Wednesday, July 17, 2013

Gross Income Should Not Include Lodging Sales Tax When Talking Value!

When our guests pay for their full stay, we include our local state sales tax. How this translates in accounting terms is that the cost of the room is revenue earned and the state lodging sales tax is a liability. The tax is not ours to keep, it's ours to pay to the state each month.

When brokers, lenders and buyers look at profit and loss statements during due diligence, we need to determine if the gross revenue includes the sales tax and if it does, there should be an expense line item for sales tax (payable) so that we can net it from the gross revenue collected. Sometimes the lodging tax is netted from the gross revenue collected when it's posted thus we never see it. Either way is acceptable, we just need to know in order to determine the gross revenue net sales tax when analyzing value.

So why is it so important to net the sales tax from the gross revenue? There are a few reasons. One of the methods of business valuation used is a GRM (gross revenue multiplier) and another more heavily used is a capitalization rate (cap rate). If the gross revenue is inflated by including the sales tax, we don't have a true sense of the real revenue. And since we take the gross revenue and multiply it by the recent GRM (taken from other sales), it would be falsely inflated if it included sales tax. However, since the cap rate is calculated based on the NOI (net operating income), it is not affected by including sales tax in both the revenue and expenses because the sales tax is a wash in this calculation method.

For example:
If ABC Inn is listed for $1,050,000, has a gross income of $214,000 (including sales tax) and NOI of $90,0000, sales tax collected is $14,000. Let's assume the recent GRM is 4.5 and the recent cap rate has been 9.5%. Doing some cursory calculations, here's what we end up with:
GRM = $900,000 (net sales tax)
GRM = $963,000 (including sales tax) 
Cap Rate = $891,000 

You can see that the assumed value of the inn in this scenario is based solely on the GRM including sales tax is over inflated by $63,000 when the sales tax is not ours to keep, so there should never be a value placed on what is not ours.

We also see that the cap rate and the GRM (net sales tax) are very close in value and within 85% of list price, so it would seem that the list price based on these calculations is a reasonably defensible list price.

But it's up to the lender and appraiser to make the final determination of value. But this information is valuable for you to use when doing a quick evaluation to know if the numbers are within a range of where you need them to be, either as a buyer or seller.

Remember... this is still

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