The Evolution of EBITDA in the Hotel Industry
If you’re not sure what EBITDA stands for, let alone what your hotel’s EBITDA is, these numbers won’t mean anything to you. The EBITDA calculation is one of the simplest and most powerful ways to measure your property’s financial performance. The EBITDA margin can be used to improve your total revenue management approach – bringing better profitability and financial growth to your hotel management business. Here’s what EBITDA is and why you should pay attention to this key performance indicator.
What is EBITDA?
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It’s a basic measure of profitability and can be used as an alternative to simple earnings or net income.
The easy way to calculate EBITDA is to start with operating profit – earnings before interest and tax (EBIT) – and then add depreciation and amortization. There is an EBITDA formula, which is:
EBITDA = Total Revenue – Expenses (excluding interest, taxes, depreciation, and amortization).
You will find your earnings, taxes, and interest on your hotel’s income statement. Look for depreciation and amortization in the notes to your operating profit report or cash flow statement.
Why do companies use EBITDA instead of a more comprehensive profit margin calculation? EBITDA became a popular calculation in the 1980s as investors began to look at distressed companies in need of financial restructuring. EBITDA was a way to ascertain whether or not a company could pay back interest on a financing deal. Today, investors use EBITDA to evaluate businesses with different capital structures, tax rates, and depreciation rules. It’s a good way to assess the earning potential of a start-up or a newly restructured company that may have a lot of debt. EBITDA strips out costs that can hide how a company is really performing; some analysts use it as a proxy for cash flow.
Applying the EBITDA Formula to Your Hotel Business
EBITDA is a particularly useful formula for the hotel industry where many properties have a large number of assets. EBITDA allows you to demonstrate potential profitability and show creditors the amount of money available to pay interest when financing and accounting decisions are taken out of the equation. If you manage a hotel with locations in other countries or regions, EBITDA is a good formula for comparing financial performance without the complication of different tax rates.
To apply the EBITDA formula to your hotel, start at the top of your profit and loss statement (P&L). The first section of your P&L will show revenue: total income generated from rooms, food and beverage, and other hotel services – the spa, gift shop, lobby shop, or events.
As you continue down the statement, you’ll reach expenses: what you’ve spent on things like payroll, inventory, cleaning and laundry, and other purchases. These are your operational expenses. There will also be some fixed costs and “undistributed costs”, such as marketing costs and OTA fees.
To get your EBITDA, simply take the total revenue (from the first section) and subtract your total expenses (from the second section).
The Evolution of EBITDA in Hotels
Any examination of EBITDA in the hotel industry needs to start with rooms revenue and lately alternative accommodations like Airbnb are making room revenue harder to earn. As a result, hoteliers are turning to new revenue streams, like food and beverage earnings and lobby shops, to increase profitability. “We’re talking about revenue generators—beverage is back with a vengeance,” one hotelier told Hotel Business. “We’ve done three rooftop bars and have four more in the process—great margins, very socially acceptable, makes the hotel stand out. Those are the kinds of things that people are buying into now."
Earnings equal revenue minus expenses and on the other side of the P&L calculation, expenses are increasing in key areas. Rising labor costs are weighing on hotels as minimum wage hikes take effect this year in many states. This year, 21 states have raised their minimum wage; states like Massachusetts and Washington require hourly rates as high as $13.50. Payroll accounts for more than 42% of a hotel’s total operating expenses, which means even incremental changes can impact your EBITDA dramatically.
Other big changes relate to the exclusions from EBITDA. Hotel financing has evolved, changing the interest calculation for many hotels. Hotels are taking short-term loans: $31.7 billion of which are due this year. These loans were taken as the result of “heavy acquisition and brand consolidation activity,” reports ReBusiness Online.
Taxes have also increased in the hospitality sector. The average state lodging tax revenue grew 2.92% from 2017 to 2018; this tax is imposed as a flat dollar rate per night. This tax is passed through to the guest. High taxes discourage guests from staying longer – or at all. This impacts your hotel’s revenue streams and may also change where you make your incremental profit.
Lastly, depreciation and amortization have remained relatively constant variables. Amortization is similar to depreciation, but it applies to an intangible asset – a patent, trademark, or franchise agreement, for instance. Franchise fees are obviously very relevant in the hotel industry; these fees include charges for royalties, marketing, frequent traveler programs, sales and reservations, and other miscellaneous fees. In 2010, franchise fees averaged 6.8% of room revenue; fees increased to 7.2% in 2016.
Increasing taxes, interest, and franchise fees can’t be ignored when planning your hotel’s operating budget. But, for the purposes of EBITDA, removing these costs gives you a clearer picture of your property’s financial health.
How Tech Can Help Your Hotel Better Optimize EBITDA
These changing variables mean that hotels must deploy a total revenue management approach to optimize their EBITDA. Total revenue management refers to managing all revenue sources in your hotel – not just room revenue, but food and beverage, spa and gym, events, and tours.
Start by optimizing your rooms revenue using a pricing and yield management tool like Duetto’s GameChanger. GameChanger is a powerful revenue management system that simplifies pricing to capture the best revenue possible for your room inventory. Duetto reports that GameChanger customers see an average RevPAR Index increase of 6.5% from using the platform. The tool allows revenue managers to drive direct bookings through enhanced pricing, setting rates and offers at a price point that makes you the most money while still converting.
Next, dive into your F&B revenue. Lobby bars have blown this revenue stream wide open. As Hotel Business reports, “lobbies are being redefined, many without registration desks and many that put a focus on the lobby bar. ‘The way we approach it is we see every seat in the lobby as a revenue seat. Why put seats there for people to sit in? Put seats there for people to sit in and buy something.’” Revenue management systems like Duetto meeting this trend by getting better at pricing tRevPAR. This gives your team a better understanding of how to price rooms based on expected F&B revenue, allowing you to optimize total profitability by guest.
And finally, don’t ignore your data. Business intelligence tools like Duetto ScoreBoard take total revenue management a step further, allowing hoteliers to make more data-driven decisions with granular real time data around key facets of the business like channel mix and profitability. ScoreBoard provides performance forecasts and analysis across your portfolio, updating in real-time to show you how your different revenue streams are performing. Optimize your decision making to drive revenue through the best booking channel while saving costs from areas that aren’t working. Your EBITDA will thank you for it.