
Treasury Stock (5,564,000)
Other Equity Adjustments 13,000
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Total Capitalization 3,376,000


Total Equity 1,142,000
Total Liabilities & Stock Equity 7,933,000
Cash Flow (168,000)
Working Capital 564,000
Free Cash Flow 621,000
Invested Capital 3,376,000
Exhibit 1.1 (MARRIOTT INTL INC (NYSE: MAR) | Balance Sheet, 2010)

Hyatt hotels corporation Balance Sheet as on December 31st 2009

Amount in Million dollars


Balance Sheet – Assets
Cash and Equivalents 1,327,000
Restricted Cash 11,000
Accounts Receivable 410,000
Inventories 133,000
Prepaid Expenses 85,000
Current Deferred Income Taxes 23,000
Total Current Assets 1,989,000
Land & Improvements 562,000
Building & Improvements 3,594,000
Machinery, Furniture & Equipment 1,125,000
Construction in Progress 246,000
Total Fixed Assets 5,527,000
Accumulated Depreciation & Depletion 1,922,000
Net Fixed Assets (Net PP&E) 3,605,000
Intangibles 284,000
Cost in Excess 113,000
Non-Current Deferred Income Taxes 74,000
Other Non-Current Assets 1,090,000
Total Non-Current Assets 5,166,000
Balance Sheet - Liabilities, Stockholders Equity
Total Assets 7,155,000
Accounts Payable 196,000
Short Term Debt 12,000
Accrued Liabilities 282,000
Other Current Liabilities 5,000
Total Current Liabilities 495,000
Long Term Debt 1,620,000
Minority Interest 24,000
Total Non-Current Liabilities 1,644,000
Total Liabilities 2,139,000
Common Stock Equity 5,016,000
Common Par 2,000
Additional Paid In Capital 3,731,000
Retained Earnings 1,338,000
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Treasury Stock (2,000)


Other Equity Adjustments (53,000)
Total Capitalization 6,636,000
Total Equity 5,016,000
Total Liabilities & Stock Equity 7,155,000
Cash Flow 224,000
Working Capital 1,494,000
Free Cash Flow 166,000
Invested Capital 6,636,000
Exhibit 1.2 (HYATT HOTELS CORP (NYSE: H) | Balance Sheet, 2010)

Current Ratio: It is computed by dividing total current assets by the current liabilities, is a
widely used indicator of liquidity. According to Ciaran Walsh, the current ratio of a firm
represent those assets which can, in the ordinary course of business, be converted into cash
within a short period of time, normally not exceeding one year. Current ratio is also called the
working capital ratio since it is related to the working capital of the firm. This ratio is applied
to test solvency as well as in determining short term financial strength of the business.
(Chowdhury, 1991)

Current ratio of Marriott International Inc = Current Assets / Current Liabilities

= 2,851,000/ 2,287,000

=1.25 or 1.25:1

Current ratio of Hyatt Hotels Corporation = Current Assets / Current Liabilities

= 1,989,000 / 495,000

= 4.02 or 4.02:1

Interpretations

In case of Marriott International Inc the current ratio is 1.25:1 which means that for every
dollar of current liabilities, 1.25 dollars of current assets are available to meet them. The
current ratio of 4:1 for Hyatt Hotels Corporation signifies that 4 dollars of current assets are
available for every dollar of current liabilities. The liquidity position, as measured by the
current ratio is better in the case of Hyatt Hotels Corporation as compared to Marriott
International Inc. This is because the safety margin in the latter is substantially higher than in
the former. A slight decline in the value of current assets will adversely affect the ability of
Marriott International Inc to meet its obligations and therefore from the point of view of
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creditors it is a more risky venture. In contrast there is a sufficient cushion in Hyatt Hotels
Corporation and even with 100% shrinkage in the value of its assets it will be able to meet its
obligations in full. For creditors the firm is less risky. The interpretation is that Hyatt Hotels
Corporation has better liquidity/short-term solvency.

In theory a low and declining current ratio would indicate an inadequate margin of safety
between the assets that presumably are, or will be able to liquidate claims, and obligations to
be paid. On the other hand an extremely high current ratio may be indicative for the current
requirements and poor credit management in terms of over-extended accounts receivable. At
the same time, the firm may not be making full use of its current borrowing capacity (Khan &
Jain, 1992)

Management has to maintain an adequate level of current assets without compromising on the
profitability of the firm. In a nutshell, a high current ratio may be an outcome of a large
inventory, excess balance of overdue receivables due to slow collection or liberal credit
policies, or holding of too much cash that is actually required. (Iyengar, 2008)

Acid Test (Quick) Ratio: The acid ratio serves as a supplement to the current ratio. The acid
test ratio measures liquidity by considering only ‘quick assets’. Quick assets are cash and
equivalents. Inventories and expenses paid in advance are excluded from the calculation.
Depending on the inventory and prepaid expenses, there may be minor to significant
differences between the current ratio and acid test ratio in some operations. (Iyengar, 2008)

It is a measurement of a firm’s ability to convert its current assets quickly into cash in order
to meet its current liabilities. (Khan & Jain, 1992)

Quick Ratio of Marriott International Inc = (Cash + Marketable securities + Accounts


receivable) / Current Liabilities

= 953000/2,287,000

= 0.42:1

Quick Ratio of Hyatt Hotels Corporation = (Cash + Marketable securities + Accounts


receivable) / Current Liabilities

= 1737000/495000
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= 3.51:1

Interpretations

In case of Marriott International Inc the quick ratio is 0.42:1 which means that for every
dollar of current liabilities, 0.42 dollars of quick assets are available to meet them. The quick
ratio of 3.51:1 for Hyatt Hotels Corporation signifies that 3.51 dollars of quick assets are
available for every dollar of current liabilities.

The interpretation that can be placed on the current ratio (1.25:1) and quick ratio (0.42:1) of
Marriott International Inc is that a part of the current assets of the company is tied up in slow-
moving and unsalable inventories and slow-paying debts. The firm would find it difficult to
pay its current liabilities. They should arrange for additional cash. On the hand in case of
Hyatt Hotels Corporation the current ratio is 4:1 and quick ratio 3.51:1, which indicates that
the business has a very strong short-term financial strength to pay of its current liabilities at
short notice.

If quick assets can't cover current liabilities, investors will say the
company is failing the acid test. There should be an element of realism to
such measures. For instance if a company has current liabilities of 25
million dollars and quick assets of 10 million dollars then technically it's
failing the acid test - but this would really only be the case if that same
company has negligible net fixed assets or was in a cash flow negative
position. Of course, a company with current liabilities of 25 million
dollars and quick assets of 10 million dollars with no real fixed assets or
cash flow should be red flagged by investors. (Hasenfuss, 2007)

Debt to Equity Ratio: The debt to equity ratio is computed by dividing


the total debt of the firm by its shareholders equity. The purpose of the
ratio is to measure the mix of funds in the balance sheet and to make a
comparison between those funds that have been supplied by the owners
(equity) and those that have been borrowed (debt). (Walsh, 2002)

Debt to equity ratio of Marriott International Inc = Total Liabilities /


Total Owners Equity

= 6,791,000 / 1,142,000
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= 5.95:1

Debt to equity ratio of Hyatt Hotels Corporation = Total Liabilities /


Total Owners Equity

= 2,139,000 / 5,016,000

= 0.43:1

Interpretations

In case of Marriott International Inc the debt to equity ratio is 5.95:1


which means that for every dollar of owner’s net worth, the enterprise
owed its long term creditors 5.95 dollars. And for Hyatt Hotels
Corporation the debt to equity ratio is 0.43:1 which means that for every
dollar of owner’s net worth, the enterprise owed its long term creditors
0.43 dollars.

Marriott International Inc has a high debt to equity ratio which means
that it has been aggressive in financing its growth with debt. It also
shows a large share of financing by the creditors relatively to the owners
and therefore, the creditors have a larger claim against the assets of the
company. The owners are putting up relatively less money of their own.
It is a danger signal for the creditors. If the project should fail financially,
the creditors’ would lose heavily. Moreover, with a small financing stake
in the firm, the owners may behave irresponsibly and indulge in
speculative activity. If they are heavily involved financially, they will
strain every nerve to make the enterprise a success. Therefore there is a
high risk involved for the creditors of Marriott International, Inc. A high
debt-equity ratio has equal serious implications from the firm’s point of
view also. A high proportion of debt in the capital structure would lead to
inflexibility in the operations of the firm as creditors would exercise
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pressure and interfere in management. Secondly, such a firm would be


able to borrow only under very restrictive terms and conditions. Further,
it would have to face a heavy burden of interest payments, particularly in
adverse circumstances when profits decline. Finally the firm will have to
encounter serious difficulties in raising funds in the future.

The share holders of the firm would, however, would stand to gain in two
ways: (i) with limited stake, they would be able to retain control of the
firm and (ii) the return to them would be magnified. With a large
proportion of debt in financial structure, the earnings available to the
owners would increase more than proportionately with an increase in
operating profits of the firm. This is because the debt carries a fixed rate
of return and if the firm is able to earn on the borrowed funds a rate
higher than fixed-charge on loans, the benefit will go to the shareholders.
Technically this is referred to as leverage or trading on equity. (Khan &
Jain, 1992)

In case of Hyatt Hotels Corporation, the Debit-to-equity ratio is low and


has just the opposite implications. To the creditors a relatively high stake
of the owners implies sufficient safety of margin and substantial
protection against shrinkage in assets. For the company also, the
servicing of debt is less burdensome and consequently its credit standing
is not adversely affected. The shareholders of the firm are deprived of the
benefits of trading on equity. The preceding discussion should leave no
doubt that both high and low ratios are not desirable. (Khan & Jain,
1992)

Long-term Debt to Total Capitalization Ratio: Calculation of long


term debt as a percentage of the sum of long term debt and owners equity
is another indicator of long term solvency. The sum of the long term debt
and the owner’s equity is known as total capitalization. The only
difference between the two is that current liabilities are excluded from
the numerator whereas long-term debt is added to the denominator.
Current liabilities are not considered as current assets are generally
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adequate to cover the liabilities and also current liabilities are not a long
term concern. (Iyengar, 2008)

Long-term Debt to Total Capitalization Ratio of Marriott


International, Inc = Long-term Debt / (Long-term Debt + Total
Owner’s Equity)

= 2,234,000 / 3376000

= 0.6617 or 66.17%

Long-term Debt to Total Capitalization Ratio of Hyatt Hotels


Corporation = Long-term Debt / (Long-term Debt + Total Owner’s
Equity)

= 1620,000 / 6636000

= 0.2441 or 24.41%

Interpretations

The long-term debt to total capitalization ratio of Marriot International


Inc for the year 2009 is 66.17 percent of its total capital. And the long-
term debt to total capitalization ratio of Hyatt Hotels Corporation for the
year 2009 is 24.41 percent of its total capital. A low ratio of debt to total
capital of Hyatt Hotels Corporation is desirable from the creditors’ point
of view as there is sufficient margin of safety available to them. But its
implications for shareholders are that, debt is not being exploited to make
available to them the benefit of trading on equity. On the other hand a
high ratio of debt to total capital of Marriot International Inc would
expose the creditors to high risk. The implications of the ratio of equity
capital to total assets are exactly the opposite to that of debt to total
capital.

Conclusion

While financial ratios could be useful in raising some pertinent questions


about the performance of a company and highlighting areas of attention
to the managers, its utility is greatest when making inter-firm
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comparisons. Questions such as: how a firm utilizes its assets, or how
their productions costs compare with those of its competitors are tests of
financial stability. Even though a company may be doing well, this
comparison will show how well, or if there is room for even better
performance. Indeed, the uses of ratios seldom provide information about
the current health of a firm since they cannot decipher the managerial
actions being taken. They measure a static position and do not account
for the dynamism of managerial behaviour in shaping alternative
strategies. Ratio analysis acts as the dipstick of financial health rather
than a thorough inspection.

Bibliography

Books:
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Chowdhury, A. B. (1991). Financial Ratios and Working Capital.


kolkata: Management Technologists.

Iyengar, A. (2008). Hotel Finance. New Delhi: Oxford University Press.

Khan, M. Y., & Jain, P. K. (1992). Management Accounting. New Delhi:


Tata Mcgrawhill Publishing House.

Walsh, C. (2002). Key Management Ratios: how to analyze, compare


and control the figures that drive company value. New Delhi: Macmillan
India LTD.

Journal Articles:

Hasenfuss, M. (2007). The quickest way to solvency. Finweek , 56-57.

Langford, D., Iyagba, R., & Komba, D. M. (1997). Prediction of


solvency in construction companies. Construction Management &
Economics , 317-325.

Pearce II, J. A., & Doh, J. P. (2002). Improving the Management of


Turnaround with Corporate Financial Measures. Academy of
Management Proceedings & Membership Directory , B1-B6.

Websites:

HYATT HOTELS CORP (NYSE: H) | Balance Sheet. (2010). Retrieved


April 19, 2010, from finapps.forbes:
http://finapps.forbes.com/finapps/jsp/finance/compinfo/FinancialIndustri
al.jsp?tkr=H

MARRIOTT INTL INC (NYSE: MAR) | Balance Sheet. (2010). Retrieved


April 19, 2010, from finapps.forbes:
http://finapps.forbes.com/finapps/jsp/finance/compinfo/FinancialIndustri
al.jsp?tkr=MAR