The profitability of a company is its ability to generate wealth through its management in a given time period.
To measure the profitability of the company, there is a series of methods called profitability indicators.
With these profitability indicators the performance of the results of their entrepreneurial management are measured, and the observers of our budget can make appreciations on the same.
It is very important to know about these indicators, and to become familiar with how they are calculated, since they are used with the utmost care especially in dealing with banks.
Main indicators of company profitability
Let’s define the 3 main corporate profitability indicators:
- ROI (Return on Investment) = Profitability of the capital invested in the company
- ROE (Return on Equity) = Profitability of the entrepreneur’s own capital
- ROS (Return on Sales) = Profitability of sales
1) ROI (Return on Investment) indicates the profitability of the capital invested in a company.
The capital invested in the company is the sum of net working capital and fixed assets. This index is very important for the entrepreneur, since it is used to evaluate how much the capital invested in the company makes (both on its own and on loan). The ROI is calculated through an operation in which the operating income (or operating result) is entered in the numerator and the operating net invested capital in the denominator, they are divided between them and finally multiplied by 100, obtaining the percentage of return on the invested capital.
ROI = (Operating Income / Invested Capital) X 100
2) The second index (ROE = Return on Equity) measures the profitability of the resources that the entrepreneur has personally invested in the company as equity or risk.
Of course the result of this index is the yield of risk capital; it goes without saying that the ROE should be at least equal to the yield on government bonds, with the addition of a premium ranging between 4/5% plus the supplement of an additional premium for the specific risk of the company and of the sector (starts at 3% and can even reach 20%).
ROE = (Profit of the Accounting Period/ Net Equity) X 100
3) The third indicator is the ROS (Return on Sales) . It measures the average profitability of sales, and it is a very interesting indicator, especially to make comparisons with companies operating in the same industry. It is obtained by dividing operating income and sales for the year:
ROS = (Operating Income / Revenues from Sales) X 100
This index is fundamental, because it measures the average margin obtained from one’s own turnover – before taxes and financial charges – and allows to obtain indications on the level of your operational management. If, e.g., in my sector the profitability of sales is 10% and my company has a ROS of 4%, it means that there are critical issues to be faced and that they could concern for example prices and / or sales channels or costs of production.
How the profitability of a hotel is measured
To answer the question “how the profitability of a hotel is measured?” and analyzing the three indicators of corporate profitability from a hotel perspective, it is clear that the first two need the knowledge of the “upstream” situation of the investment (e.g. the invested capital for the ROI and the net equity for the ROE).
In addition to this, it is impossible – because of the very nature of the factors that make up these indicators – to provide general criteria and / or measures.
The indicator that we of the Franco Grasso Revenue Team use to value the profitability of managing a hotel is the ROS (Return on sales): it indeed points out the average marginality of the turnover.
We start from this indicator in the analysis of the profitability of a hotel because we consider it the most suitable for our practices for the management of the Revenue Management of our hotel clients, since the denominator (and partly also the numerator) is represented by the data on which we intervene and that we increase more directly (the sales volume).
We can compare the ROS to the Gross Operating Margin (GOM), which is always an indicator of profitability and naturally it shows the income of a company based only on its characteristic management, gross of interests (financial management), taxes (fiscal management), depreciation of assets and amortization.
The GOM is an information more important than the profit for the financial analysts because it allows to see clearly if the company is able to generate wealth through the operative management, therefore excluding the maneuvers made by the company administrators (amortization and provisions, but also financial management) which do not always give a correct view of the company trend.
if GOM = Operating revenue – Operating costs * and ROS = Operating revenue – Operating costs * / Total production of the rooms, it follows that ROS = GOM / Total sales
* In the Operating Costs we include – although they are not part of it – also the fixed costs, because they represent a fundamental parameter from an entrepreneurial point of view.
Of course the GOM can be calculated during the final balance, or it can be predicted.
Each of its components depends on the combined action of different factors:
- Turnover of the rooms (Revenue Management)
- Variable costs * (They should have an incidence of around 30% on total sales)
- Fixed costs *, which are difficult to generalize, depend on contingent situations (they should not exceed 40/45% of total sales).
* The Revenue Controlling determines the reduction of total costs – fixed and variable – functional to the increase in revenues (in addition to the reorganization of the operational organization chart).
The rooms turnover depends in return on the Revenue Penetration Index:
we can assume that a 50 rooms hotel in a central location in Valencia can reach a RatePar (selling price per available room) of 50 € (of course if managed with our Revenue Management).
So the turnover of the rooms will be (365 * 50) * 50 € = 912.500 € *
Note = * Here when we talk about room turnover we always refer to the selling price, which is therefore equal to the total sales of rooms in BB gross VAT.
Considering that in a traditional management variable costs + fixed costs should have an overall incidence of 70/75% (variable costs 30% + fixed costs 40/45%), we deduce that the average operating income should be about € 228,125 (about 25%).
The profitability of a 50 room hotel in Valencia (that correctly practices Revenue Management, Revenue Controlling and has ordinary fixed expenses) is € 228,125 per year, naturally including interests (financial management), taxes (tax management), depreciation of assets and amortization.
If the 50 rooms hotel were in Milan, the RatePar – linked to the Revenue Penetration Index – would be higher; probably fixed and variable costs would also be higher, but their incidence in ABSOLUTE terms would be lower, and therefore even the GOM would be higher.
In the case of application of a good Revenue Management, as we have seen in our structures, the incidence of fixed costs on total sales tends to fall as production increases, while the incidence of variable costs can also increase in percentage but – in absolute terms (which is what counts) – will always lead to an increase in absolute value of the GROSS OPERATING MARGIN and therefore of OPERATING PROFIT.