DEGREE OF
OPERATING
LEVERAGE
AS AN
INDICATOR
OF ECONOMIC
READINESS OF
SELECTED HOTELS
IN CEBU
DEGREE OF OPERATING LEVERAGE AS AN
INDICATOR OF ECONOMIC READINESS OF
SELECTED HOTELS IN CEBU
Chapter 1
Chapter 2
Chapter 3
Chapter 4
Chapter 5
DEGREE OF
OPERATING
LEVERAGE
AS AN
INDICATOR
OF ECONOMIC
READINESS OF
SELECTED HOTELS
IN CEBU
Chapter 1
Introduction
Chapter 1 - RATIONALE
• Tourism → hotel industry → comfortable lodging
establishment
• The study is aimed to obtain data on the relationship
of a hotel’s operating leverage with its financial stability
measured through sustained profits
• Operating leverage → analysis of fixed costs and
variable costs
• High DOL
growth
dramatic improvement
recession
steeper erosion of income
Chapter 1 - PROBLEM
The research is aimed to establish DOL as an
indicator of economic readiness of selected hotels
operating in Cebu.
Specifically, the researchers desire to answer:
1.How do the selected hotels classify their expenses as to
either fixed or variable?
2.Based on the conducted survey, how can hotel
expenses be generally classified as to either fixed or
variable?
Chapter 1 - PROBLEM
3. What are the break-even points (BEPs), margins of
safety (MOSs), and degrees of operating leverage
(DOLs) of the selected hotels from 2004 to 2010?
4. What is the relationship among the computed CostVolume-Profit Analysis tools?
5. Can the degree of operating leverage be used as an
indicator of economic readiness?
Chapter 1 - ASSUMPTIONS
The researchers deem the following assumptions
reasonable and necessary:
1.In the absence of Philippine-specific data regarding
economic periods and events, international and/or
United States-setting data shall be presumed to be
applicable in the Philippines.
Chapter 1 - ASSUMPTIONS
2. The recession began on December 2007 and started
recovering at the beginning of 2010.
3. The researchers are primarily dealing with secondary
data. Having no means of ascertaining that these data
are free of misstatements, they are presumed to be
true and correct at their face value.
Chapter 1 - HYPOTHESES
The researchers present the following hypotheses:
1.The ↓ BEP, ↑ MOS, ↑ amount by which sales can drop
before the hotel incurs financial losses
2.The MOS is inversely related with DOL
3.The DOL can be used as an indicator of the hotel’s
economic readiness by citing the DOL’s relationship with
the hotel’s BEP and MOS
Chapter 1 – SIGNIFICANCE OF THE STUDY
This study may be beneficial to the following
stakeholders:
1. Hotels
2. Hotel Associations and Department of Tourism
3. National Economy
4. Academic Researchers
Chapter 1 – SCOPE AND LIMITATIONS
1. Criteria for selection of hotels:
• must be operating in Cebu.
• must be a member of the Hotel, Resort, and
Restaurant Association of Cebu (HRRAC).
• must be registered with the Department of Tourism
(DOT).
• must have filed their annual financial reports to the
SEC Cebu for the period 2004 – 2010
2. Limitated to secondary information, cost
classification being internal in nature
Chapter 1 – DEFINITION OF TERMS
1. Break-even Point
• the point where total contribution margin equals
total fixed costs
• the level of sales at which profit is zero
2. Degree of operating leverage:
• is a measure, at a given level of sales of how a
percentage change in sales volume will effect
profits
Chapter 1 – DEFINITION OF TERMS
3. Economic Readiness
• a hotel’s ability to profit, and sustain the same,
despite fluctuations in room demand, pricing
strategies, and operating costs
4. Fixed Costs
• a periodic cost that remains more or less
unchanged irrespective of the output level or sales
revenue, such as depreciation, insurance, interest,
rent, salaries, and wages
Chapter 1 – DEFINITION OF TERMS
5. Margin of Safety
• the excess of budgeted (or actual) sales dollars
(pesos) over the break-even volume of sales dollars
(pesos)
6. Variable Costs
• a cost that changes in proportion to a change in a
company's output level or sales revenue.
Chapter 2
Theoretical Background
Chapter 2 – REVIEW OF RELATED LITERATURE
• Tourism - an integral part of the Philippine economy
Iris Ng, 2004
• 136 hotels listed nationally, 19 are in Cebu
www. dot.gov.ph
• Hotel, Resort & Restaurant Association of Cebu
(HRRAC) - the umbrella organization that speaks
or the hospitality industry in Cebu
www.hrrac.net
Chapter 2 – REVIEW OF RELATED LITERATURE
• Global Recession - began on December 2007
and intensified on September 2008
National Bureau of Economic Research
Business Cycle Dating Committee
• Philippine Hotel Industry experienced growth during
recession, unlike the global hotel industry
Leo Reyes, 2008
Chapter 2 – REVIEW OF RELATED LITERATURE
• The ability of hotel companies to maintain room
rates as much as possible and to deliver the same
service levels should have the most significant
impact on their ability to weather the downturn
Neil Salerno, 2008
• Operating Leverage – fixed vs. variable costs
• high in companies with high fixed cost relative
to variable costs
Ben McClure, 2006
Chapter 2 – REVIEW OF RELATED LITERATURE
• High DOL translates to more money from each
additional sale if there is no need to increase costs
Raleigh & Roginsky, 2006
• High DOL entails high BEP – profit increases rapidly
as sales increase once the BEP is reached
Garrison, et al., 2009
• BEP – revenue exactly equals costs
Garrison, et al., 2009
Chapter 2 – REVIEW OF RELATED LITERATURE
• Margin of Safety (MOS) – measures how far the
company is operating from its BEP
Garrison, et al., 2009
Chapter 2 – THEORETICAL FRAMEWORK
• Common tools used in CVP analysis:
o BEP – level of sales at which total revenue
equals total expenses
o MOS – amount by which sales can drop before
incurring losses
o DOL – measure at a given level of sales of how a
percentage change in sales volume will affect
profits
Chapter 2 – THEORETICAL FRAMEWORK
• A company incurring high fixed costs (CM constant)
will demonstrate high BEP, which when deducted
from total revenue, generates low MOS
• DOL – highest in companies with high fixed cost
• Hotels – businesses incurring significant fixed
operating cost
Chapter 2 – THEORETICAL FRAMEWORK
High
Fixed
Costs
High
BEP
High
DOL
Low
MOS
Increased
likelihood of
future losses
Decreased
economic
readiness
Low
Fixed
Costs
Low
BEP
Low
DOL
High
MOS
Decreased
likelihood of
future losses
Decreased
economic
readiness
Chapter 2 – CONCEPTUAL FRAMEWORK
Independent
Variables
 Sales
 Fixed Cost
 Variable Cost
Intervening
Variables
DOL
Economic
Readiness
Economic Boom
• Management philosophy
 Gov’t Intervention
 HRRAC practices
Economic
Recession
DOL
Economic
Readiness
Chapter 3
Research Methodology
Chapter 3 – RESEARCH DESIGN
• Descriptive research design
o to determine the DOL of selected hotels in Cebu
and DOL’s relationship to the economic
readiness of these hotels
Chapter 3 – RESEARCH ENVIRONMENT
• focused particularly on hotels located in Cebu
because of its convenience and being the 2nd
biggest growth center in the country
Chapter 3 – RESEARCH RESPONDENTS
The selection was based on the criteria set to limit
the scope of the study.
The respondents were:
1.
2.
3.
4.
5.
6.
Cebu City Marriot Hotel
Cebu Grand Hotel
Century Plaza Hotel
Golden Valley Hotel
Montebello Villa Hotel
Waterfront Cebu City Hotel
Chapter 3 – RESEARCH INSTRUMENTS
• Survey questionnaire - to obtain information of each
hotel’s treatment of expenses, whether fixed or
variable
• Secondary Data - financial statements (FS) obtained
from SEC to calculate the DOL, BEP, and MOS of the
hotels subjected to this study
Chapter 3 – RESEARCH PROCEDURES
• Gathering of Data
- two researchers were assigned to obtain the
selected hotels’ FS from the year 2004 to 2009
- from the statement of comprehensive income, a
listing of expense accounts was drawn.
- survey was conducted after sending a request
letter
Chapter 3 – RESEARCH PROCEDURES
• Treatment of Data
- each hotel’s treatment of variable and fixed costs
were tabulated
- Using the FS, the researchers computed the DOL,
BEP, and MOS of the selected hotels
• The following formulae were used:
BEP =
Fixed Costs
Contribution Margin
Contribution Margin
DOL =
Net Operating Income
or EBIT
MOS = Sales − BEP
Chapter 4
Presentation, Analysis, and
Interpretation of Data
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
• Survey Results
- of the six hotels selected, only four responded:
Cebu Grand Hotel, Century Plaza Hotel, Golden
Valley Hotel, and Montebello Villa Hotel.
Fixed Costs
- audit professional fees
- cable TV services
- directors’ fees
- employee retirement
expenses
Variable Costs
- bedroom supplies
- food and beverages
- laundry services
- light, power and water,
- office supplies
- repairs and maintenance
- representation expense
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
Cost Classification
Mixed Cost
Account Title
Fixed Cost
F
%
Advertising expense
Audit professional fees
4
100
Bad debt expense
1
25
Variable Cost
F
%
3
75
Mostly Fixed
F
%
Mostly
Not Applicable
Totals
Variable
F
%
1
25
F
%
F
%
4
100
4
100
1
25
2
50
4
100
Bank charges
3
75
1
25
4
100
Bedroom supplies
4
100
4
100
4
100
4
100
4
100
4
100
Cable TV services
4
100
Data processing
1
25
Depreciation expense
2
50
Directors' Fees
4
100
3
2
75
50
Table 4.1 Classification of Hotel Costs (by the selected hotels)
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
• Researchers’ classification of costs based on academic
theory
Fixed Costs
Variable Costs
- Cable TV services
- Bedroom supplies
- Depreciation expense
- Food and beverage
- Employee retirement expense - Fuel and oil
- Employee SSS, PHIC, HDMF - Bank charges
- Janitorial service
- Laundry services
- Medical expense
- Advertising expense
- Rent expense
- Office supplies
- Salaries and wages
- Repairs and maintenance
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
Difference of Treatments
1. Light, power, and water - usually semi-variable, in
practice, entirely variable costs.
2. Insurance
• property liability - fixed cost
• health and accident insurance - semi-variable
costs, in practice, entirely fixed costs.
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
Hotels
Cebu Grand
Hotel
Century
Plaza Hotel
Golden
Valley Hotel
Marriot
Hotel
Montebello
Villa Hotel
Waterfront
Cebu City
2004
2005
2006
2007
2008
2009
21,803,689
23,534,330
25,101,155
25,755,624
26,372,012
29,879,119
4,502,869
7,577,459
5,022,963
7,041,894
6,425,926
7,590,098
5,824,797
12,330,503
11,270,089
11,067,101
10,864,455
10,389,350
171,863,661
178,592,371
193,484,544
195,670,764
157,016,858
227,619,796
48,988,731
49,373,500
50,824,128
55,168,635
60,273,516
69,016,893
591,133,311
559,717,221
730,822,462
667,163,891
745,077,510
809,463,497
Table 4.2 Break-even Points of Selected Hotels
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
Break-even Point Formula:
BEP =
Fixed Costs
Contribution Margin
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
90,000,000.00
80,000,000.00
Amount (in Philippine Pesos)
70,000,000.00
60,000,000.00
Cebu Grand
50,000,000.00
Century Plaza
Golden Valley
40,000,000.00
Marriot
Montebello
30,000,000.00
Waterfront
20,000,000.00
10,000,000.00
2004
2005
2006
2007
2008
Year
Figure 4.1 Break-even Point Graph
2009
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
Margin of Safety Formula:
MOS = Sales − BEP in sales
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
Hotels
Cebu Grand
Hotel
Century
Plaza Hotel
2009
2008
2007
2006
2005
2004
6,424,766
16,408,065
16,408,065
18,044,260
12,987,388
11,437,352
(2,194,803)
824,641
5,395,294
1,210,611
(1,878,127)
579,318
Golden
Valley Hotel
Marriot
Hotel
Montebello
Villa Hotel
3,751,265
3,619,319
3,619,319
3,848,704
3,565,165
2,536,805
136,173,329
148,009,631
218,047,213
238,768,610
218,066,831
164,952,851
9,311,117
21,051,850
21,051,850
35,092,798
31,332,536
20,905,935
Waterfront
Cebu City
(123,386,438)
(18,878,565)
(18,878,565)
43,136,407
232,675,644
72,234,173
Table 4.3 Margin of Safety
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
60,000,000
50,000,000
Amount (in Philippine Pesos)
40,000,000
30,000,000
Cebu Grand
Century Plaza
Golden Valley
20,000,000
Marriot
Montebello
10,000,000
Waterfront
0
2004
2005
2006
2007
2008
(10,000,000)
(20,000,000)
Year
Figure 4.2 Margin of safety graph
2009
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
Degree of Operating Leverage Formula:
Contribution Margin
DOL =
Net Operating Income
or EBIT
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
Hotels
Cebu Grand
Hotel
Century
Plaza Hotel
Golden
Valley Hotel
2009
2008
2007
2006
2005
2004
5.04
2.49
2.82
2.28
2.72
2.79
(2.46)
8.79
7.66
5.15
(3.03)
8.77
3.77
4.00
3.99
3.93
4.46
3.30
7.77
2.86
2.28
2.71
3.95
6.41
3.43
3.00
2.52
2.39
1.82
2.08
Montebello
Villa Hotel
Waterfront
Cebu City
Table 4.4 Degree of Operating Leverage
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
10.00
9.00
Amount (in Philippine Pesos)
8.00
7.00
6.00
Cebu Grand
Century Plaza
5.00
Golden Valley
Marriot
4.00
Montebello
Waterfront
3.00
2.00
1.00
2004
2005
2006
2007
2008
2009
Year
Figure 4.3 Degree of Operating Leverage Graph
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
Relationship among BEP, MOS and DOL
- the higher the BEP, the lower the
MOS, the greater the DOL
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
0.90
0.80
0.70
0.60
0.50
Break-even point
Margin of Safety
0.40
Degree of Operating Leverage
0.30
0.20
0.10
0.00
2004
2005
2006
2007
2008
2009
Year
Figure 4.10 Cebu Grand Hotel’s BEP and MOS (expressed as a percentage of sales);
and DOL (expressed in tenths)
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
1.00
0.90
0.80
0.70
0.60
Break-even point
0.50
Margin of Safety
0.40
Degree of Operating Leverage
0.30
0.20
0.10
0.00
2004
2006
2007
2008
Year
Figure 4.11 Century Plaza Hotel’s BEP and MOS (expressed as a percentage of
sales); and DOL (expressed in tenths)
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
0.90
0.80
0.70
0.60
0.50
Break-even point
0.40
Margin of Safety
Degree of Operating Leverage
0.30
0.20
0.10
0.00
2004
2005
2006
2007
2008
2009
Year
Figure 4.12 Golden Valley Hotel’s BEP and MOS (expressed as a percentage of
sales); and DOL (expressed in tenths)
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
0.70
0.60
0.50
0.40
Break-even point
Margin of Safety
0.30
Degree of Operating Leverage
0.20
0.10
0.00
2004
2005
2006
2007
2008
2009
Year
Figure 4.13 Cebu City Marriott Hotel’s BEP and MOS (expressed as a percentage of
sales); and DOL (expressed in tenths)
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
1.00
0.90
0.80
0.70
0.60
Break-even point
0.50
Margin of Safety
0.40
Degree of Operating Leverage
0.30
0.20
0.10
0.00
2004
2005
2006
2007
2008
2009
Year
Figure 4.14 Montebello Villa Hotel’s BEP and MOS (expressed as a percentage of
sales); and DOL (expressed in tenths)
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
0.80
0.70
0.60
0.50
Break-even point
0.40
Margin of Safety
Degree of Operating Leverage
0.30
0.20
0.10
0.00
2004
2005
2006
2007
2008
2009
Year
Figure 4.15 Waterfront Cebu City Hotel and Casino’s BEP and MOS (expressed as a
percentage of sales); and DOL (expressed in tenths)
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
From figures 4.9 – 4.14, it could readily be
seen that DOL is inversely related to MOS; while
DOL is directly related to BEP.
Chapter 4 – PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
Hotel
Correlation Coefficient
Cebu Grand Hotel
-0.9857
Century Plaza Hotel
-0.9943
Golden Valley Hotel
-0.9936
Cebu City Marriott Hotel
-0.9941
Montebello Villa Hotel
0.1903
Waterfront Cebu City Hotel and
Casino
-0.9893
Table 4.5 Coefficient of Correlation between MOS (as a percentage of sales) and DOL
DOL is negatively correlated with MOS, with an
exceptions. This means that, if DOL increases, one can
anticipate for a decrease in MOS.
Chapter 5
Summary of Findings, Conclusion,
and Recommendation
Chapter 5 – SUMMARY OF FINDINGS, CONCLUSION, AND RECOMMENDATION
• Summary of Findings
1. DOL is inversely related to MOS.
2. DOL is directly related to BEP, though at varying
degrees, with some exceptions.
3. The higher the BEP, the lower the MOS, and the
greater the DOL, with one exception
4. DOL was highly negatively correlated with MOS.
5. DOL was positively correlated with BEP.
Chapter 5 – SUMMARY OF FINDINGS, CONCLUSION, AND RECOMMENDATION
Conclusion
The classification of expenses, as to fixed and
variable is not constant among hotels, depending
on the nature of the expense and the viewpoint of
hotel management.
• Hotels with higher BEP’s have the tendency to
increase their BEP’s in the years to come.
• Hotels with lower BEP’s tend to demonstrate
relatively static BEP’s
•
Chapter 5 – SUMMARY OF FINDINGS, CONCLUSION, AND RECOMMENDATION
Conclusion
The higher the BEP, the lower the MOS, the greater the
DOL. However, such relationship is not linear; the
degree of change in one does not result to a
proportional change in another.Moreover, DOL is highly
negatively correlated with MOS, and is positively
correlated with BEP.
Chapter 5 – SUMMARY OF FINDINGS, CONCLUSION, AND RECOMMENDATION
Conclusion
A high DOL indicates low MOS and lesser ability to
handle and survive drastic falls in sales. Thus, the
researchers conclude that DOL can be used as an
indicator of economic readiness of hotels.
Chapter 5 – SUMMARY OF FINDINGS, CONCLUSION, AND RECOMMENDATION
Recommendations
1. Future researchers - conduct further study on DOL
as an indicator of economic readiness of industries
other than the hotel industry.
2. Hotel managers and executives - use this study to
design a cost strategy responsive to business cycle
fluctuations
3. Accounting students – use this study to help future
employers manage company costs
4. All stakeholders – conduct further readings on
DOL
Thank you.
DEGREE OF OPERATING LEVERAGE
AS AN INDICATOR OF ECONOMIC
READINESS OF SELECTED HOTELS IN CEBU
Mr. Jun Alipe
Ms. Jovelyn Q. Yu, CPA, MBA
Mrs. Concepcion Rasalan-Racaza, CPA, MSA