How to use financial ratios to invest in hospitality
Financial ratios are an important guide to the health and profit of a company but it is important to remember to keep the following points in mind:
1. Ratios are backward-looking
Ratios use financial data to measure how the company has performed in the past. Thus, they don’t necessarily predict future performance. Use the ratios alongside strategic and market analysis to ascertain if the company is likely to continue its past performance going forward. In other words, is the company changing its strategy, or is the market changing?
2. Different ratios for different parts of the company
Make sure you are using the right ratios to answer any questions you may have about the performance of each facet of the company’s operations. If you are concerned about a company’s solvency, look at the liquidity and debt ratios. If you are concerned about its profitability, look at the margin ratios. Remember that these ratios will change over time as the company faces different opportunities and challenges.
3. Use the right benchmarks
Don’t compare the ratios of a hospitality company against a company in a completely different industry because differences in their respective operations will result in differences in their ratios. There are also often significant differences within a given industry. For example, in the hospitality industry hotels have high fixed costs while a coffee shop will have relatively low fixed costs, so the debt ratios of well-performing companies in either of these categories will likely look quite different. Furthermore, don’t look at your results in isolation, but instead, compare them to a well-performing company or a wider industry average.