Resisting Temptations is Not Just a Diet Thing
Resisting Temptations is Not Just a Diet Thing
By Scott Bushnell
Do you need to make money with your inn? For some inns, the answer is no. The 2004 PAII study shows that more than half of the participant inns (up to 8 rooms) rely on income from outside of the inn. And even the larger inns, more than a third, rely on outside income. Perhaps it is by choice, or by necessity, that a large number of inn owners work elsewhere.
But for those inns where there is no outside income, the business MUST make money…enough money to not only pay the expenses, but also enough to pay the mortgage and a little left over for the owners as well.
Net Operating Income (NOI) is the amount of income left over after the operating expenses are paid. Operating expenses are all the daily (e.g. food), weekly (e.g. payroll) and monthly (e.g. telephone, electric) bills that arrive with excruciating regularity. But those aren’t the only bills that have to be paid! Innkeepers like a little spending money, too, and the mortgage rolls in monthly as well.
The reason that owner’s draw, and mortgage payments, (as well as depreciation and taxes) are “below the line” accounts is that they can be significantly different for each inn owner and should not be included in the financial performance of the inn. A buyer who commits a huge down payment when purchasing has a smaller monthly debt payment than a buyer who puts down the minimum. And some owners need large owners’ draw to pay for the non-inn related expenses such as college for the kids, alimony, or personal vacations while other owners may not need much cash from the business at all. So mortgage debt and owner’s draw are left out of the NOI calculation in order to focus on the inn’s performance measurements.
Managing NOI, however, presents a couple of ethical and illegal temptations. During the growth and maturity and, let’s call it the “heyday” of a viable inn’s life cycle, life is good! There is money left over even after paying all expenses AND the mortgage and owner’s draw. The wise inn-owner typically reinvests the “extra” money back into the inn…perhaps with some new window treatments to upgrade a room (expensed), or a capital investment which actually changes the value of the physical property, such as a new roof (which is capitalized). A temptation may be to expense that roof instead of capitalizing it. Why? Higher expenses lowers NOI (Remember: Revenue - Expenses = NOI) and lowering NOI reduces Federal and State Income Taxes. These innkeepers want to enjoy the short term rewards of paying less income taxes each year. But not capitalizing an investment (usually over a particular $ level…ask your accountant what YOUR level should be) hurts the inn’s book value on the balance sheet. But the temptation is there, to keep the hard earned dollars OUT of Uncle Sam’s pockets in the short run (only to pay him later). Those who succumb easily to this temptation often under-report revenues (such as cash sales) and over-report expenses (such as personal food charged to the inn’s food budget). All this to reduce NOI and short-term taxes due. But then your records do not reflect the actual strength of your business. Additionally, by not adhering to the tax code, the business could face substantial interest and penalties if audited by the IRS.
Then life-goals change. You’ve decided to sell, and the world is turned upside down…when it comes to NOI.
Now it is time to impress a buyer with the profitability of the inn and the behaviors change! It’s time to increase revenue and count every cent that is earned and to keep expenses as low as possible…hopefully without hurting the appearance, maintenance, and salability of the inn. Those people cleaning the rooms that you’ve been calling “independent contractors” that are being paid under the table to avoid withholding must now be properly reported, and the gas for the car on your vacation charged to the company credit card, and the kid’s cell phones, now must all come out of the expense accounts of the business. It is time to sacrifice a little income taxes in order to increase NOI (and the real profitability) of your inn.
You can change those behaviors now, but it takes a few years of Profit and Loss statements reconciling with the tax returns to demonstrate the inn’s profitability…a few years that can really drag on if you are eager to sell. Without several years of reconcilable records, someone (you, your accountant, or consultant) has to develop an artificial view of what the records WOULD have looked like HAD they been properly managed. And these analyses are never as convincing to a buyer as several years of actual reconcilable records…and could present a speed bump or roadblock in the selling process.
Remember this passage in Alice in Wonderland by Lewis Carroll?
Alice was a little startled by seeing the Cheshire Cat setting on a bough of a tree a few yards off.
”Would you tell me please, which way I ought to go from here?”
“That depends on where you want to get to” said the cat.
“I don’t much care where-“ said Alice.
“Then it doesn’t matter which way you go” said the cat.
“-so long as I get somewhere.” Alice added as an explanation.
“Oh you’re sure to do that’ said the cat, “if you only walk long enough.”
Be careful where you are going…or you might get there! Like Alice, without having a road map to the long-term financial GOAL for the investment in your inn, it is quite human to succumb to the temptations with their short-term rewards, or to wander aimlessly from one behavior to the other. Your goal is to maximize the rate of return on the huge investment you have made in your inn. The total VALUE of your inn will be the combination of three elements: the physical property’s value (enhanced by capitalized investments), the furniture and fixtures (some expensed and some capitalized), and the value of the business itself which is driven by the strength of the Net Operating Income. Filing accurate tax returns, while taking advantage of all legal tax savings opportunities, will also allow you to sleep better at night. Managing your financial performance indicators properly from the time you first get into your inn will ensure your records are ready whenever you decide to get out.
(Copyright, Scott Bushnell, 2006, All Rights Reserved)