In today’s world, tourism is a key source of income in many areas. It serves as a spread head of regional development and in coming years it is expected to contribute actively to the diversification of economic structure and the employment challenges across whole of the UK. However many tourist enterprises are quite small and lack financial muscle. As per statements marked by World Travel and Tourism Council (WTTC) it has been revealed that the travel and tourism industry in the UK is almost 5 times the size of automotives industry (Contribution of tourism to GDP in UK shows fastest growth.
In this report various aspects relating to cost and profit maximization in tourism operations, sources of finance available for expanding operations for tourism sector has been discussed in context to renowned Tourism Brand, Thomas Cook. Discussions have also been held on use of management accounting information tools in decision making process of business leaders. Ultimately, report also covers assessing financial performance of another tourism company, being TUI Travel Plc through conducting ratio analysis test.
Cost ascertainment and cost accounting in the travel and tourism sector is a pathless land. Unlike manufacturing costs relating to providing any service is a critical process. Companies in tourism sector need to differentiate their tour packages from that of competitors, which is done through pricing strategies. However, proper pricing of a product cannot be done unless all relevant cost in offering tour packages has been clearly identified. As a matter of cost differentiation, costs are segregated into variable and fixed costs using direct costing method. Direct costing is based on underlying assumption that when the current volume changes, company’s only encounter a change in variable costs which tend to move in the same direction as sales volume moves (Fritzsch, 2011). However, when expansion is concerned regarding capacity utilization, fixed costs also adopt a hike and do not remain the same.
Tourism companies including Thomas Cook make use of direct costing method applying cost-volume-profit analysis, which is consider the most effective tool that managers of an economic entity dispose of (Alex, 2012). Cost accountants of Thomas Cook make use of CVP analysis to examine the behavior of company’s total revenue with related total costs and results of operations under the influence of changes in sales volume of packages offered, sales price per package, fixed costs or variable costs. Managers also make use of CVP analysis when they assess incremental revenue and costs associated with expanding a product line may be in existing or new market (Peters and Wieder, 2013). If incremental revenue in the proposed evaluation is more than its incremental costs than the project under impression is made acceptable or otherwise not. CVP analysis even helps to determine product package mix by figuring out contribution margin of each category of product or service offered.
Akin to evaluating capital projects, financial management is also to be assured while developing a product. It aims to identify costs associated with the making of the service or development of product and ensuring that costs does not exceed benefits derived from sale of product or delivering service. Thomas Cook also makes use of marginal costing technique supported by activity based costing which helps them appropriate pricing for their tour packages.
In order to sustain and make assumptions for future growth, it is order to adapt suitable pricing strategies and while formulating such strategies customers must be placed at the heart of the organization. Because faith among customers is not developed towards company’s product or service offerings unless price of product or service matches the utility associated with the respective product or service. Prices of the product can be assigned in many ways few of which are explained below:
Market led pricing: Under this approach firm prices its product or service offering in line with competitors maintaining a slighter difference, which may be high or low than to gain competitive advantage. Thomas cook can make pricing decisions for its tour packages in line with competitors. If the quality offered in product is higher than that of competitors, then the prices can be hiked at reasonable intervals (Kleinsasser and Wagner, 2011). It is usual practice for companies operating in similar line of business to price their product or service at par or with a slighter change. Such practice is widely adopted in FMCG sector.
Cost plus pricing: This approach aids business leaders to price their product at cost plus reasonable profit margin for their efforts. It ensures that cost is recovered and the funds for future growth and sustainability are made available in form of profits.
Cost led pricing (Marginal Approach): Cost accounting experts believe that a firm in the initial years of establishment must operate at break-even at the minimum. Operating at break-even will mean no profit or loss generated in operations. As a fundamental assumption of variable costing, it is laid that the cost of production should not include fixed overheads incurred for administration and only production related overheads to form part of cost of production (Moutinho, 2011). Hence, Thomas Cook can price their product by charging administration cost to profit and loss ant not to cost of production.
Absorption costing: Similar to marginal costing, it is also a cost led pricing technique. Being a traditional method of costing, it believes that each cost incurred by the business must be charged to production and then cost per unit is to be determined. Cost incurred may vary from year to year, but prices once adopted cannot be changed every year. Theoretically, it is possible to price the product based on this approach but practical difficulties cannot be overlooked.
Seasonal Pricing: Company has got a full year rate stated in its brochure. Discount and other concessional rates are offered to the customers according to seasonal volume of sales (Zhao, Ritchie and Echtner, 2011). Like in wedding seasons tour packages include sighting various cities across the world at high prices and when sales are low in off seasons; discount offers are given to customers in order to operate at break even.
In fact, to operate at Break even, Companies adopt such pricing strategies that maintain a reasonable margin of safety by offsetting market demand.
Tourism industry is usually affected by numerous factors being present in the environment in which it operates. Such environmental factors include seasonal variations, social environment, current trends, marketing staff a.nd bad debts incurred. Factors have been well explained below:
Global Political Influence: Thomas Cook being an international travel and tourism company is influenced by global political factors. Respective laws and regulations in the countries in which business concern operates may affect positively or in other manner. Some countries have placed restrictions in operating tourism business only when the business enterprise possess valid license to operate. It is required on the part of the company to adjust themselves fulfilling political requirements. Government of any nation allocates annual funds to be deployed in tourism sector (Kim and Kim, 2013). In order to avail such funds being granted is subsidies to maintain competitive edge over others, business must adhere to prescribed conditions laid by regulatory authorities.
Technological changes: Technological changes occurring within tourism surround several factors from medical advances to innovative space tourism (Middleton and Clarke, 2012). New customers have added to the tourism industry only because of better communication, transport and safety measures. Online booking of travel packages have made it easy for the customers to address their travel issues promptly from home. Travel companies that offer online booking services and viewing our packages through brochures published on net can better seek customer’s attention and increase their volume of sales and related profitability.
Seasonal Variation: Demand varies from season to season in travel and tourism sector. As the supply is not even throughout the year, break even cannot be determined easily. It is vital on the part of the operational managers to offset the demands between different seasons using seasonal pricing strategies (Hung and et.al., 2011). Generally, a rack price is determined and stated in the brochures, which prevails throughout the year subject to discount and concession offers. Profits in the peak season are generally high while in off seasons, a loss may be reported. In order to offset such demand, high prices are charged in peak seasons against off seasons.
Economic factors: Thomas cook being a company with global operations is exposed to various economic factors like foreign exchange fluctuations, inflation and interest cost on its funds. When the invoiced currency is devalued, purchasing power reduces and vice versa. When the interest cost on funds borrowed at fluctuating rate of interest marks an increase, profits gets diminish. Similarly, when the inflation is experienced, value of money and substantial profits are being absorbed.
There have been evolved in the recent years, numerous management accounting information tools which aids business leaders and operational managers in their decision making process. Such information needs strong base on which reliance can be placed. Management makes use of accounting data to be applied in various tools while processing information. Management accounting information tools mainly includes under mentioned mechanisms of assessing information:
Interpreting financial statements: Financial statements depict financial standing and financial performance of the organization by preparing and presenting them to various stakeholders associated with the company. As a matter of statutory reporting requirement of the companies under respective companies act, all companies are required to prepare their financial statements which shall include a Balance Sheet, and Profit and Loss Account at the minimum (Hill, Perry and Andes, 2011). However, few companies are also required to present cash flow statement, which depicts how well the company manages its cash flow.
Balance sheet: Balance sheet depicts the financial strength of the enterprise on a particular date. It determines whether the concern is able to meet its financial commitments with the stated amount of assets. Unless balance sheet is prepared, net worth of the business cannot be known.
Profit and loss account: Profit and loss account depicts operational performance of the business. It also determined the prospects of the company in future. If the balance in the profit and loss account is positive, it shows positive prospects for future and vice versa.
Cash Flow Statement: Cash flow statements depict how well the cash and cash equivalents are managed in the business during the given period. It reports cash receipts and cash spending from business activities mainly classified into operating, investing and financing. It aids in cash planning and managing working capital requirements.
Preparing Budgets and Forecasts: Budgets and forecasts are prepared for future planning which are based on prevailing circumstances and are restated when the change in circumstances occurs. Budgets and forecast serve as target performance which is to be achieved at the minimum with available amount of resources (Gelinas, Dull and Wheeler, 2011). Budgets helps to shape future by placing concern of business leaders in achieving figures of budgeted performance. Budgets occur in various forms, few of them is discussed below:
Cash Budget: As a matter of controlling cash flows, cash budgets are prepared which reflects, from where the cash will be received and where it will be expended. As regards business sustainability, budgeted profit and loss account is prepared which reflects how well the company will conduct its business activities.
Budgeted Profit and loss account: Budgeted profit and loss statement is prepared to forecast profit or loss on future transactions of the budgeted period, which may be monthly, half yearly or annually. All related expenditure and income likely to occur in the budgeted period are been addressed in the statement. It helps to reduce the risk of uncertainty associated with future operations.
Variance analysis: As a measure of control mechanism, companies conduct a variance analysis test to assess financial performance. Actual figures of reported period are compared with budgeted figures, and reasons for deviation are recorded. Under or over performance can only be assessed when variance analysis is made. Inter years comparisons are also made using variance analysis for different years of same line items, so that control can be exercised.
Management Information System: This tool helps in gaining information to managers to aid them in strategic planning and defining objectives. They occur in form of appraising capital projects using NPV evaluation, IRR method. Management information system also determines enterprise value using PE multiple of the company relating to earnings per share (Johnson, Kioko and Hildreth, 2012). Credit appraisal companies like CRISIL are built with installed software which reads accounting data of the company from various aspects in order to rate them regarding their financial soundness.
Based on what is covered in the above task, stakeholders associated with Thomas Cook make use of various information tools in order to suffice their information need. As far as assessing financial performance of the whole group is concerned, Company prepares consolidated financial statements to measure financial performance of parent company and all related subsidiaries operating across the globe (Ormiston and Fraser, 2013). Consolidated financial statements are prepared in line with IFRS reporting framework so that global investors are able to make inter firm comparison. Being a company with global operations, company prepares segmental accounts in order to depict relative profitability of various segments in which it operates. Decisions relating to continuation or exit plans cannot be made unless appropriate accounting data is made available (Inman, 2014). Various ratios are being used by the stock analysts and the company itself to make prone analysis of company’s operational performance and financial soundness by working out prescribed liquidity and profitability ratios. Unless such ratios do not meet industry standards prospective investors will not fund the company for additional capital requirements.
Interpretation: Referring to the above-tabulated figures of financial years of TUI Travel Plc for the year 2013 and 2012, conclusion regarding financial performance of the company can be drawn. Company maintains a reasonable gross profit margin of 10-11% for both the years under comparison, eventually indicating company’s business activities are worth pursuing. However, gross profit of the current year is high yet net profit in 2013 has been declined by 55.79%, which is on account of increase in cost of administration by 10.25% in current year. Company is able to operate above its break-even which is evident from observing net profit margin being positive in number. However, less net profit margin is not reasonable in for undertaking capital expansion projects. Company is not able to manage its working capital requirements adequately as company’s liquid current assets are not sufficient to meet company’s current liabilities. Industry standard current ratio is generally considered to be 1, while the company has 0.5 times for both the years. Inventory turnover has been improved by 6.82 % while debtor’s turnover has marked decline by 2.54%. Returns generated by deploying assets of the company is less, which may seek draw inventor’s attention and may act as a stringent to growth when investors will no more be interested in fusing further capital into the company. Return on assets has substantially declined by 56% in current year drawing shareholders attention. More debt is introduced in the business, which is not backed by sufficient equity in 2013, leaving debt equity ratio of 1.08 times in 2013 against 0.58 of 2012. Interest coverage has been declined by 15% drawing debt lenders attention. Hence, it is recommended to TUI Travel Plc to generate lucrative returns for capital contributors. Further administration cost must be controlled as it sucks substantial part of the gross profit of the concern.
Ministry of Tourism does not provide finance for tourism businesses, but as an aid to pursue capital projects, it has a Tourism Demand Subsidy Scheme that helps small communities with high tourism to invest in the infrastructure in order to sustain their tourism industry (Thomas, 2013). MOT also maintains a discretionary fund in the name of Tourism Facilities Grants Programme that provides finance for non-commercial tourism facilities to increase overseas visitors (Hall and Page, 2014). Raising finance for capital projects can be availed from three main sources generally debt funding, equity financing or government funding. Funding of various types of projects is referred below:
Developing heritage sites: Developing heritage sites can be financed by approaching Global Heritage Fund (GHF) which is a non-profit making organization operating internationally. It has in its mission statement the objectives to protect and preserve significant and endangered cultural heritage sites in the developing world (Global Heritage Funds, 2014). However projects are selected by GHF on its discretion involving project appraisal by GHF’s senior advisory board.
Cross Railway Network Project: There is a long term uncertainty in the funding of railway infrastructure. Infrastructure funding can be made through issuing infrastructure bonds by the UK government which offers a risk free rate of return to investors subscribing such bonds. Bonds may be issued at zero coupon rates at high discount prices or may be issued at fixed rate of return.
Integrated footpath development and improvement: In order to undertake footpath development and improvement UK local government has framed schemes for allocating funds for development of rural footpaths and bridleways (Funding drive, 2014). Local taxes collected have been utilized for using finance for such purposes.
Tourism Information Point: Tourism information point can be developed using debt financing (Debt Financing, 2014). Funding through debt finance involves availing loans from banks and financial institutors, funds from private lenders. Debt funding has a predefined schedule of principal and interest payments. Loans generally operate in two categories being operating loans and term loans:
Operating loans are sanctioned by banks for short term financial needs which may serve as meeting working capital requirements (Frasch, 2013). Term loans are raised for capital purposes which may road development and other infrastructure issues.
Other Infrastructure projects: As far as developing highway and freeway projects are concerned, government in recent years have started outsourcing contractors who are engaged to develop and maintain freeways for a certain period by undertaking expenses on their own and in turn receive revenues in form of toll charges. To undertake such projects government issues tenders based on which interested contractors bid their respective prices incorporating their terms and conditions (Wilson and Simmons, 2013). Contractor with lowest bid price is awarded the contract by signing service concession agreement between the contractor and highway authorities. Post maturity period of such projects, toll plazas are handed over to the government back again.
Based on discussions held and evaluation made of various aspects of tourism business, it can be concluded that ascertaining cost and eventually developing pricing strategy is a critical process. Applying new techniques of direct costing using Activity based approach has helped Thomas Cook to price their product appropriately according to market conditions. Report also covered how various factors present in the environment affects functioning of tourism companies. Significance of financial ratios was being discussed in assessing financial performance of the entity. At last, various sources of funding capital projects associated with tourism were referred.