Calculating Flow Thru - What’s the Correct Formula?

Lakshmi Narasimhan Soundararajan

Founder of Ignite Insight LLC

The simplest way to calculate profit flow through is take following steps:

1. Determine difference in dollar amount between Current Period Profit (Net Income, GOP or other profit KPI) and Previous Period Profit. This is A in the formula that will follow.

2. Determine difference in dollar amount between Current Period Revenue (Gross Revenue, Rooms Revenue or other revenue KPI) and Previous Period revenue. This is B in the formula that will follow.

3. Divide A by B and Multiply by 100.

FORMULA

Current Period Profit - Previous Period Profit

-------------------------------------------

Current Period Revenue - Previous Period Revenue

X 100 = Profit Flow Through %

Notes & Interpretation:

The Flow Through concept can be stated as: What % of every dollar of incremental revenue earned is going to the bottom line.

Flow Through depicts efficiency in retaining profit from each incremental dollar of revenue.

Profit Flow Through calculation does not work when difference between current and previous period profit or revenue is negative.

Ralph Miller

President at Inntegrated Hospitality Management Ltd.

Flow-Through =(This Period GOP - Prior Period GOP)/ (This Period Revenue - Last Period Revenue)

David Lund

The Hotel Financial Coach

Flow thru is first of all "a concept" and it's wrapped around the idea that if revenues go up or down my profit "should" react in a prescribed manner if I'm doing a good job as a manager controlling my payroll and expenses.

It's rather straightforward when things move up together, for example, revenues are up 100k compared to the same month last year and my GOP is up 60k – my flow is 60%. This means I keep $.60 of profit for every new dollar generated in revenue.

It gets more complicated when we mix up the results.

Here are a series of examples.

Revenues up 100k – GOP down 30k – flow thru is -130%. In other words for every dollar of additional revenue, I lost $1.30 in GOP. Not a very good result.

Revenues down 100k and profit up 25k – flow thru is 125%. In other words for every dollar of lost revenue, I earned $1.25 in additional GOP. Go to the front of the class.

Revenues down 100K and profit down 200k – flow thru is -200%. In other words for every dollar of lost revenue, I lost $2.00 in additional GOP. Better look for a new GIG.

Revenues up 10K and profit up 50k – flow is 600%. In other words for every dollar of additional revenue, profit went up $6.00. Now that's a great result.

Revenues up 10k and profit down 30k – flow is -400%. In other words for every dollar of additional revenue earned I lost $4. Get out your resume.

Revenues down $1000 and profit up $1500 – flow is 250% In other words for every dollar of revenue lost, I generated $2.50 of additional GOP. Time for a raise!

As for a formula that you can use in excel it's an at/if deal. Imagine the variance of the revenue is in cell J9 and the variance in the GOP is in cell J11 – here is what the formula would look like =IF(J9>0,IF(J11>0,(J11/J9),(+J11/J9-1)),IF(J11>0,(-J11/J9+1),(-J11/J9))). I must admit that I copied this from a good friend a long time ago, as this code is above my pay grade.

If you want to read more about flow thru – I have written 3 different articles, flow, negative flow, and the 21-point flow thru inspection, so check out my website blog for those or find them here on Hospitality Net. I also give away a "flow-thru cheat sheet" so if you want a copy send me an email: [email protected].

Agnes DeFranco

Ed.D., CHAE, CHE, CHIA, CAHTA is a professor and Conrad N. Hilton Distinguished Chair at the Conrad N. Hilton College, University of Houston

Just like any accounting topic, flow through and flex ratios look complex to many, and the interpretation with both the positive and negative signs resulting from the calculation also seems complicated. However, just like any accounting topic, once we take a few minutes and explore some examples, they are actually quite simple and amazingly useful. Thus, I am totally for these two metrics!

First and foremost, what are these ratios? Forecasting hotel revenue has always been an art and a science, with a crystal ball throwing in there for good measure. Even when a budgeted amount is decided, the actual revenue may be over or under the budget. When actual revenue is over the budgeted amount, the hotel is bringing in more revenue, but it is not all good news as yet. Why? The key is not how much incremental revenue we can bring in, but how much of the incremental revenue we are able to “flow through” and capture as profit – thus the “flow through” ratio. On the other hand, if the actual revenue is less than the budgeted amount, how well we are able to “flex” our budgeted expenses, to be innovative to still protect, and better yet, improve the budgeted profit is even more crucial – thus the “flex” ratio. Let's take a look.

FLOW THROUGH

As mentioned, “flow through” is used when actual revenue is better than the budget. This ratio can also be used to compare the current year's revenue to the previous year's, and can be computed for the entire hotel or by departments such as Rooms Flow, F&B Flow, etc. Simply put, it is the percentage of incremental profit that “flows” to the bottom-line from each incremental dollar of top line revenue. This formula can be used for any level of profit, such as EBITDA. Below is the flow through GOP formula. Just change the GOP numerator to the desired profit line, you will have the appropriate flow through formula. To calculate the flow through GOP:

Flow through happens when actual revenue is greater than budgeted revenue, but whether the actual GOP is better than the budgeted GOP, that's where the ratios can be positive or negative. A positive flow through of 30% means for every additional $1.00 of revenue, the hotel can net $0.30 as gross profit. On the other hand, a negative flow through of say 20% means for every additional $1.00 of revenue, the gross profit actually decreased by $.20, indicating there are serious issues with controlling costs. Of course, you would prefer high positive flow through percentages. The industry average of flow through is between the range of 50%-60%. Take a look at the two flow through GOP ratio examples below:

Scenario 1: Hotel Alpha

	Actual	Budgeted	Variance
Revenue	1,200,000	1,000,000	200,000
GOP	860,000	750,000	110,000

Flow Through GOP = (860,000 – 750,000)/(1,200,000 – 1,000,000)

                            = 110,000/200,000

                            = 55%

The 55% flow through GOP translates to every additional $1.00 of revenue, the hotel can net $0.55 as gross operating profit. Good news!

Scenario 2: Hotel Beta

	Actual	Budgeted	Variance
Revenue	1,200,000	1,000,000	200,000
GOP	700,000	750,000	(50,000)

Flow Through GOP = (700,000 – 750,000)/(1,200,000 – 1,000,000)

                            = -50,000/200,000

                            = -25%

 

This -25% translates to every additional $1.00 of revenue, Hotel Beta actually lost $0.25 as gross profit. How can this be? Well sometimes, when a hotel does not budget properly and the demand is higher, bring in more revenues, the hotel is not equipped to deal with the increase demand and may have to use contract labor or pay overtime. Other expenses may also increase to net only $700,000 in GOP. In this case, Hotel Beta not only fail to keep any of the increase in revenue and actually lost profits as well. Thus, both positive and high flow through ratios are good for hotels.

FLEX

“Flex” happens when revenue is less than that of the budget or the previous year. It is the amount of profit that is saved as revenue declines. When revenue is less than the budgeted amount or the previous period, hotels now need to become “flexible” and innovative to save or keep as much of the revenue as possible in the bottom-line by flexing their expenses. Just like flow through, flex can also be computed by departments and for different profit levels. The mathematical formula is the same as the flow through formula, except it is set up as “1- Flow Through” formula. The easiest way to remember is calculate your flow through and then minus it from 1 to obtain your flex.

Flex happens when actual revenue is less than budgeted revenue. Again, whether the actual GOP or profit level is better than the budgeted, that's where the ratios can be positive or negative. For example, a positive flex of 30% means for every $1.00 decrease in revenue, the hotel can save $0.30 as gross profit. On the other hand, a negative flew of 20% means for every $1.00 of decrease in revenue, the gross profit actually loss $.20 in gross profit. As with flow through, you would prefer high positive flex ratios, indicating you are saving more money. The industry average of flow through is between the range of 30% to 35%.

Why are the standards of flex ratios less than flow through ratios? Well, it is always an easier situation when a hotel makes more revenue, as the hotel should be able to increase its costs slightly to service the revenue increase. However, when revenue is less, cutting costs to save as much revenue as possible to the bottom line is much harder. During COVID, the flex ratios were only at the 10% to 15% range because the revenue drop was so sudden and drastic that it was very difficult for hotels to flex or respond accordingly. Let's look at two flex GOP ratios below:

Scenario 3: Mountain Lodge

	Actual	Budgeted	Variance
Revenue	900,000	1,000,000	(100,000)
GOP	680,000	750,000	(70,000)

 

Flex GOP = 1 - [(680,000 – 750,000)/(900,000 – 1,000,000)]

  = 1 - [-70,000/-100,000]

             = 1 - 0.70

             = 30%

In this case, although Mountain Lodge experienced a $100,000 decrease in revenue, its GOP only dropped by $70,000, showing that the hotel is flexible and innovative enough to save 30% of its loss revenue to the bottom line.

Scenario 4: Seaside Bungalows

	Actual	Budgeted	Variance
Revenue	900,000	1,000,000	(100,000)
GOP	630,000	750,000	(120,000)

 

Flex GOP = 1 - [(630,000 – 750,000)/(900,000 – 1,000,000)]

  = 1 - [-120,000/-100,000]

             = 1 - 1.20

             = -0.20

             = -20%

Seaside Bungalows in this scenario also experienced a $100,000 drop in revenue, and this is bad news already. However, its GOP dropped by $120,000, exceeding the decrease in revenue. With a negative flex ratio, Seaside was not only inflexible and unable to save or keep the revenue, it is losing an extra 20% more. This spells very bad news for Seaside. 

Flow through and flex ratios can help management to determine how effective management is at securing additional profits or savings to ownership. Having more revenue is good, but if a hotel is not able to flow that revenue to the profit lines, it is a red flag. When revenue is less, the ingenuity and resourcefulness of management are reflected in the flex.

See, these ratios may become you best loved indicators on your financial dashboard!