Summarizing: Financial situation of the hotel is unstab

Question

Summarizing: Financial situation of the hotel is unstable, solvency and liquidity suffering
Recommendations:

Sakshi Sharma · Accepted Answer

CASE STUDY: 
Overview of the financial performance:
Revenue has increased by a CAGR of 6.11% from 2015 to 2020, while the global hospitality market has grown at a CAGR of 13.9%. This indicates that the company is growing at a sluggish pace. Gross margin has largely remained stable around 55 to 56% while net operating profit or EBIT fell from 15.62% in 2015 to 12.16% in 2020. Net margins have declined from 7.49% in 2015 to 2.84% in 2020. The company is having substantial fixed costs which is taking up most of the gross margins. Staff cost is the largest component of fixed costs, which accounts for about ~ 23 to 27% of revenue and has grown at a CAGR of 9.86% over the five-year period. Finance costs also have increased substantially leading to low net margins.
Review of working capital and liquidity position:
Debtors’ collection period has increased from 80 days in 2015 to 99 days in 2020, while inventory holding period has increased from 71 days to 105 days. Payment period for suppliers have increased from 83 days in 2015 to 101 days in 2020. Current ratio of the company has ranged from 0.61 to 0.65 which is far below the required ideal of 2. This indicates that the company’s funds are locked up in inventory and receivables and the company is unable to make prompt payments to the suppliers and has been availing short term credit facilities to meet the liquidity needs and for running the operations. Funding the operations out of credit is an expensive affair as short-term facilities tend to carry high interest costs. 
Fixed Assets:
There have been significant additions to fixed assets over the five years, part of which is replacement of existing assets and the balance is towards expansion. This has largely been funded out of long-term debt, retained earnings, and funds allocated as depreciation.
Debt: 
Though the quantum of long-term debt is less than equity and the debt-equity ratio is within the ideal of 2 (1.34 for 2020), there is a large increase in the amount of short-term credit facilities availed during 2015 to 2020.

Recommendations: 
The company needs a major cost overhaul and cost restructuring exercise to identify the nature of major fixed costs, and manage these costs more efficiently. Specifically, staff costs should be investigated and streamlined. For e.g., re-arrange the job descriptions to include only value adding activities while eliminating redundant ones, automate for routine tasks, and retain only the core employees with an altered pay structure and incentives. Rates for variable costs should be locked-in by signing long-term supplier contracts, to avoid substantial increase in variable costs. 
The company needs to focus on improving its cash collection cycle. This can be achieved through new credit policies to customers with shortened credit period, creating incentive structure rewarding with different discounts for prompt payments with a week, a fortnight and a month and charging penalty for delayed payments beyond one month. The company should also re-evaluate and renew its inventory policy, process of stocking and re-ordering, to avoid build-up of inventories. These measures will help reduce the longer conversion cycle and realise cash sooner which then, can be used to pay off the suppliers on time. While these are in progress, the company should re-negotiate terms with the banks or restructure the existing short term credit facilities for reducing the interest rates and finance costs. 
Investments in fixed assets should be evaluated and only those projects generating more sales should be undertaken. The company should consider adding new service lines like retail and expansion into new geographies, which can increase profits. 
To conclude, re-organisation and restructuring of existing operations and costs are recommended to stabilise the existing business. Credit facilities should be restructured. Growth opportunities should be pursued though new business lines and new geographies to generate more sales and profits.

Strengths:
1.	Sustainable sales despite the slow growth rates
2.	High gross margins
3.	Long term solvency is good
Weaknesses:
1.	High proportion of variable costs
2.	Substantial fixed costs, specifically staff costs
3.	Poor liquidity position
4.	Significant short term credit facilities

Summarizing: Financial situation of the hotel is unstable, solvency and liquidity suffering

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