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THE FINANCIAL FEASIBILITY OF

YOUR TOURISM BUSINESS


CONTENTS
The Financial Feasibility of your Tourism Business ......................................................2
Pre-Feasibility ...............................................................................................................2
Financial Analysis......................................................................................................3
Market Analysis .........................................................................................................3
Technical Constraints ................................................................................................3
The Financial Quick Test.............................................................................................3
Profit Projections .......................................................................................................4
Business Costs........................................................................................................10
Profitability Forecasts ..............................................................................................11
Cash Flow Projections.............................................................................................11

The Financial Feasibility of your Tourism Business


A business can be defined as any scheme or activity in which financial
resources are to be invested with the expectation of a return and which lends
itself to reasonable analysis and evaluation.
What, then, makes a business feasible? Being feasible implies that a
business is sustainable in the long term, it is practicable, and it will meet your
objectives.
Depending on the size, complexity and financial risks involved you will be well
advised to prepare a business feasibility study. There are many professionals
who are well equipped to assist and there is a lot you can do yourself,
however you are strongly advised to seek advice from your accountant.
For a business to be proven feasible, it is accepted practice for two studies to
be carried out:

The preliminary feasibility, or pre-feasibility, which examines:


- whether the business meets minimum financial requirements
- whether there is a market for the finished product
- whether it is technically feasible
This stage is sometimes referred to as the pre-investment study.

The full feasibility is a more detailed analysis of:


- the technical aspects
- capital costs
- operating revenues, expenses and cash flows
- marketability
- the social and environmental impacts.

Pre-Feasibility
There is no standard method or technique for doing a pre-feasibility. The
suggestions provided here should be used as a guide only. There are many
other approaches that can be taken. In the final analysis it will be your
decision as to which approach is best suited to your needs.
A pre-feasibility is undertaken in the very early stages of a business to
determine whether it is worth further consideration. This is where some ball
park figures are generated.
At the very least there are three key elements you will need to look at:
Financial Analysis
Market Analysis
Technical Constraints

Financial Analysis
The purpose of this part of your pre-feasibility is to determine the start-up cost
of the business, how it will be financed, what price will be charged to the
customer and what the likely return will be to you.
Market Analysis
The purpose of a market analysis is to determine if there is a market for the
product. It is strongly recommended that you speak to Tourism Western
Australia staff when undertaking your market analysis. We may be able to
provide some insights you have not yet considered.
Learn as much as you can about your potential customers. For starters, try to
find out:
What they buy?
Where your customers can be found? Are they mostly in Perth,
interstate, overseas or some mix of all?
When do they purchase? Do they have long lead times or make
spontaneous/impulse decisions?
Why they buy? What really motivates them?
What are your potential competitors saying about your prospects?
Technical Constraints
There is a real need to identify potential government planning regulations that
may need to be complied with, preliminary engineering and design issues
where applicable, and potential social and environmental impacts.
The Financial Quick Test
Here is a very simple approach to ascertain whether you have the financial
capability to consider doing a pre-feasibility.
The Business Hurdles
What will be the total
cost of the project?

What is your equity in


the project?

Amount to be
borrowed

Work out your


expected revenue

Revenue

Interest payments

The interest rate hurdle

Business cost hurdle

The interest rate hurdle

=
All other costs

=
Principal repayments

Repayments hurdle

The repayments hurdle

=
Desired Profit

The business cost


hurdle

Is there anything left


for me?

The primary aim of your financial analysis at the pre-feasibility stage is to


determine whether:
The revenue generated from the business will cover expenses
The rate of return on your funds invested in the business is equal to or
better than established benchmarks.
At a minimum you should include the following:
An assessment of the required capital investment and proposed capital
structure
Proposed financing arrangements
A depreciation schedule
Profit and loss forecasts
Cash flow forecasts
An evaluation of cash flow projections.
Profit Projections
Profit is measured as Revenue - Expenses = Profit
The first step is to determine the revenue potential of your proposed business.
For most tourism businesses there is a standard way to determine revenue.
Many newcomers to tourism significantly overestimate revenues.
Once you have worked out the revenue capabilities of your business proposal
the next step is to look at the expected costs. Many newcomers substantially
underestimate costs.
It is then possible to examine the liquidity side of your business, that is, cash
flow.
Revenue Determination
Three factors need to be known before a revenue stream for a tourism
business can be determined. These are:

Capacity

Utilisation

Price

Capacity
This is the basic number of saleable units of the product you intend having on
the market at any one time. For a hotel it is rooms. For a coach, boat or
aircraft it is seats.
Many accommodation operators prefer to talk in terms of room nights. The
formula used to calculate available room nights is:
Available Room Nights = Rooms Available x Nights Open for Business

Capacity is fixed unless of course you have an expansionary development


program. Capacity is in effect the supply side of your business. You will be
investing in capacity.
Throughout this section we will use an example Anywhere Motel- to
illustrate the main points.
Worked Example

Anywhere Motel
Anywhere Motel has 100 rooms. The owners want to express the motel's
capacity in terms of room nights. They also want to work out the revenue
potential of the property.

Firstly, let's work out the annual number of rooms nights available. This is
given as follows:
Annual Room Nights Available =
Room Nights

100 Rooms X 365 Nights = 36,500

Utilisation
Because unused units of capacity can not be stored, you need to have a good
idea of capacity utilisation over any given period. Utilisation refers to how
much capacity was actually sold. Rarely will total capacity be sold every day
of the year.
Tourism operators refer to utilisation in terms of occupancy rates
(accommodation) and load factors (coaches, boats and aircraft).
The room occupancy rate for an accommodation establishment is given by
the following:
Occupancy Rate (%) = Rooms Occupied x 100
Rooms Available
Hence, the occupancy rate of an accommodation establishment is a ratio of
the number of rooms occupied to the total number available.
Worked Example

Anywhere Motel

If an average of 50 rooms is occupied each night by paying guests, then the annual room
occupancy rate for Anywhere Motel is:
Occupancy Rate =

Rooms Occupied x 100


Rooms Available
50 x 100
100

50%

Anywhere Motel has an annual average room occupancy rate of 50%

It is useful to also work out the room nights occupied.


For an accommodation business, once the occupancy rate and capacity are
known it is a simple task to determine the rooms night occupied. It is given by
the formula:Room Nights Occupied = Rooms Available x Occupancy Rate

This figure is very important. It can be considered as the level of


consumption.
Worked Example

Anywhere Motel
The annual number of room nights occupied generated at Anywhere Motel will
be:
Room Nights Occupied

=
=

36,500 X 50%
18,250 Room Nights

The proprietors of Anywhere Motel produced and sold 18,250 room nights.
The remaining 18,250 room nights were, in a sense, wasted. They can not be
stored. Their capacity to generate revenue for the business has gone forever.
A room or a seat is said to be a highly perishable product.
It will be noted from the above that while the occupancy rate provides a basic
measure of market demand it does not tell exactly how many guests you can
expect at a given occupancy.
Annual occupancy rates and load factors rarely reach 100% and must be built
over time. Capacity utilisation is usually lower in the early few years of a
business than once it is established in the marketplace.
There are several problems associated with using occupancy rate as the sole
measure of performance or productivity. Artificial price decreases can boost
occupancies and consequently given an inflated view. This issue is
particularly important if you are considering buying an existing business.
Price
Pricing is the only marketing decision that will impact on revenue. All other
marketing decisions will impact on expenses. The average price you sell your
product at can be varied - it is the only element of revenue you do have direct
control over.

One of the more important factors you will need to consider when pricing your
product is that of travel agent's commission. In particular you need to be
aware of the tourism industry practices for marking up a price.
When working out the annual expected revenue flow you will be interested in
the average price (or tariff). However, the average price does not necessarily
mean the selling price.
The actual selling price can vary quite considerably. For example, high
season, shoulder and low season pricing, corporate, travel industry and group
rates, and so on.
Annual Revenue
Three factors combine to determine revenue, as follows:
Revenue = Capacity x Utilisation x Price

Depending on the nature of the business, for example, a coach tour or tourist
attraction, there are some subtle differences in the method of calculation.
It is important to keep in mind at this early stage that the revenue generated
by the business will not alone determine whether the investment is
worthwhile.
Worked Example

Anywhere Motel
The average room tariff is $120.00. The annual room revenue will be:
Rooms Revenue

=
=
=

Rooms available X 365 X Occupancy % X Tariff


100 X 365 X 50% X $120
$2,190,000

How to Work Out Your Fair Share


One of the first issues that will confront you is to work out an estimated
occupancy rate.
There are several ways you can do this. One method is known as the fair
share calculation. Essentially, this method says that, all other things being
equal, you can expect to gain a share of demand that is proportional to that of
existing competitors.
For accommodation businesses it is the ratio of the proposed new capacity
your business will bring onto the market to the total (competitive) capacity that
is already available. Fair share can be calculated as follows:
Fair Share (%)

Your New Capacity


x 100
Existing Capacity + Your New Capacity

The fair share is the starting point for further analysis. The new business may
be able to get more than this depending on its competitive characteristics.

Worked Example

Anywhere Motel
The proprietors of Anywhere know that there are six other competitive hotels and motels in
town with a total capacity of 900 rooms. They want to work out their likely fair share of the
market.
Fair Share (%) =

100 Rooms
900 Rooms + 100 Rooms

x 100

= 10%
The proprietors can expect to get 10% of the market. If the existing accommodation
operators are experiencing an average of 60% occupancy, the new average once your
business becomes established will be 54%.

How to Work Out the Required Number of Customers


In order to determine the potential revenue, you must make assumptions
about occupancy either in the form of a room occupancy rate, coach load
factor or some other measure. In doing so you are, in fact, making
assumptions about the number of customers the business will attract.
Ultimately, you will need to know the actual number of customers required to
make the business profitable.
It is possible to make these estimates in a systematic manner particularly with
respect to accommodation businesses.
The key variables are the number of guest nights, guests per room and
average length of stay.
Guest Nights

Paying guests generate guest nights. However, guest nights and room nights
are not the same thing because more than one guest can be accommodated
by one room. Therefore, in order to find the required number of guests, you
need to know the number of guests per room. The formula for calculating
guest nights is:
Guest Nights = Room Nights x Guests per room

Guests Per Occupied Room

The average number of guests per room will need to be estimated. It is rare
for this figure to be greater than 2.0 (unless the business operates exclusively
in the family market). Guests per occupied room for a locality can often be
found for a locality in the Australian Bureau of Statistics Tourist
Accommodation Survey.

Average Length of Stay

The second variable that needs to be known before guest arrivals can be
calculated is the average length of stay. Average length of stay can often be
found from industry averages through the Australian Bureau of Statistics
Tourist Accommodation Survey. Where statistics are not available, you will
need to make a best guess.
Guest Arrivals

These two variables, guest nights and average length of stay, can be divided
to find guest arrivals:
Guest Arrivals =

Guest nights
Average Length of Stay

Guest arrivals can often be found for a locality in the Australian Bureau of
Statistics Tourist Accommodation Survey.

Worked Example

Anywhere Motel
On average guests stay two nights at the motel and the average number of
guests per room is 1.2.
Therefore:
Guest Nights
room

18,250 occupied room nights X 1.2 guests per


=

21,900 guest nights


and

Guest Arrivals

21,900 guest nights


2 nights
=

10,950 guest arrivals

The proprietors of Anywhere Motel need to find a market of at least 10,950


guests, that is, 30 guests per day, in order to satisfy their revenue
requirements.

Travel Agents Commission


Paying commission is a standard way of life in the tourism industry and it is a
concept that tourism operators need to understand to take advantage of the
distribution channels available.
There are two ways of reaching potential clients:

Directly advertising, brochure distribution, website


Indirectly using retail travel agents, wholesalers and inbound tour
operators

There is a cost attached to both methods that needs to be considered in your


financial feasibility assessment and the cost of tourism products.
Tourism operators do find difficulty in justifying the commission required by
some agents, yet the costs in accessing these markets are generally way
beyond the reach of small operators and the cost of paying commission is
often balanced out by the number of bookings received direct by the business,
which do not incur a commission.
The normal commission rate to retail travel agencies is 10 per cent. When
you have determined your net rate, that is, the rate that includes your costs
and allows for some return as profit, you need to mark it up by 11.1 per cent
(or one ninth) to provide for the 10 per cent commission charged on the retail
rate. For example, a tour with a net rate of $180 that relies on travel agents
for all of its bookings will need to charge $200 for the tour ($180 plus 11.1 per
cent, or $20). If the tour operator only receives 25 per cent of bookings from
travel agents, a markup of only $5 is required to achieve the required net rate
of $180. Wholesale agents charge higher rates of commission sometimes
up to 30 per cent - because they are responsible for funding the brochures
that contain your businesss details. A similar calculation is necessary to
determine the required selling price for the tour. It is therefore important to
keep accurate sales records that show the source of bookings wholesale
agents, retail agents and bookings direct from customers. Tourism WA has
prepared a publication on commission rates.
Business Costs
Business costs can be divided into two groups - fixed costs and variable costs
such that:
Total Cost = Fixed Costs + Variable Costs

Fixed Costs
Fixed costs tend to remain relatively stable over a given occupancy range.
Examples are

Depreciation

Lease payments

Rates and Taxes

Office expenses

Insurances

Interest on borrowed funds

Salaries of the general manager and key personnel

If loan funds are to be sought, a major expense item will be interest payments.
The use of loan funds also means that you intend to introduce debt into the
capital structure of your business. Your business will then be described as
geared. Gearing will be discussed further in a later section.
Variable Costs
Variable costs, on the other hand, tend to change in direct proportion to
changes in occupancy.

Consumable items in rooms

Laundry costs

Room cleaners labour costs

Food and beverage costs

Agents Commissions

Advertising

Credit card charges.

Some costs, such as advertising, have both a fixed and variable component.
For example, some base level of advertising will be maintained regardless of
the level of sales.
Profitability Forecasts
Once you have an idea of revenues and expenses it is possible to start
making some profitability forecasts.
This can best be achieved through computer spreadsheet analysis.
An example of a typical spreadsheet for several businesses is available from
Tourism WA. Take special note of the presentation and not the actual figures
themselves. It is common to provide projections for the first five years of the
business and, for the first year, monthly figures.
Cash Flow Projections
The net cash flows of a business and the profit generated in a given year are
not the same thing. Many businesses have in the past failed despite rapid
profit growth. Profit can increase without a corresponding increase in net
cash flow. For example, depreciation does not involve any cash outflow
although it is charged as an expense against income. Furthermore, principal
payments on borrowings do not feature in the profit and loss statement.
These and other adjustments must be made when determining cash flow.
The business spreadsheet examples provide both profitability and net cash
flow projections and reconciliation between both.

Tourism Western Australia 2009


DISCLAIMER
This document has been prepared by Tourism Western Australia predominantly from
information and data gathered in the course of its activities. No person or organisation should
act on the basis of any matter contained in this document without considering and, if
necessary, taking appropriate professional advice. Neither Tourism Western Australia, nor
any of its employees, undertakes responsibility to any person or organisation in respect of this
document.

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