Break Even Analysis and the Seasonality Crunch
By Lakshmi Narasimhan Soundararajan - Exclusive for 4Hoteliers.com
Thursday, 16th March 2023

Exclusive Feature: Is your hotel or restaurant breaking even during low business volumes?

Introduction: One of the enduring legacies of Covid-19 pandemic is how it made businesses scramble to discover their breakeven points.

This is particularly true of hospitality enterprises which are at their core seasonal businesses. By virtue of being seasonal in nature, they go through periods of low business volumes. These low periods bring with them what can be termed the seasonality crunch – low revenue months.

It is ironical that most hotel enterprises (until covid-19) never even knew where their breakeven points were at. Why not? Well, the rooms departments were so busy running 90% plus occupancies or restaurants packed in their meal periods to not bother at all.

However, the pandemic literally brought the hotel industry to its knees. Now they needed to pay heed to this analytical tool. One of the most critical pieces of information for management on business performance is whether they are breaking even as the often-misunderstood term goes.

Breakeven is subject to as many interpretations as its use. So, what is this mysterious breakeven point?

Understanding Break Even Point

If bottom line is the ultimate citadel of business performance, then keeping it going becomes the dominant goal. However, how will you know if you are breaking even? And what is breakeven anyway? Let us begin with a basic formula of business: Revenue minus Expenses equals Profit.

When expenses are higher than revenue, losses occur. You may not have realized it, but losses generally begin with low business volume months. This is simply because low business volume months in most cases mean low revenue months.

You may be wondering how all this is related to the break-even concept? Let me clarify. The breakeven point broadly measures at what level of business volume in your operation do your revenue equal expenses.

Business volume in the hotel industry relates to occupancy for the rooms department and covers served for the food and beverage department. Business volume can also be called capacity utilization. Why is this so important? Let us restate the breakeven concept to understand why this is important.

Breakeven point is determining at what level of the capacity the operation revenue and expenses become level. Notice, that I have used the word capacity. I will explain shortly. We will be using an example of a restaurant which is part of the food and beverage department of a hotel. In the case of a restaurant, business volume is the number of covers served or simply covers served. It is the same as occupancy for the hotel rooms department. However, before that, let us set the foundation for the breakeven analysis. And that is how expenses behave in the operation.

Fixed and Variable Expenses

We need to understand the behavior of expenses in a restaurant business to arrive at a breakeven calculation. There are two types of expenses based on behavior:

  • Fixed Expenses and
  • Variable Expenses

Fixed expenses are those expenses that will be incurred irrespective of business volume. In other words, whether you serve 0 covers or 110 covers per day, your fixed expenses will remain the same.

On the other hand, variable expenses are those that are incurred only in relation the business volume or actual covers served. If no covers are served (0 covers), variable expenses will also be zero.

Examples of fixed expenses could include the major employee complement in a restaurant. This is on the assumption that although downsizing may occur, however, the entire employee head count cannot be just fired if business volumes go down.

In other words, the major permanent labor force can be considered a fixed cost. A certain smaller chunk of the labor force can be let gone based on business volume levels. This of course will be very different where most employees are on contract and can thus be let gone when business volumes drop. This happens in North America.

Examples of variable expenses are like cost of food or beverage or supplies related to the operation. The classic example here is the food cost. If a cover (dish or meal) is served and revenue realized, then it will bring with it direct variable costs of the food items in the dish. Thus, cost of food is a direct variable cost.

Knowing which costs remain fixed and which move with business volumes is an important performance measurement exercise. It is vital for a breakeven calculation. For instance, if a restaurant has high fixed costs, then it will take higher number of covers to cover those fixed costs. This will make the breakeven point high (see example later) and reduce potential for growth in profitability.

Break Even Point and Capacity

The other key index that requires understanding is the capacity of a restaurant. This is simply the highest covers that can be served in that restaurant given its current facilities (seat capacity). A capacity is a design decision that is taken at the time the restaurant operation is being visualized. It must be a decision taken after rigorous market research into the sources of the revenue and profiles of the customers in an effort to yield growing revenues and sustained profits.

Break Even Point Example

The 3 Cs of Break Even Point
Capacity, Cost and Cover are the 3 Cs of calculating Break Even Point for your restaurant outlet.

Although capacity will seem to play a minor role in the actual calculation, it actually impacts the other two (cost and cover) significantly.

Capacity of Restaurant: 200 Seats
Table Turnover: Assumed to be “1”
Month: September 2022
Covers: 3,600 (120 Per Day)
Average FNB Check: $14.50
Service Charge: NIL
FNB Revenues: $52,200
Fixed Costs: $21,500 Scenario 1
Fixed Costs: $13,500 Scenario 2
Variable Cost Per Cover: $6.75
Variable Cost Total: $24,300

SCENARIO 1 (Fixed Costs $21,500)
FNB Revenues: $52,200
Total Costs: $45,800
(Fixed + Variable Costs)
Dept Profit: $6,400
Dept Profit %: 12.3%

SCENARIO 2 (Fixed Costs $13,500)
FNB Revenues: $52,200
Total Costs: $37,800
(Fixed + Variable Costs)
Dept Profit: $14,400
Dept Profit %: 27.6%

Why is Break Even Point important?

From the example we see that profitability jumped from 12.3% to 27.6% when Fixed Costs were reduced from $21,500 to 13,500.

Why are we considering fixed costs here?
This is simply because these are the costs which will be incurred irrespective of whether the restaurant serves 0 covers or 6000 covers in the month of September. In other words, revenue must first cover these fixed costs. Any additional covers served after covering fixed costs will only incur variable costs and that is how profitability is enhanced. You can always add variable costs later if you want to compare total costs to revenue for breakeven analysis.

So, breakeven is closely related to what level of covers in the operation need to be served before fixed costs are exceeded. A quick method of calculation often used is to divide fixed costs by the average check to arrive at the number of covers needed to at least equal fixed costs.

In this case, it will be $21,500/$14.50 = 1,483 covers for the month or approximately 49 covers per day. For this restaurant with a capacity of 200 covers, the breakeven point for fixed costs is thus 49 covers. If we divide 49 by 200, we get 24.5%. In other words, at 24.5% of restaurant capacity (seats), it will cover its fixed costs.

This is a healthy situation since we saw earlier that once fixed costs are covered, they do not change, and any additional covers will only bring variable costs.

Thus, breakeven analysis is one of the most powerful principles governing any operation including the restaurant operation. Let us restate it. If the restaurant is able to meet its fixed costs at 24.5% of capacity, it has potential to grow its cover count. Those additional covers will only incur variable costs. This will greatly enhance its profitability.

Break Even Point and Profitability

We saw in the previous section the reason why the principle of breakeven is so critical for a restaurant operation (in fact, any business operation). However, it is in its ability to point to the direction that the profitability is taking that the real power of this key performance indicator is realized.

Every restaurant operation wants to enjoy a continuous stream of customers and covers served which will produce incremental revenue and yield good profits. But it is even more crucial that the restaurant operation shows the potential to produce sustained profits. This can only happen when in comparison to the capacity of the restaurant outlet, its breakeven point for the current operation level in terms of covers served is low. In the example, we saw how the breakeven point assuming a certain fixed cost level was at 24.5%. This means that future cover additions will only incur variable costs and the potential of 75.5% (100% less 24.5%) is a healthy sign of an operation that can grow.

On the other hand, say, if the fixed cost level was such that the break-even point was at 60%. This would mean that the operation is already past the halfway mark when it is breaking even. This gives the operation less cushion to weather storms - for example a drastic fall in covers which would reduce its ability to meet its fixed costs (given a certain average check assumption). This is the reason why it is also key that the capacity of a restaurant outlet is decided after extensive market research and determining that a sustained cover count would be achieved. This is right at the restaurant outlet design stage.

The Restaurant Owner Perspective

Restaurant businesses are dynamic operations with frequently changing customer tastes and preferences. It is necessary that the restaurant management is laser focused on this phenomenon.

From a stakeholder angle, it is essential that management identifies danger signs of:

  • Any high fixed cost incidence
  • Resulting in high breakeven point.

As long as management can read the signs and take corrective action to keep breakeven levels acceptable, they will be heroes in the eyes of the stakeholders. Anything to the contrary may well decide the fate of their survival.

Lakshmi Narasimhan Soundararajan is the founder of Financial Skills Academy a New York city based enterprise focused on hotel finance training, coaching and consultancy. Lakshmi has been teaching undergraduate and graduate courses for a decade at New York University, Jonathan M Tisch Center of Hospitality as an Adjunct Assistant Professor during Spring and Fall semesters. He teaches hospitality finance, business development among other courses.

Right from the time he was in school, Lakshmi had a head for numbers. In fact, he says, numbers talk to him and tell him stories. At the same time, as he fashioned his career in the hospitality industry, he worked closely with colleagues who did not have a financial background. He saw them struggle with numbers and fear them.
Lakshmi made up his mind there and then to commit his career to hotel finance training by simplifying numbers for the benefit of his non-financial background colleagues.

He founded Financial Skills Academy with the philosophy of assisting managers and small business owners to Build Financial Skills, Knowledge and Ability in themselves.

His vision is for Financial Skills Academy to be the Ultimate Learning Hub for Hotel Finance Training.

Lakshmi 's all-time favorite historical figure is Leonard Da Vinci and in particular Da Vinci's love for simplicity. When founding Financial Skills Academy Lakshmi based the value proposition for his hotel finance training courses on three foundational principles: SIMPLE. NON-TECHNICAL. USABLE.
Blog and eLearning Portal: www.profitsmasterclassblog.com

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