Beating The Budget ~ US Hoteliers Underestimated 2005.
By Robert Mandelbaum
Friday, 13th October 2006
When budgeting for 2005 in the fall of 2004 US hotel managers had a keen understanding of the position of the lodging industry on the business cycle. 

Being the first year out of the recession, 2004 was a year of tremendous growth in occupancy, accompanied by modest gains in average room rates (ADR). 

Therefore, when looking forward to the next step up the recovery cycle, hotel managers foresaw somewhat of a reversal in growth patterns for 2005.  Following historical patterns, the second year of a recovery should be typified by moderate gains in occupancy, along with strong growth in ADR.  Accordingly, hotel operators budgeted for a 2.0 percent increase in occupancy and a 4.7 percent bump in room rates for 2005.  In hindsight, the performance levels actually achieved in 2005 by these same hotels were somewhat surprising.

As general managers, controllers, and directors of sales begin the process of preparing their 2007 budgets and marketing plans, we thought we'd take a look back at the historical budgeting accuracy of U.S. hotel operators.  From PKF Consulting's Trends in the Hotel Industry database of 5,000 hotel financial statements for 2005, we identified approximately 600 statements that contained 2005 budget data.  Based on these statements, we compared the revenues and expenses projected for 2005 with what was actually earned and spent.

ADR Expectations ExceededTo evaluate the accuracy of hotel budgets in 2005, we start at the top of the income statement.  The hotel managers in our sample forecast a 7.4 percent increase in total revenue.  By year-end 2005, the actual growth in revenue was 8.8 percent.

The main reason for the over-achievement in revenue was the ability to raise room rates to a greater degree than expected.  The budgeted average daily room rate increase for 2005 was 4.7 percent.  This compares to the 7.6 percent increase in ADR that was actually achieved for the year.  Concurrently, the number of occupied rooms at the sample properties increased 2.1 percent, just slightly greater than the 2.0 percent budgeted figure.

While rising room rates helped hotel managers beat their budgeted rooms revenue, their forecasts for revenue from other sources fell short of expectations.  For 2005, the sample hotels projected an 8.4 percent increase in the revenue derived from food, beverage, telecommunications, minor operated departments, and other miscellaneous sources.  In actuality, these other revenue sources grew just 7.0 percent for the year.  Given the accuracy of the occupancy forecast, it appears that hotel managers were less successful in raising the prices in these other revenue-generating departments compared to the room rate increases achieved at the front desk.

Cost Containment

Besides occupancy, hotel managers were most accurate in budgeting for their 2005 operating expenses.  Operators planned for a 5.5 percent increase in costs for 2005.  This compares to the 6.1 percent actual increase in expenses for the year.

Most hotel operating costs are considered variable expenses.  In other words, the expense fluctuates up and down given the volume of business at the property.  Given the degree of accuracy with which hotel managers were able to forecast the number of rooms occupied, it is not surprising that the expense budgets were fairly accurate.  However, the slight excess in operating expenditures is consistent with our observations of increased investment in guest services and amenities.

Bottom-Line Bulge

The combination of strong revenue growth, plus expense control, led to a favorable budget disparity on the bottom-line.  Operating profits (before capital reserve, rent, interest, income taxes, depreciation, and amortization) were budgeted to grow a healthy 13.3 percent from 2004 to 2005.  Fortunately for these same properties, profits grew at an even greater pace of 17.4 percent.

All property types enjoyed profit growth in excess of their 2005 budgets, except for convention hotels.  The managers at these large properties slightly underestimated their revenues (7.0 % budget vs 8.0% actual), however, severely misjudged their growth in operating expenses (2.2% budget vs 6.4% actual).  The net result was an overly optimistic projection of 23.1 percent profit growth, compared to just a healthy actual increase of 13.2 percent.

Looking toward 2007, almost all industry participants are forecasting continued growth in revenues and profits.  However, the paces of performance gains will most likely slowdown as we approach the peak of the current upward business cycle.  Historically, hotel managers have underestimated performance during upswings in the business cycle.  On the other hand, hotel budgets tend to be overly optimistic during industry recessions.  It will be interesting to see how accurate hotel managers are at budgeting their revenues, expenses, and profits as we coast along at the top of a business cycle the next few years.

2005 Budget vs Actual – All Hotels
(Percent Change From 2004 – 2005)

Note: * - Before deducting capital reserves, rent, interest, income taxes, depreciation, and amortization.  

2005 Budget vs Actual – By Property Type
(Percent Change From 2004 – 2005)

2005 Budget vs Actual – By Property Type
(Percent Change From 2004 – 2005)

Note: * - Before deducting capital reserves, rent, interest, income taxes, depreciation, and amortization.

Source: PKF Hospitality Research

Robert Mandelbaum is the Director of Research Information Services for PKF Hospitality Research.  He is located in the firm's Atlanta office.  For more information on the reports and services PKF-HR offers to assist hoteliers in the budgeting process, please visit our website at www.pkfc.com/store, or call Claude Vargo or Brandon Culp at (866) 842-8754.
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