Written by: Laura Resco
Flow through and flex are two key metrics of hotel profitability. While flow through is the percentage of extra profit that flows to the bottom line from each incremental dollar of revenue, flex is the amount of profit that is flexed (or saved) when there is a revenue shortfall. The purpose of this article is to provide a simple framework to help you add these metrics to your operational analysis toolkit.
Calculating flow through and flex is very simple: you just need the total revenue and gross operating profit (GOP) for two time periods.
Flex is nothing more than 1 – Flow through: when we look at flex, we are not interested in how much of the loss in revenue flowed to the bottom line but rather, how much of the revenue shortfall didn’t translate into a profit crunch.
Interpreting Flow Through
Flow through deals with revenue increases. To analyze the results, we need to consider two key components: sign and absolute value.
The sign of the flow through percentage tells us whether GOP changed in the same direction as revenue or not. If it’s positive, it means that GOP increased; if it’s negative, it means that GOP decreased.
The absolute value of the flow through percentage measures the magnitude of the change in GOP in relation to the change in revenue. When the absolute value is greater than 100 percent, it means that GOP overreacted (the change in profit was greater than the change in revenue), and when the absolute value is smaller than 100 percent, GOP underreacted (the change in profit was smaller than the change in revenue).
The table below summarizes this discussion:
Flex is used when there is a revenue decrease. We have established before that the calculation has two main terms: (1) “1 – “, and (2) “flow through”.
The sign of the flow through term shows us whether GOP reacted in the same direction as revenue: it will be positive when GOP decreases following the revenue shortfall, and it will be negative when GOP increases despite the loss of revenue. Let’s now combine this with the “1 – “ term of the flex calculation: using basic algebra we can see that flex will be smaller than 100 percent whenever GOP decreases (moves in the same direction as revenue) and it will be greater than 100 percent whenever GOP increases (moves in the opposite direction as revenue).
Think about it this way: if revenue declined by $100, and GOP fell also by $100, flex will be 0 percent (no lost revenue was saved as profit). If GOP fell by $90, it means that you saved $10 as profit, and your flex will be 10 percent. At the point where the GOP change is $0, flex will be 100 percent (you saved all lost profit as revenue). Consequently, any flex above 100 percent accounts for those instances where GOP increased despite revenue declines.
What role does the sign of the flex percentage play? Even though it is not an indicator of direction, the sign of the flex percentage is extremely important: flex will only be negative when the GOP decrease is greater than the revenue shortfall. Thus, a negative flex percentage tells us that we didn’t save any part of the lost revenue, and even worse, profits continued to decline beyond the revenue crunch.
The table below summarizes our discussion about flex:
Table 3: Flex interpretation
The Bottom Line
Flow through and flex are key indicators because they incorporate in one single metric both the changes in the top line and the effectiveness of cost controls to protect the bottom line. In the case of flow through, a higher percentage means that the hotel keeps a tight rein on costs in the face of a business expansion. For flex, a higher percentage means that the operation is flexible and able to find cost-saving opportunities during a downturn.
What are the typical flow through and flex percentages for your operation? What are your flow through and flex percentage goals? What about your competitors? If you don’t know, I invite you to use the framework above to start finding the answers and add another layer of profitability analysis to your operational performance assessment.