The answer to this question can be as simple or complicated as you wish to make it, but you will want to set a goal you find acceptable based on the parameters discussed in this post. Please keep in mind that I am speaking in generalities and there are certainly a number of ways to get a final answer.
Where do I start?
Start with a full year financial statement in hand and you will want to identify every line item to determine if it is a variable or fixed cost. The fixed costs would be the items that do not fluctuate based on the number of rooms sold for a given period. Some examples of these costs would be associates that are on salary, cable or satellite service, billboard advertising, and other items of that nature. When going through this process you are going to have to make some decisions. For example, maintenance expenses; some of these can be either fixed or variable. My belief is that each room and piece of equipment should be kept on a set preventative maintenance schedule regardless of occupancy, which results in accounting for most of the maintenance expenses, including most wages, as fixed expenses. The other train of thought is that if your occupancy is down you can cut your maintenance expenses because your rooms and equipment isn’t getting as much use so it will not need it. In this case, some of those expenses would be considered variable. This is but one example you will need to consider when going through this process. How you account for these items is completely up to you and how your properties are run.
I have determined what is fixed and variable, now what?
Now it is time to set goals. Add all of your fixed line items and divide them by your total expenses to get the percentage of fixed expenses. That would be your percentage of fixed costs and in turn should also be very close to your flow through goal. The reason this works is because all of these items are (hopefully) already budgeted and therefore any additional revenue will have no bearing on these line items. That means the additional revenue will only be affected by the variable expenses and the fixed percentage should “flow” directly through the financial statement to the bottom line. If you subtract that number from 100%, it will obviously give you the variable expenses and it should be very close to your flex goal. The theory here is that when you fall short of budgeted revenues you still have the fixed costs, but shouldn’t have the variable expenses. The property should save or “flex” the variable expenses and that savings should be reflected in the house profit variance. To be fair, the flex and flow goals should equal 100% when added together. I have heard flow through goals anywhere from 50% to 80% and it really is dependant on how much of the expenses are variable. You are basically putting a percentage on your fixed costs (flow goal) and your variable (flex goal) costs. At Springwood Hospitality our goals for flow is 70% and our flex goal is 30%. Basically we are saying our fixed costs are 70% and variable costs are 30%. You may find that you are more comfortable with a lower flow number and a higher flex number or vise versa. It is really your call.
Don’t go throwing those numbers around just yet; in Part 3, I will discuss how to calculate flow to improve performance.
Hospitably Yours,
Justin
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