Financing Tourism

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Chapter 8

• Financing Tourism
• Operations

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Human Resource Management in Tourism

• by
• Pro. Jin Ciping
• Bachelor of Science in Tourism
  Management
• (H54050020)
• Nanchang University
• School of Economy and Management
• Department of Tourism Management

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Learning outcomes

• Comprehend some of the features published company
  accounts
• Understand why accounting ratios are used
• Be aware of sources of funding

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Contents

• 1. INTRODUCTION
• 2. THE PRIVATE SECTOR
• 3. MULTINATIONAL ENTERPRISES
• 4. SOURCE OF FINANCE
• 5. INVESTMENT
• 6. SUPRANATIONAL INVESTMENT

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1. INTRODUCTION

• Importance of Financing
• Source of Finance

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Importance of financing

• The development and management of the tourism
  industry depends on the accessibility to capital
  and sources of finance so that businesses can be
  well developed for the existing enterprises to
  enable them to expand and develop the markets for
  tourism products and services.

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Source of finance

• Many businesses are based within the private
  sector, their access to source of finance for
  investment purposes comes from
• Banks
• Finance houses and
• Other lending institutions
• A number of other public sector agencies (assist
  the tourism sector with pump-priming funds)

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2.THE PRIVATE SECTOR

• Ratios
• Ratio Practice
• Ratio analysis
• Methods of Ratio analysis

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Ratios (1)

• Messenger and Shaw 1972
• In order to determine how effectively a
  business is being managed, information is needed
  about how it uses its assets to generate profits.
• Within the private sector, tourism business
  depend on the assets and investment to make a
  profit in their business operation.

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Ratios (2)

• Profitability is vital to the financial health of
  a firm.
• Ratios are used when assessing the financial
  performance of an organization because they allow
  comparisons to be made with other businesses in
  the same sector. They can be more useful than
  analysis of absolute numbers

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Ratio practiceSIA --- a corporation group

• The Singapore International Airline ( SIA )
  corporation
• group. The group is vertically integrated. The
  group
• includes
• Singapore Airport Terminal Service
• SIA Engineering Group
• Silk Air
• A tour operation

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Silk Air --- an outlet

• Silk Air is a outlet of SIA. It operates routes
  to
• ?Malaysia
• ?Thailand
• ?Vietnam
• ?Cambodia
• ?Indonesia
• ?The Philippines
• The route network is secondary gateways for
  business and leisure travel.

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SIA published company resultsAudited results for
SIA
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Audited balance sheets for SIA
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Results Explanation (1)

• 1998-99 the company
• The companys operating profit was 549m, a
• decrease of 206 (754.9-548.8)m
  (-27.3),
• compared with the previous year 1997-98
  
• economic depression in Asia
• 2. Revenue rose 106m (7075-6968) (1.5) to
  7075m
• Expenditure increased by 312m (6526-6214) (
  5)
• to 6526m

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Results Explanation (2)

• 3.The profit before tax was 882m, down (-14.5)
• 4. The profit after tax was decreased by a
  smaller amount of 106 (919-813) ( -11.5) to
  814m, as provision for taxation dropped 44m (
  -39.2), because of low changeable income

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Results Explanation (3)

• 1998-99 the outlets
• 1. The operating profit rose 83m (38.6) to
  298m
• The major contribution to the higher profits came
  from
• ?Singapore Airport Terminal Service Group
• ?SIA engineering Group
• ?Auspice
• ?SIA Properties

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Results Explanation (4)

• This profit compensated the loss made by the Silk
  Air
• 2. The profit after tax increased by a higher
  amount of 113m ( 64.6) to 289m
• The accounts results are made by ratio
• analysis below

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SIA group borrowings
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Ratio analysis

• Ratio analysis is a useful tool ,but it can only
  give some indication of future trends and must be
  considered in the general economic climate.
• The use of ratios( percentage analysis method )
  can monitor the specific trends( of changes of
  business) over time.
• Methods of ratio analysis
• ?liquidity
• ?the fixed assets to current assets ratio,
• ?ratio to assess the profitability of the
  business and
• ?the gearing ratio.

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Methods of ratio analysisLiquidity 1.1

• The liquidity(goods that can be easily sold for
  money) of any company is important , because it
  shows the solvency (the ability to pay) of the
  business
• Or how easily expenses can be met with cash
  payments

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Liquidity 1.2Definition

• Liquidity demonstrates the solvency of the
  business in other words, how easily expenses can
  be met with cash payments. The current capital
  ratio is one of the ratios which measures
  liquidity. Its formulation is Group current
  assets
• Group current liabilities

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Liquidity 1.3

• The formula
• Group current assets
  S4,212.3
• 
  1.231
• Group current liabilities S3,400.8
  
• This provides a ratio of 1.231, indicating that
  the companys liabilities are covered ( 1.23gt 1 ).

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Fixed assets to current assets ratio 2.1

• The fixed assets to current assets ratio is
  important, because generally it is the current
  assets which earn profits for the firm.
• Messenger and Shaw1993
• The higher the ratio of the current assets to
  the fixed assets, the more profitable the firm
  should be

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Fixed assets to current assets ratio 2.2

• The formula
• Group fixed assets
• Group current assets

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Fixed assets to current assets ratio 2.3

• 1999(Sm) 1998(Sm)
• 11,666.8 11,398.0
• 2.81
  3.61
• 4,212.3
  3,144.5
• In 1998, the firm got higher profits

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Profitability 3.1

• The profitability of the business can be
  assessed, using the following ratio, usually
  expressed as a percentage.
• The formula is
• Group profit before tax
• Group total revenue

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Profitability 3.2

• 1998-99(Sm) 1997-98(Sm)
• 1,116.8 1,1171.8
• 10014.3
  100 15.2
• 7,795.9 7,723.9

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Gearing rate 4.1Definition

• The use of the gearing ratio can assess the
  capital structure of a business, the gearing
  ratio shows the extent of debt compared to equity
  (right) or share capital.
• .
• The formula is
• Debt
• ???
• Equity

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Gearing rate 4.2

• The group
• 1999(Sm) 1998(Sm)
• 35 31.1
• 0.0028
  0.0027 (higher)
• 12,188.5 11,380.1

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3.MULTINATIONAL ENTERPRISES

• Advantages of multinational enterprises
• Transfer pricing

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Multinational enterpriseDefinition

• Corporations or large companies which invest
  in more than one country and do global business

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Multinational enterprise

• Curtin and Busboy 1999
• In some tourism destinations, esp. the
  developing countries, the power and size of
  transnational corporations has an enormous
  impact, because their investment remains
  seductive ( very attractive). Initially,
  development may bring jobs and increased
  prosperity but long-term stability is not
  guaranteed.

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Advantages of multinational enterprises operating
in tourism (1)

• To the tourism destinations, esp. in the
  developing countries
• ? These corporations can play a vital role in
  the
• creation of employment, output growth and
  
• development.
• ?Large transnational enterprises play very
  important
• role in the tourism development process
  especially
• from the financial way.

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Advantages of multinational enterprises operating
in tourism (2)

• To multinational enterprises
• ?These companies financing the tourism
  destination, esp. in the developing countries can
  make the businessmen get the benefits from the
  tax incentive policies --- significant financial
  returns.
• ?The key attraction for businesses to operate in
  more than one country is the ability to declare
  profits in nations with lower tax rates which is
  called transfer pricing (OP)

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Transfer pricingDefinition

• A multinational enterprise can declare profits
  in the nation with lower rates it invests in
  business.

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Transfer pricingBefore
Country Tax rate True cost price (A) Contribution to selling price (B) True net profit (B-A) True tax liability
X 45 150 180 3045 13.50
Y 15 300 340 4015 6.00
Z 20 450 480 3020 6.00
900 1000 25.50
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Transfer pricingAfter
Country Transfer price (stated cost) ( C) Stated profit Tax paid
X 170 10 4.50
Y 290 50 7.50
Z 440 40 8.00
20.00
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Transfer pricing explanation

• Bull two advantages
• 1. If the corporation operating across more than
  one country takes the policy of the transfer
  pricing, it can state ( declare ) profits in the
  tax-minimizing nations and pays lower tax.
• 2. Large companies can benefit from foreign
  currency scheduling and option open to large
  companies with respect to the financial futures
  market.

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4. SOURCE OF FINANCE

• ?Issues of dividend
• ? Bank loans
• ?Issues of debentures
• ?Government fund

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Issues of dividend

• To shareholders, a percentage of annual profits
• To the company, raising finance through this way
  is attractive --- low risk
• If the company does not make a profit, they will
  not issue a dividend.

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Issues of debentures

• These are loans with a fixed rate of interest
  over a specific period of time.
• The principal ratio to evaluate financial returns
  to investors is the return on capital Employed (
  ROCE )
• Profit ( before interest to debt holders )
• 
  100
• Capital employed

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INVESTMENT

• To remain competitive, businesses need to invest
  in some items.
• In making investment decisions, a company will
  use methods to assess capital investment
  programmes

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Three ways of investment

• the replacement of fixed assets
• the addition of more new assets
• the combination of the 2 above

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Methods to assess investment programmes (1)

• Payback period --- Payback shows how quickly
  an
• investment will have covered its cost
  through the
• cash flow it generates. (OP)
• Net present value (NPV)
• Internal rate of return (IRR)

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Methods to assess investment programmes (2)

• Payback shows how quickly an investment will
  have covered its cost through the cash flow it
  generates
• Messager and Shaw 1993
• A project may be chosen in preference to
  another just because it has quick payback while
  another with a slower time may in fact have a
  longer life with greater cash flow ( shorter time
  helps the investment cover its cost longer time
  may makes the investment a longer life with
  greater cash flow) Enterprises can choose each
  according to their own

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Methods to assess investment programmes (3)

• Generally
• The greater cash flow, more quick the payback
  period
• To a hotel, 6-7 is the best payback period,
  because it is just the time when hotel equipment
  needs replacing
• The most quick hotel payback period in the world
  is 4 years

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Payback example
Large aircraft (million) 2small passage jets (million)
Capital expenditure -38 -29
Year
1 Cash flow 7 5
2 Cash flow 9 7
3 Cash flow 10 11
4 Cash flow 12 12
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Understanding the example

• 1. The large aircraft will have covered its cost
  by the end of year 4.
• 2. Two smaller jets will have covered its cost
  before the end of the fourth year.
• The two aircraft may provide the flexibility a
  low-cost carrier enquires though individual
  passenger capacity is less
• The shortcoming with this method is that it does
  not include after-cost-returned cash flow
  analysis except the payback period, because the
  asset has still remained value.

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Payback formula (1)

• Payback period methods have two formulas
• Total sum
  invested
• 1. Payback period
• Cash flow
  annual
• Cash flow annual Revenue invested -
  Expenditure added -Replacement invested) ( 1 -
  Rate ) Replacement

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Payback formula Example 1

• Resumed that when a hotel is being innovated
  and constructed, its total sum invested is
  13.20m, with the replacement of 6 years. After
  constructed, it will have annual revenue of
  4.50m, added expenditure ( cost ) of 2.20m, and
  33 rate. How many years does the payback period
  need?

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Payback formula Solution

• 1. Total sum invested is 13.20m
• 1320
• 2. Annual replacement 220m
• 6
• 3. Cash flow ( 450-220-220) (1-33) 220
• 226.7m
• 1320
• 4. Payback period 5.82
  (year)
• 226.7
• ? The payback period needs about 6 years

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Payback formula (2)

• 2. When cash flow are different in years
• Total sum invested net cash flow i
• n payback period i the year invested

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Payback formula Example

• Now that a hotel invested 12.00 m. Cash
  flows within 5 years are 50, 300, 350, 400, and
  450. Please count the payback period ( unit is
  00,000 )

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Payback formulaSolution

• Payback period1st year 2nd year 3rd year
• 4th year
• 1200- cash flows ( 4
  years)
• cash flow ( 5th year)

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Payback formulaSolution

• 
  1200-50-300-350-400
• 1200 50300350400
  
• 
  450 ( 0.222)
• Payback period 1st year 2nd year 3rd year
  4th year
• 0.222 year 4.222
  ( years)
• The good point is in simplicity, the shortcoming
  is the formula does not consider time value of
  money

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Understanding methods to assess investment

• Go and Pine1995
• NPV and IRR are the most commonly used
  measures of investment
• Messasge and Shaw 1993
• The advantage of the methods is to that it
  considers the time value of money, so that the
  value of money received in the future can be
  compared with present sums

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6. SUPRNATIONAL INVESTMENT

• A number of institutions at supranational level
  have a significant effect on international
  tourism industry through financial way
• EU funds
• The World Bank Group

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Global distribution of IFC investments In tourism
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Conclusion

• The ability to raise finance is clearly very
  important in tourism development.
• The enterprisers with good credit will find
  access to ( put up ) capital more
• easily than the individuals with just a
  business idea.
• In some countries, where the private sector has
  been unable to finance
• large projects, the public sector will assist
  private sector projects such as
• tourism attractions.
• In making investment decision, bankers and
  investors will use a range of
• accounting ratios to compare the target
  business with others.
• Investment will consider the composition of the
  senior management team.

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Topic discussion

• Outline how multinational companies have affected
  international tourism development.
• Talk about the methods of source of finance.