The Art and Science of Hotel Budgeting: Time for a Rethink?

In the fast-paced world of hospitality, the saying "failing to plan is planning to fail" is highly significant. Whether they run luxurious resorts or small bed-and-breakfasts, hotel companies spend considerable time and effort creating annual budgets. This process is meticulous and time-consuming. However, there is an ironic twist to this story. Despite the significant amount of time and effort invested in budgeting, many hotels often find that the budgets they have created do not align with the reality that unfolds just a few months into the new year.

As I explore the various reasons - unpredictable market conditions, internal obstacles, and global turmoil - it's important to reflect on whether the traditional approach to budgeting is still relevant. Is there a more agile and efficient method that better aligns with today's rapidly changing landscape? Let's start with the steps in budgeting for hotels. All steps except the first are straightforward but time-consuming, primarily because of the many suppliers and costs needed to run a hotel.

Is budgeting critical in hotels?

An old tradition stipulates that budgeting is critical for any business, including hotel companies. A well-crafted budget is a financial roadmap that helps a company plan for the future, allocate resources, and make informed decisions.

Plan for the future

All hotel budgeting starts with revenue. As a hotelier, you must look into the future, at least into the next fiscal year, which often tends to be calendar years. The first question is: Will next year be much different than this year? The default answer is that the destination visitors needing overnight accommodation will be the same next year unless there are significant changes in the demand drivers, such as the number of events or structural changes, like a corporate headquarters move. The second question is: Will the hotel increase, keep, or decrease market share, in other words, capture more, the same, or less of the available market? The default answer is that the hotel will capture the same market share unless the hotel supply has changed (more or fewer rooms or competitors have renovated) or the hotel has substantially upgraded its facilities. For most hotels worldwide, next year will be the same as this year. If you have a revenue manager, the job is to make a realistic forecast for room revenue (occupancy and ADR) by copying the actuals from last year with a few calendar adjustments for events and holidays. The revenue manager would need less than a day for this.

Allocate resources

Do you plan any changes in how you manage the hotel? If not, allocate the same resources as last year. If you have plans to change the way you work, like becoming more productive by becoming more digitalized, you have to budget for these projects. Changes take time, so budget any changes as pure costs for next year. The results from these efforts will show up as profits the following year if the project is successful. Yes, inflation will increase costs, and the only way to offset these increases is by increasing the price of rooms and all products and services.

Financial roadmap

Now, you have the outline for a financial roadmap. You should now have a realistic plan based on reality rather than a dream. If you have a positive cash flow, you can think about the future and how to use the cash to improve the hotel's position on the market to maximize revenue and profits for coming years. If you have a negative cash flow, you must find the problem before jumping to conclusions or actions. Do not scream and shout that your team has to produce better figures. That will lead to an unrealistic budget that will be off early next year.

Make informed decisions

To make informed decisions, you need data and information that can give valuable insights. Reaching the budget or your objectives will only be possible by systematically collecting, compiling, and analyzing the hotel's performance.

Why budgets tend to deviate from reality

However, most hotels overdo budgeting and discover that budgets deviate from actual performance as the year progresses. Let's look at several reasons why budgets may be significantly off a few months into the year, particularly in the hotel industry.

Unpredictable Market Conditions

1. Seasonal Fluctuations: The hotel industry is susceptible to seasonal trends. Every hotel is highly knowledgeable about seasons, but even if a budget accounts for these fluctuations, unexpected weather events or other unforeseen circumstances can throw projections off course.
2. Economic Instability: Economic downturns, inflation, or even local events affecting tourism can impact a hotel’s revenues and costs. The flow of visitors to a destination might increase or decrease due to economic changes, but it is doubtful that visitors will completely abandon the destination.
3. Competition: Most competitors behave the same way as last year, but especially in a downturn, competition might behave irrationally, affecting performance.

Internal Challenges

1. Operational Inefficiencies: Operational costs may vary from the budget due to inefficiencies, maintenance issues, or unexpected expenses. Most hotels know these issues and need contingency plans to minimize risks.
2. Employee Turnover: Staffing needs and associated costs may not be what was initially estimated, requiring additional resources for training and recruitment.

Planning and Methodology Issues

1. Inaccurate Historical Data: Budgets often rely heavily on past performance data. The budget may go wrong if this data is incorrect or not adjusted for one-time events.
2. Over-optimism: Budgets may be set with overly optimistic revenue projections and underestimated costs, creating a plan that is not achievable. This is primarily due to an over-optimistic or pressured management to deliver profits for the hotel company or the owner.
3. Lack of Flexibility: Traditional budgeting processes may not be designed to adapt to changing circumstances, thus becoming outdated quickly.
4. Complexity: Hotels often have multiple revenue and cost centers, making the complex budgeting process difficult for people outside the industry. Hoteliers are used to the complexity, so this is rarely a problem.

External Factors

1. Technological Disruption: Rapid technological advancements might require unplanned investments or operational changes. It is unlikely since hotels are slow to adopt new ideas and technology.
2. Social and Cultural Trends: Changes in consumer behavior can affect room bookings, dining, and other services hotels offer. These changes tend to be incremental yearly but could have decade-long implications.
3. Global Events: Natural disasters, political instability, or health crises (like the COVID-19 pandemic) can have a drastic impact on travel and, consequently, hotel bookings.

Apart from a pandemic, these and other factors are familiar to hoteliers and should not impact budgeting. A bigger problem is unrealistic ambitions from top management and owners and impatience to reach higher profits fast enough.

A better way

A better way is to skip the budget and spend time improving the business. The revenue manager already has a 12-18-month rolling forecast for room revenue, so management understands what the future might look like. Could you extend the forecasting to all revenue sources for a full view of the total revenue for the hotel company?

Start analyzing the customer acquisition cost and generate ideas on reducing these costs. These costs have gone from 5-6 % 20 years ago to 15-25 % today. Unfortunately, the trend leans toward a further increase if these costs are not managed correctly.

Spend time developing internal processes to become more productive to increase guest satisfaction (to create more returning guests and positive reviews and recommendations) and decrease the cost of servicing the guests.

There is no need for a budget if there is an updated forecast for revenue, cost, profit, and cash flow.