Are you ignoring hotel inventory management to your own peril? Losing money in the process! If yes, you are letting go the most powerful tool there is to boost the bottom line of your hotel.
How, you want to know?
Fair enough.
I will lay out a compelling case for hotel inventory management to deliver the highest return possible on investment.
More specifically, I will tell you the metrics you cannot take your eyes off!
Let’s do this.
Hotel Inventory Management – Buzzword or Effective ROI Strategy?
Do you have an effective inventory management strategy?
Often, the person asking the question is as puzzled as the person being addressed.
This confusion is born out of one fact.
Traditionally inventory is considered the domain of the bean counters or accountants.
This involves:
- accounting for inventory,
- how to physically verify them,
- using them to charge cost of goods sold
and so forth.
But inventory management as a strategy is far removed from the mere act of accounting for the purchase and use of inventories.
In fact, a lot hinges on how the word "inventories" and the term "inventory management" are understood to realize their worth and value.
Role of Inventory
While inventories have different roles to play in a hotel business their key role is managing expenses.
More specifically, the expense called Cost of Goods Sold.
In effect, inventories primarily allow you to manage expenses.
Having said the above, it is appropriate to point out again that inventories have other roles to play.
These other roles are like:
- ensuring continuous supply of goods for the hotel operation
- managing the purchase or procurement function
and so forth.
But the most important role as we noted earlier is to manage expenses.
How do we do that?
Conduit Between Purchases and Sales / Consumption
You could call inventories:
- the conduit between purchases on one side
- and sales or consumption on the other
Let me explain.
To understand the concept of conduit better, a bit of understanding of accounting is needed.
Fear not.
No technical stuff!
You include expenses in the hotel (or any other business) profit and loss statement based on an important accounting principle.
Expense means anything that has resulted in:
- goods consumed or
- service rendered
This means that a purchase made by the hotel can be of two types:
- goods for which hotel holds inventories and
- goods directly issued to the hotel operation
Let me address “2” first.
Goods purchased and directly issued to the hotel operation are considered expenses.
These go into the Profit and Loss Statement immediately on accounting.
“1” above is treated differently when purchases are made of goods for which hotel holds inventories.
In this case, the goods are sent to the hotel store facility.
It is only when these goods are issued from the store to the operation, they are considered expenses.
This normally happens at the end of the month when the hotel takes physical inventories.
Physical inventory taking is the process of counting every item of inventory and comparing with the book records.
Let’s see how this works.
Purchase -> Inventories -> Sales Triangle
We can broadly use a term – “Purchase – Inventories – Sales Triangle
Without launching into a detailed discussion, let me state it as a formula.
This formula is used for accounting purposes regularly.
PURCHASE – INVENTORIES – SALES TRIANGLE
Opening Stock (beginning of month) of Goods in the Hotel +
Purchases of Goods (for which hotel holds inventories) =
Total Goods in the Hotel Store (-)
Closing Stock (end of month) of Goods in the Hotel =
Cost of Goods Sold (this is expense for the month)
Notice the last line in the formula above (Cost of Goods Sold).
Cost of Goods Sold is what is taken into hotel profit & loss statement for the month.
We have now understood how expensing works.
Let us see what inventory management is.
What is Inventories Management?
So, you realize that expensing works in tandem with inventories.
In other words, inventories management is the process of ensuring a continuous supply of goods to the hotel operation.
This is by managing purchases and the opening and closing stock of goods.
Included in this process is:
- understanding how much consumption takes place,
- managing purchases to match consumption and
- using month end physical inventory to determine closing stock
Par Stock Levels
Understanding consumption of goods begins with a key concept in inventories management.
Par Stock Levels.
What is this concept?
Why is this critical?
Inventory items in a hotel store can run into hundreds.
And each item can have a consumption level different from the others.
So, how can a hotel manage inventories efficiently.
By laying out par stock quantity levels.
Par Stock levels are determined for two types of goods:
- Goods which are for sales – these form part of revenue.
- Goods which are for consumption – these form part of expenses.
Let us briefly understand what “for sales” means.
Say, the hotel restaurant is selling wine in its bars.
The bar has about 30-50 wine items in its menu list.
During the month the bar sells wines in glasses and bottles.
As wine sales are made and bottles get over, fresh wine bottles have to be replaced.
So, par stock levels for consumption of each type of wine are needed.
Purchases of wine bottles will be based on the wine sales.
In general, based on sales in past six months or more, par stock levels are laid.
Purchases are then made based on the par stock quantity and current physical stock.
By tailoring purchases to the sales, the hotel ensures continuous growth in revenue.
So, inventories management is bolstering sales and revenue for the hotel.
Let us now see what “for consumption” means.
The hotel also keeps stock of goods which are consumed in the operation.
Housekeeping uses cleaning supplies to keep the hotel operation areas clean.
Say, the housekeeping is consuming floor wash detergents each month.
Housekeeping has about 10-20 cleaning supply items in its list.
Each day cleaning supply bottles are consumed and have to be replaced.
So, par stock levels for each type of cleaning supply are needed.
Purchases of cleaning supply bottles will be based on the month consumption.
In general, based on consumption in past six months or more, par stock levels are laid.
Proficiency in inventory management makes the difference between:
- less or more sales for the hotel on the one hand and
- control in consumption leading to lesser expenses for the hotel on the other
Holding and Selling or Consumption Strategies
Par Stock Levels are the first step to an efficient inventories management process.
However, there is a strategic approach that enhances it significantly.
Setting par stock levels by itself does not result in efficiency.
It is the holding and selling / consumption strategies that make it efficient.
What do I mean by that?
Inventory Management - the 3 Way Relationship
Inventory management boils down to two key principles:
- Selling inventory and
- Holding inventory
This might seem obvious.
However, the error is in taking it for granted.
So, let me ask a question.
Are you Holding What You are Selling?
Let me clarify why I am asking that question.
The core principle with Inventories is:
You Hold Inventories that You are Selling
You DO NOT Sell Inventories that You are Holding.
Inventory is the Effect NOT the Cause.
The Cause is Sales or Consumption.
This brings us to the classic Inventory Triangle:
- Sales (or Revenue)
- Consumption and
- Inventories
Your Sales Mix and Pricing strategies are the central driving forces in your journey to food and beverage / restaurant profit.
In that journey, inventories are not far behind.
The obvious fact is that you cannot sell what you do not have.
However, inventories allow you to gauge the extent of effectiveness of your:
- sales mix and
- pricing strategies.
We will see how soon.
I will explain the relationship among the 3 elements of the triangle.
The Inventory Triangle
Managing inventories is a delicate balancing act of cost, effort and risk.
There is a Cause Effect Relationship principle in operation
The Food and Beverage Operation Example
The Food & Beverage department has much higher Direct expenses compared to the Rooms department.
This is the reason why its profitability is also lower than that of the Rooms department.
For example:
- when a menu item is served as a dish in the restaurant within the hotel
- simultaneously, a direct expense called the Food Cost is incurred.
This Food Cost is not only a Direct expense but also a Variable Expense.
The Beverage Cost is another Direct Variable Expense representing beverage that is served along with the food menu item.
Look at Food & Beverage statement for Taste Buds Restaurant below:
Paradise Hotel Food and Beverage Dept (Taste Buds Restaurant) Gross Profit
Notice the line above the Food Cost line - it says Cost of Goods Sold.
We saw earlier how the Cost of Goods Sold is arrived at in accounting.
This is a unique representation of the Food Cost expenses.
It is applicable to the Beverage Cost as well.
It is important to understand this for effective inventory management.
Let us revisit a concept we learned earlier.
Food Costs and Beverage Costs are two items for which the hotel holds inventories.
It means that ingredients that form part of the food cost are:
- first purchased and
- held as inventories in the hotel storage facilities.
They are then issued to the kitchen and used to prepare menu items in the restaurant.
So, what is different?
We will reiterate three stages involved here which we saw earlier.
Those ingredients:
- are purchased to begin with,
- they then form part of inventories held in storage facilities of the hotel and
- finally, are issued to the kitchen for preparation of menu items.
Here is the important thing to know.
This involves the way expenses for inventory items are accounted for.
So, inventories have to be managed efficiently in expenses management.
This is applicable for those goods for which the hotel holds inventories.
I will close by saying that often hotel managers think inventories management is only for accountants.
That is as far from the truth as that bottom line is only for accountants.
As a hotel operation manager, your performance is gauged by revenue and profitability.
And that is enhanced with a strategic inventories management process.
Lakshmi Narasimhan Soundararajan is the founder of Financial Skills Academy PLUS a New York city based enterprise focused on complete financial learning ecosystem involving training, coaching and consultancy. Lakshmi taught undergraduate and graduate courses for more than a decade at New York University, Jonathan M Tisch Center of Hospitality as an Adjunct Assistant Professor during Spring and Fall semesters. Topics included 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 (middle managers) who did not have a financial background. He saw them struggle with numbers and fear them.
Lakshmi made up his mind to commit his career to hotel financial literacy training by simplifying numbers for the benefit of his non-financial background colleagues.
He is currently working on Financial Skills Academy PLUS a membership concept portal exclusively for assisting hotel middle managers to build Financial Literacy in themselves.
His vision is for Financial Skills Academy PLUS to be the Complete Financial Learning Ecosystem for Hotel Middle Managers.
Lakshmi 's all-time favorite historical figure is Leonard Da Vinci and in particular Da Vinci's love for simplicity. While developing his membership site, Lakshmi based the value proposition for his hotel finance training courses on three foundational principles: SIMPLE. NON-TECHNICAL. USABLE.
