Break-Even Analysis: Definition and why it is a must for 2023.

Definition

Break-Even Analysis in finance, business, and cost accounting refers to the point at which total costs and total revenues are equal. Break-even analysis is used to determine the number of units or revenues required to cover total costs (fixed and variable costs).

 

Formula 

BP Units = FC / (SP-VC)

 

Concepts

FC = Fixed Cost

SP = Selling Price

VC = Variable Cost

CM = Contribution Margin

CM = SP - VC

CM% = CM / SP

Now that we have seen the basic definitions and concepts, let's see how it is calculated in the case of a hotel.

 

BEP Occ.%

Let's assume that the owner of the hotel A wants to know the occupancy rate he has to achieve to reach BEP.

Hotel A

- Number of rooms: 50
- Days of operation: 180
- Average rate: 120
- Fixed cost: 400,000
- Variable cost: 20

We start by calculating the BEP in the number of nights

BEP Units = FC / (SP-VC)

400,000 / (120-20) = 4,000

This means that Hotel A has to sell 4,000 nights to reach BEP.

Now, we can easily translate this into an occupancy rate:

BEP Occ.% = BEP Nights / Available Nights

4,000 / (180 x 50) = 44.44%

So the hotel must achieve at least 44.44% occupancy to reach BEP, where its sales will equal its total expenses.

 

BEP Revenue

In a subsequent calculation, suppose that the owner of the hotel A wants to know what revenue he needs to achieve to reach BEP.

We start by calculating the contribution margin percentage:

CM% = CM / SP

(120 - 20) / 120 = 83.33%

Then we divide the fixed costs by the contribution margin percentage: 

BEP Revenue = FC / CM%

400,000 / 83.33% = 480,000

So the hotel must achieve at least 480,000 in revenue to reach BEP, where its sales equal its total expenses.

 

BEP ADR + Profit

Finally, our hotelier wants to know the average price he should charge for his rooms to not only reach BEP but also to make a profit of 150,000.

We start by calculating the desired revenue:

BEP Revenue + Profit = FC + Profit / CM%

400,000 + 150,000 / 0.8333 = 660,000

And we continue by calculating the desired average rate:

BEP ADR + Profit = BEP Revenue + Profit / BEP Units

660,000 / 4,000 = 165

This means that in order for Hotel A to cover all its costs and make a profit of 150,000, it would have to charge an average rate of 165.

 

BEP and Revenue Management

Now that you have seen the definitions of Break-Even Analysis and how it can be calculated in the case of a hotel business, let's look at how this relates to a hotel's revenue management strategy. As an approach, with Break-Even Analysis we start the analysis internally. Meaning first the tough questions need to be answered before a hotelier can get into the process of implementing any revenue management strategy:

 

- What are the salary costs including employee taxes?

- What are the energy costs?

- What are the debt obligations plus interest? (if any)

- What are the variable costs for rooms?

- What are the variable costs for F&B?

 

Having answered the difficult questions and first analyzing what is happening in your own hotel business, you can start looking at the external environment by asking the respective questions:

 

- What is the average market rate in which the hotel exists?

- What is the average occupancy rate of the market in which the hotel exists?

- Who are the direct and indirect competitors? What do they offer and at what price?

- What are the developments in the hotel's target markets?

- What are the hotel's booking channel shares?

 

By starting our analysis internally and doing the corresponding BEP Analysis, we get closer to reality and look at our business and the market more rationally. Only by taking a holistic approach to revenue management, i.e. looking at revenue, costs, and profit, can we implement the right pricing strategies and tactics. For example, if the average price to cover all expenses and make a profit is €300, but the average market price is €75, it is easy to see that a challenge arises. Similarly one might plan to build a hotel in a high-end area where the ADR of the area is €300. However building the hotel, operating it to the standards of the competition, and getting a good return on investment requires a BEP + Profit ADR of €800. Again, is it worth the investment, or should another hotel investment be considered?

TIP: BEP Analysis should be done before deciding to invest in a hotel property and definitely by a team with specialist knowledge, experience, and know-how. In any case, it is the first step towards a strong and successful revenue management strategy.

 

At Panel Hospitality - Hotel Management we help you achieve your goals. Our partnership models are designed by hotel owners for hotel owners. For more information on BEP Analysis and our hotel management services, please feel free to contact us.

 

Panos Noulas 

BA Hospitality Management, Hotelschool the Hague

Panel Hospitality Founder