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CHAPTER 1: INTRODUCTION

1.1 Hospitality Industry

Hospitality is generally known as the act of generously providing care and kindness
to whomever is in need. It refers to the relationship between a guest and a host
especially the act or practice of being hospitable. Hospitable means the reception
and entertainment of guests, visitors, or strangers, with liberality and goodwill or in a
simple word ‘Courtesy’

1.2 Organizations within Hospitality Industry

There are four major types of sub-sector in the hospitality industry which are:

I. Lodging
• Hotels and motels
• Meetings, conventions, and expositions

II. Foodservice
• Restaurant and catering

III. Travel
• Air
• Cruise
• Rail
• Coach
• Automobile

IV. Recreation
• Attraction
• Gaming
• Parks

1.3 Functions of Financial Department in Hospitality Organizations

Finance can be defined as managing fund for future benefits of the business. In
simple definition, a firm needs to find the sources of fund and then plan to utilize or
use the fund for firm’s benefits.

I. Sources of Fund – How the organizations find/obtain the funds needed


for running the organizations’ activities

a. Loans
Organizations can obtain the fund needed by borrowing from the
financial institutions. Loan involved a long-term commitment and the
company needs to pay the principal plus the interest for the loan
obtained.

b. Shares or bonds
Shares can be issued by the organizations to obtain the financial
needed. Issuing shares involves a lot of process but it is a popular
method for an established company to obtain a large amount of fund.
Bond is a debt financial instrument which has no positional interest in
the company as compared to share.

c. Sales of products
Selling of a product above the cost of production will bring profit and
thus funding day-to-day business operation. In manufacturing, the
selling price is determined after calculation of every cost involved in
the transformation process of input to output plus all the relevant
operational expenses. But for hospitality organizations, sales of the
products include rooms, and food and beverage. The calculation of
the price is slightly different from manufacturing industry.

II. Uses of Fund – How the organizations utilize the fund obtained for
execution of day-to-day operations

a. Profit maximizations
Profit is derived when the sales revenue is higher than the cost
incurred at one particular period; ie one month. In hospitality
organizations, the pricing of services offered should be precise in
order to maximize profits. The funds available should be used in
accordance to the priorities for example marketing, allowance to the
salesperson, allocation of the budget to every departments etc.

b. Wealth maximizations
Value of the organization is determined by the stock price. It values
should encompasses the earnings per share, dividend policy, rate of
return, risk, and market capitalization. The organization should
operate efficiently in order to maximize the value of the stock price
hence increase the shareholders confidence level.

c. Funding operational expenses


There are varieties of department in hospitality organizations such as
Food and Beverage, Human Resource, Administration, Sales,
Purchasing, Accounts, Housekeeping, Banquet etc. All of these
departments need funds to pay for the salaries, utility, raw materials
etc.

d. Tax considerations
Tax is a financial charge or levy imposed by the government to an
individual or corporation for various purposes. Examples of taxes that
are imposed by the government to the business are corporation tax,
income tax, land value tax, Sales tax, Tariffs etc.

e. Charitable purposes
Many organizations today have embarked themselves in charitable
activities for helping the unfortunate people or less develop countries
to minimize the hardships of these people or countries. The amount of
charity budgets are all depending on the net income of the
organizations and it is tax deductible.
1.4 Scope of Financial Management

Every department in an organization plays important roles for business survival and
growth. Therefore cooperation among departments is vital to ensure the company
move forward smoothly. Financial management covers multidimensional approaches
such as the following:

1.4.1 Financial Management and Economics


Investment decision and financial planning of the present and future projects
are closely related with the microeconomic and macroeconomic. Financial
management considers economic approaches such as time value of money,
inventory planning, feasibility studies and many more.

1.4.2 Financial Management and Accounting


Accounting provides the recording and reporting of the financial information of
a company. Therefore financial management uses this financial information to
evaluate the present project before making an investment for the future
projects. Financial management makes forecasting based on the information
from income statement and balance sheet.

1.4.3 Financial Management and Mathematics


Statistical tool analyses are important in estimating future projects. Cost of
capital, capital structure theories, dividend theories, ratio analysis, and
budgeting use mathematic equation and statistical tools to facilitate the
calculation.

1.4.4 Financial Management and Production Management


Production management requires raw materials, machinery, equipments,
wages and salaries, and operation expenses. To better allocate these
production resources, financial management use the target financial
performance in assisting production management in determining the future
budgets.

1.4.5 Financial Management and Marketing


Marketing department identify the target markets of the company’s products
and services. Therefore marketing department must spend the budget
allocated for ensuring promotional campaign reach the target market.
Marketing department must work closely with the financial department to
determine the right budget needed for present and future promotional
campaign.

1.4.6 Financial management and Human Resource


Human resource department provides workforce to all the functional areas in
the company. Financial management deals with evaluating the requirement of
workforce in every department and allocates the budget for wages, salaries,
commission, bonus, pension, and fringe benefits.

1.5 Significance of Financial Management

Based on the scope of financial management, it is obvious that the financial


management is very important in every organization. Every business must ensure
they maintain the sufficient financial resources towards achieving objectives in the
short and long run. The significance of the financial management are as follows:
1.5.1 Financial Planning
Financial management deals with managing and planning the financial
resources of the business that mainly concern with the survival growth of the
business in the long run.

1.5.2 Acquisition of Funds


Financial management must carefully acquire the sources of funds with
minimum repayment value in terms of interest rates or higher dividend
payout. Thorough consideration in acquiring funds must be made because it
involves long-term commitment.

1.5.3 Allocation of Funds


Operational efficiency can be achieved if the funds acquired are allocated to
the right budgets. Therefore financial management must consider reduction of
cost in every possibility.

1.5.4 Improve Profitability


Strong financial control is needed for achieving higher profitability. It means
financial management must analyze the budgetary and actual performance
continuously as well as comparing the company’s performance with the
competitors or industry average.

1.5.5 Increase the Value of the Firm


Investors concern with the value of their investment. Therefore, financial
management must allocate the right amount for retained earnings and
dividend payout to ensure the investors feeling towards the dividend received
is fair.

1.5.6 Promoting Savings


Savings and retained earnings are important for future contingency plan.
Financial management sometimes can take advantage of speculation
activities for example buying materials or assets when the prices are cheaper.
CHAPTER 2: ENVIRONMENT OF HOSPITALITY FINANCIAL
MANAGEMENT

2.1 Types of Finance

2.1.1 Private Finance


Private finance deals with how the individual, partnership business, and
corporation generate and utilize funds for future benefits of the business.

2.1.2 Public Finance


Public finance deals with revenue generated from tax and disbursement of
the government income for country’s development.

2.2 Financial Sectors of the Economy

Individuals need money to fulfill their needs or plan while companies need money to
finance its operation especially in the initial stage of operation. These two motives
prompted individuals and companies to search for financial intermediaries. Financial
intermediary is an institution, firm, or individual who provide financial assistance to
the parties that need money for various purposes. The agreement is subject to the
conditions stated by the financial intermediary or central bank.

2.3 The Roles of Financial Intermediaries

2.3.1 Pooling the resources of individual savers


There are many individuals or corporations need huge sum of loans.
Therefore financial intermediaries need to find people to save money in their
institutions. Financial intermediaries usually lend money and invest money
from the investment/saving made by the people. For example; banks pool
many small deposits and give out large loans; insurance companies
accepting small premiums and reinvest them in order to pay large claims;
mutual funds accept small investments and pool them to buy large stock and
bond portfolios.

2.3.2 Providing payment and deposit facilities


Financial intermediaries such as commercial bank provide the facilities
through automatic-teller-machine or internet banking for the benefits of
account holders. Many transactions such as payment of bills, transfer of
money, update of accounts, reload of prepaid card, and many transactions
can be done via ATM or internet banking. Other than that, commercial bank
also provides the credit card and debit card facilities for the benefit of
customer. Credit card is referred to the advance cash provided by the bank to
the credit card holders. Holders are granted with a line of credit in which they
can use to pay for the goods or services by replacing a cash transaction.
Meanwhile debit card is referred to an electronic cheque where the debit card
holders can pay the amount of goods or services by using the amount of
money that they have in the current account or debit card.

2.3.3 Providing liquidity


Liquidity refers to how easily the asset can be converted into cash or to be
sold. Financial intermediaries must have sufficient cash inflows and outflows.
It means the financial intermediaries need to hold large amount cash inflows
such as short-term saving and long-term investment in order to provide short-
term transaction such as withdrawal of money or loan to their respective
customer.
2.3.4 Diversifying risk
Financial intermediaries can diversify risk of investment or repayment
defaulters by making various investments in capital and money market.
Financial intermediaries must allocate the right resources for loan, investment
or any other financial facilities in order to gain from every financial transaction
that they deal with.

2.3.5 Analyzing market information


Financial intermediaries can hire analysts or expertise that doing full-time
research on market sentiments, behavior, or speculation. This challenging
task needs high expertise in collecting and analyzing the right resources
before making out investment or offering financial products. The financial
intermediaries provide asymmetric information which means one group with
better information can benefit the large group of less information.

2.4 Component of Financial Intermediaries

2.2.1 Commercial Bank


Commercial Bank is a financial institution with a core business to provide
lending and saving facilities. Examples are CIMB, Bank Islam, Maybank,
RHB, and many more. Commercial bank generates income on interest rate
from loan given to individual or corporation. Other than that, commercial bank
also reinvests the money saves by individual or corporation to other financial
instrument available in the stock or money market.

2.2.2 Building Societies


Building Society provides its members banking and other financial services.
The term building society refers to the group of property developers who
become a member mainly to enjoy the privilege of acquiring loan and
depositing money mainly for property development. In Malaysia, the most
prominent building society is Malaysian Building Society Berhad (MBSB)
which core activities are granting loans on the security of freehold and
leasehold properties and providing retail financing. MBSB reinvest the money
deposit by its members for developing residential and commercial properties,
letting office buildings, and investment in stock and money market.

2.2.3 Credit Unions


Credit Union can be referred to cooperative financial institution. Usually it is
set up within the organization to provide the financial assistance to its
members. The term credit union means owing/debt community, which by
definition means a group of people who’s become a member of the
cooperative to enjoy the privilege of acquire loan and payment of bills or
services. Nowadays many credit unions set up to help people getting away
from debts or buying/renovating house. The credit union uses the monthly
membership payment to offer loan at reasonable rates.

2.2.4 Insurance Companies


Insurance Company principal activity is to hedge against risk of a contingent
loss. People search for insurance to protect damage/loss of their properties,
vehicle and even life, from accident, theft, burglary, or natural disaster.
Nowadays insurance companies provide two-in-one product where they
provide insurance policy and investment in one product. It means if the
policyholder have not making claims for any damage or loss, they can still
guaranteed with returns from investment. As a result, the policyholder can
offset the amount that they have paid for insurance premium with the return
from investment.

2.2.5 Mutual Funds


Mutual fund is an investment company where they allow public to buy shares
in its company in return for dividend received from every shares bought. The
mutual fund reinvests the money that they received from the investor to the
stocks, bonds, short-term money market instruments, or other types of
securities (forwards, futures, options, and swaps). Mutual Fund Company has
the expertise in making sound investment and therefore reinvest huge
amount of money that deposited by the mutual fund investor to the profitable
and less-risky securities. For example Amanah Saham Bumiputera (ASB)
operates by the government- linked-company that allow public to invest
money with the guaranteed dividends from every investment made. The
returns are calculated based on every Ringgit invested. Public Mutual Berhad
returns are based on the number of shares bought by the investors. Mutual
Fund returns calculated annually and basically announced at the end of every
year.

2.2.6 Pension Funds


Pension Fund is a corporation that manages employees saving plan for
retirement benefits. The savings under employee retirement benefits are
contributed by employees and their employers. Every employees and
employers must contribute to the pension funds with the rate determined by
the government. In Malaysia, the pension fund is called as Employees
Provident Fund (EPF) which manage the pension funds contribute by the
employees from the private and government sector. But many employees
from government sector opt for pension scheme which are different from the
saving made under EPF.

2.3 Business Ownership Structure

There are four main business ownership structures which are:


• Sole Proprietorship
• Partnership
• Limited Liability Corporation
• Corporation

Virtually every financial decision is influenced by tax considerations. Primary


examples are the lease versus purchase decision, the issuance of common stock
versus debt decision, and the decision to replace an asset. While the intent of this
section is not to review the rules and regulations of the income tax in detail, we will
briefly go through the tax considerations for different business ownerships.

2.3.1 Sole Proprietorship


Sole proprietorship is a business that fully owned by the owner. It means the
person who owns the business must responsible for any matters regarding
his/her business. A sole proprietorship can operate under the name of its
owner or by using a fictitious name. For example; Mr. Nazir operates a malay
restaurant by using the name of “Nazir Masakan Melayu”. The sole
proprietorship can be easier to setup and at minimal costs.
2.3.1.1 Advantages of Sole Proprietorship
• Lower start-up costs
• Ease of money handling
• Freedom of decision making

2.3.1.2 Disadvantages of Sole Proprietorship


• Personally liable for all debts and risks
• Lack of financial controls
• Difficulties to raise capital
• No reference for decision making

2.3.1.3 Tax Consideration


Tax expenditures of the sole proprietorship business are charged on the
income of the business. It means the income owned by the business is tax
deductible and paid by the owner of the business. The proprietorship
companies are not required to pay income tax. The income of the business,
less expense, is part of the personal income of the owner and is taxed
accordingly. Any profits are the owner’s alone to keep and use as the owner
sees fit. For better illustration:

Sales Revenue
Less: Variable Costs
Contribution Margin
Less: Fixed Costs
Less: Depreciation
Earnings Before Interest and Taxes (EBIT)
Less: Interest
Earnings Before Taxes Owner’s income
Less: Taxes Paid by owner
Earnings After Taxes Owner’s net income

2.3.2 Partnership
Partnership is a business that jointly owned by two or more people. It occurs
when two or more people have mutual understanding to pool capital and work
together. Therefore, all of them are the owners of the business and share the
profits and risks together.

2.3.2.1 Advantages of Partnership


• Share of capital, knowledge, ability, experience, expertise, and risks.
• Specialization can be done on partners will not be overloaded with various
responsibilities

2.3.2.2 Disadvantages of Partnership


• All partners must liable for every actions because the actions might influence
the company’s performance
• Disagreement and dispute may disrupt the business plan. Difficult to handle
disagreement when the capital ratio is not equal.

2.3.2.3 Tax Consideration


Tax expenditures of the partnership business are similar for the sole
proprietorship except the difference in distributing the net income. In
partnership, the profit and loss will be shared according to the agreement and
separate capital account must be kept for every partner. The income of the
partners after deduction of business expenses is taxed as personal income to
each partner. Doctor, lawyer, accountant, and other professional people
frequently form partnerships.

Sales Revenue
Less: Variable Costs
Contribution Margin
Less: Fixed Costs
Less: Depreciation
Earnings Before Interest and Taxes (EBIT)
Less: Interest
Earnings Before Taxes Partner’s income
Less: Taxes Paid by the business
Earnings After Taxes Partner’s net income

2.3.3 Limited Liability Company


Limited Liability Company (LLC) is a business that combines certain features
of a partnership and corporation. The difference between LLC and
partnership is it protects the owners or better called as members from
personal liability for the debts and obligations of the organization. In LLC
business, there will be major owner who entitle for the salaries as directors
thus received double income (salaries + dividends)

2.3.3.1 Advantages of Limited Liability Company


• Members are not liable on contracts made on behalf of the company
• Members are not liable on the debts of the company in case of liquidation
• Members can involved in a variety of business
• Flexible allocation of taxation

2.3.3.2 Disadvantages of Limited Liability Company


• All partners must liable for every actions because the actions might influence
the company’s performance
• Restriction on ownership

2.3.3.4 Tax Consideration


Tax expenditures of the business are paid by the business with a tax
characteristic of a partnership.

Sales Revenue
Less: Variable Costs
Contribution Margin
Less: Fixed Costs
Less: Depreciation
Earnings Before Interest and Taxes (EBIT)
Less: Interest
Earnings Before Taxes LLC’s income
Less: Taxes Paid by the business
Earnings After Taxes LLC’s net income

2.3.4 Corporation
Corporation is a legal entity comprised of group of people (known as
shareholders) to perform a business operation similar to Limited Liability
Company. The difference between Corporation and LLC is the issuance of
shares where corporation can issue shares to the public and easily
transferrable through selling of shares to other party. The shareholder is the
owner of the business and entitle of income such as capital gained or
dividend received. Capital gained is an income received for the selling of
assets while dividend received is the income earned for holding shares in the
company. Corporation exists as a going concern entity which means it is
continuously operated unless the major shareholders decide to dissolve the
business.

2.3.4.1 Advantages of Corporation


• Members are not liable on contracts made on behalf of the company
• Members are not liable on the debts of the company in case of liquidation
• Members can involved in a variety of business
• The major shareholders may elect the board of directors which will run the
operation and entitle for financial and non-financial benefits.

2.3.4.2 Disadvantages of Corporation


• Higher fees involved in setting up the corporation
• Minor shareholders has small rights in decision making process
• Ownership is transferrable thus create complicated decision making in setting
strategies.

2.3.4.3 Tax Consideration


Tax paid by the corporation not by the shareholders. Shareholders entitle for
the dividend received of earning after tax.

Sales Revenue
Less: Variable Costs
Contribution Margin
Less: Fixed Costs
Less: Depreciation
Earnings Before Interest and Taxes (EBIT)
Less: Interest
Earnings Before Taxes Corporation’s income
Less: Taxes Paid by the corporation
Earnings After Taxes Corporation’s net
income

From the Earnings after Tax, it will be paid out as follows:

Earnings After Taxes Retained Earnings Corporation’s income


Dividend Shareholder’s income

2.5 Comparison between Business Structures

SP Partnership LLC Corporation


1 Limited Liability No No Yes Yes
2. Tax on capital/equity No No No Yes
3. Business tax on owner’s income Yes Yes No No
4. Allocation of income/expenses Yes Yes Yes No
5. Ownership restrictions No No No No