Like other industries hotel operations often extend credit to customers in order to gain their business -

For hotels, permission to pay after services have been provided is most often granted to large groups and preferred corporate accounts.  For transient guests and non-preferred groups and companies, credit must be established up front either by paying a cash deposit or using a credit card.

The decision to extend credit to a group or corporate account is based on several factors.   To be considered for credit, the account must either generate a significant amount of room nights or dollars of revenue.  Secondly, the group or company needs to pass the scrutiny of a financial background check.  Ultimately, it is a subjective decision.  Hotel management needs to weigh the risk associated with collecting the account receivable versus potential profits earned.

In accordance with the Uniform System of Accounts for the Lodging Industry, most hotels have a line item entitled "Provision for Doubtful Accounts" on their operating statement.  This expense is used to track charges made to provide for the probable loss on accounts and notes receivable.  Each month, hotel managers estimate the portion of their property's receivables that they do not believe will be collectable and record this number in the Provision for Doubtful Accounts account.

In order to evaluate how accurate hotel managers have been in evaluating their credit risk, we have analyzed data from our Trends in the Hotel Industry database.  Our analysis tracked the doubtful account and credit card commission expenditures of 681 hotels for the period 1999 through 2006 (estimate).

Bad Debts, Good Collections

For the period 1999 through 2006, the Provision for Doubtful Accounts averaged in a tight range of 0.08 percent to 0.16 percent of total revenue.  However, when analyzing the data pre- and post- recession, we do find an emerging trend of declining bad debts.

From 1999 through 2002, the Provision for Doubtful Accounts averaged 0.15 percent of total revenue.  This measurement declined to an average of 0.09 percent from 2003 through 2006.  The decline in this ratio indicates that hotels have been more successful in their efforts to collect outstanding receivables.  This observation was consistent for both full- and limited-service hotels.

Given the decline in group and corporate demand during the 2001 – 2003 recession, hotel managers were most likely more lenient in their decisions to extend credit.  This was necessary to attract groups and retain preferred corporate accounts in an effort to minimize the drop in performance.

Conversely, during the recent recovery, the pendulum of negotiating leverage has favored hotels.  Therefore, when negotiating corporate and group contracts, hotel managers have been able to negotiate and enforce payment of advance deposits, as well as attrition and cancellation fees.

Priceless Credit Cards

Why have hotel managers been more successful managing their receivables?

Part of the answer has been an increase in the use of credit cards.  Credit card commissions (the cost of commission paid to credit card organizations) averaged 1.7 percent of total revenues from 1999 through 2002.  Post recession, from 2003 though 2006, this expense averaged 1.9 percent. 

Assuming the commission percentages remained the same, the increase in this ratio is indicative of a greater percentage of hotel sales being charged to credit cards.  While guests can dispute credit card charges, this form of payment certainly carries less risk than directly billing an individual guest or group after check-out.

Enhanced management of the collection process is another potential reason for the decline in bad debts.  From 1999 through 2006, we have observed an increase in the number of properties in our sample reporting a negative Provision for Doubtful Accounts expense. 

At year-end, a negative balance in the Provision for Doubtful Accounts line item means that a hotel was able to collect receivables that were once deemed to be un-collectable.  Managers have either been more aggressive in their collections efforts, or more conservative when estimating their monthly bad debt provisions.

Given the forecast of healthy market conditions for the U.S. lodging industry, hotel operators are most likely going to continue their strict management of credit.  Occupancy levels in most cities are forecast to remain above their respective long-term average in the next few years. 

Therefore, properties can continue to be selective when determining which groups and corporate accounts will be granted the opportunity to pay after check-out.

Provision For Doubtful Accounts All Hotels
Percent of Total Revenue

Credit Card Commissions All Hotels
Percent of Total Revenue

Source: PKF Hospitality Research

Robert Mandelbaum is the Director of Research Information Services for PKF Hospitality Research.  Alvin Minsk is the firm's Annual Trends Supervisor.  Both are located in the Atlanta office ( www.pkfc.com ).  This article was originally published in the June issue of Lodging Magazine.