Fundamental financial analysis is a powerful and versatile analytical tool for determining the intrinsic value of a company or an industry segment based on its future earning potential. Also known as ratio analysis among both academics and finance practitioners, it extracts historical and present data from financial statements, transforming it into valuable fragments of information based on which sound financial decisions can be made. While most of the findings obtained from fundamental financial analysis are used in the financial sector for investing and risk management purposes by financial institutions, it is worthwhile to note that the same analytic principles can easily be applied to an entire sector of the economy. This seems especially pertinent if that sector – in this case, tourism in general, and the hotel industry in particular – has been the impetus behind Croatia's overall economic growth in recent years.
Given this observation, it may come as a surprise that very little attention has been devoted to the financial aspects of the hotel industry in Croatia by academic and professional researchers alike. While the opening of new hotels – either independent or as part of international chains – is usually what piques the public's interest, an economically significant part of the Croatian hotel industry which was built, operated and inherited from the previous system remains on the margins of the spotlight. These veritable “industry dinosaurs”, with large assets and even larger liabilities on their balance sheets stand in stark contrast to the new, much smaller and agile hotel companies vying for space on the budding tourism map of Croatia. Therefore, the purpose of this study is to apply fundamental financial analysis to the entire hotel industry, identify any recent trends, and examine the sector's relative financial strengths and weaknesses in the context of risk management. The biggest contribution of this study lies in the fact that no similar investigation has been conducted in Croatia or any of the surrounding countries before. This approach will therefore break new ground with respect to empirical analysis of the hotel sector as a whole.
The study is divided into several parts. After the introductory part, Section 2 provides a comprehensive literature review on two areas of research interest: ratio analysis and Croatian hotel industry. Section 3 is devoted to the methodology used to analyze the available data. Section 4 presents the results and discussions on the topic. Finally, Section 5 concludes and presents some future research suggestions. In addition, it should be noted that this article was financially supported as part of the research project ZP UNIRI 2/17 for which full acknowledgement goes to the University of Rijeka.
2. Literature Review
As already stated, the two most common sources for extracting data when calculating ratios are derived from the balance sheet and income statement . Therefore, a financial ratio is nothing more than a value indicating the relationship of one accounting position relative to another. While theoretically it is possible to calculate an infinite number of ratios, fundamental analysis puts more emphasis on their interpretation rather than proliferation. Nevertheless, interpreting financial ratios without considering their proper context may deliver misleading results, ultimately causing more harm than good .
Ever since Graham and Dodd  laid the intellectual foundation for intrinsic valuation with their insistence on in-depth financial statement research, fundamental financial analysis has been used as a complex set of analytical tools and techniques for determining the underlying value of an asset, a company or an entire industry. In effect, ratios were used to assess the financial health of companies even before that , but the systematic approach on which Graham and Dodd insisted was further pursued and developed by a number of authors, most notable among them being Altman , Lawder , while simultaneously widely popularized in practice by the Oracle of Omaha – Buffett .
According to Kristy, about 200 ratios are currently in use by finance professionals . In order to streamline the large number of ratios available for analysis, Andrew & Schmidgall  identified five main categories of ratios based on the type of information they provide – liquidity, solvency, profitability, activity and operating ratios. While there is no standard number of ratios comprising each category, it is worthwhile to note that each category evaluates a very specific aspect of the business .
Despite the universal appeal of fundamental financial analysis, a surprisingly small number of studies have been conducted with the aim of using this technique on a specific segment of the economy. Those investigations have mainly focused on certain geographical areas like Europe [11,12,13] USA and Japan , China , New Zealand , South Africa  and so on. Others have targeted specific industries, such as finance and banking , automotive , health , and electronics . Tourism, or certain aspects of it, have also been examined, namely casinos , lodging [22,23], and clubs . Hotels and restaurants have also been examined, either as separate sectors , compared to one another , or in combination with other tourism segments, such as leisure  or amusement and airline transport .
Finally, even though tourism as a sector features prominently in the Croatian GDP with a total share of 18.1% as of 2015, while regularly being targeted by foreign portfolio investors  hotel industry as its driving force has not received nearly enough attention from the scientific community. A recent study by the European Commission remarks on the defining characteristics of the Croatian hotel industry; namely, being “dominated by large establishments in the low-mid price range” in combination with “high seasonality of arrivals...limits its spill-over effects to other sectors” . Furthermore, certain financial aspects have been more thoroughly examined than others, such as the impact of capital investments on the hotel sector , the performance of small and family-run hotels , the financial risk management challenges present in the hospitality industry , and more recently, e-tourism demand modelling .
3. Data and Methodology
This study used secondary data drawn from the Croatian Financial Agency (FINA) database for the period 2007-2017. The data is delivered in the form of cumulative annual financial statements for all companies in Croatia which have classified their operations as hotel accommodation (NKD code 55.10). In effect, the available data is therefore presented as annual aggregated balance sheets and income statements for the entire hotel industry in Croatia. It is important to note that due to the data collection methodology net income and net losses appear twice, once as part of the balance sheet and the other time as part of the income statement. Moreover, in order to correctly calculate those financial ratios where net income appears, the values have been adjusted by subtracting the correspondent net losses first.
Ten ratios and one financial metric are used to assess the various financial characteristics of the hotel industry and use them as a measure of financial risk management, presented in Table 1. It should be mentioned, however, that different naming conventions exist for different ratios across countries, which is why, for the purposes of this study and in order to reduce any possible confusion, their most generic, formula-derived names have been used whenever possible throughout the text.
Four different types of analyses were used in this study. First, the authors present a descriptive statistical analysis of select key positions in the aggregate financial statements with both central tendency and dispersion measures calculated to better capture the nature of each item. Second, horizontal and vertical analysis was performed as a preparatory step towards ratio analysis. Third, the above-mentioned financial ratios were computed for each year under observation. After calculating the financial ratios, the authors proceed with a descriptive statistical analysis of each ratio for the time period under observation. Finally, the authors perform univariate time series analysis on each ratio. The main limitations of this approach can be found in the relatively short time horizon, the low frequency of observations and the unavailability of data for similar industries as part of the wider tourism sector – such as restaurants, gambling, or amusement, for instance – that would serve as benchmark for comparing the ratios across the board and a catalyst for a more holistic financial risk management approach.
4. Fundamental Analysis Results and Discussion
The first part of the analysis presents the descriptive statistics for select positions in the aggregate balance sheet and income statement. Table 2 presents the mean and the median as the two most descriptive central tendency measures as well as the standard deviation and minimum and maximum values as the two most applicable dispersion measures, for select items presented in the aggregated financial statements, all in HRK. The last column includes the compound annual growth rate (CAGR) calculated as the geometric mean.
Although the data on variability of the financial positions provides a wealth of information, the compound annual growth rate proves the most revealing. It is evident that while the entire sector has been buoyed with strong growth, the bottom line in absolute terms is that the entire industry, on average, was reporting negative results for the period.
Horizontal and vertical analysis
The second part of this section presents the results from the vertical and horizontal analysis performed on the cumulative financial statements over the observed period. While presented in a separate subsection as part of this article, both horizontal and vertical analysis are considered an integral part of fundamental financial analysis and are often conducted as preparatory steps prior to performing ratio analysis. In effect, certain values obtained through these calculations are nothing more than the ratios in question.
Horizontal analysis is mainly used for investigating the appearance of trends within individual positions in the balance sheet and income statement over time. Table 3 displays a comparative study of the historical data during the observed period for select line items expressed through annual percentage change. A strong upward trend in most of the items shows the expansion of the hotel industry in Croatia in terms of both total assets and total revenues. A couple of consecutive financial periods with negative results may signal higher risks which is why horizontal analysis provides a time-series pattern upon which more complex financial risk management measures can be undertaken, regardless of the size of the object being analyzed – be it a company or an entire sector. For instance, the period 2010-2013 shows a downward pressure on a number of key positions such as short term financial assets, accounts receivable, and retained earnings, as the aftershocks of the Global Financial crisis from 2007-2008 spilled over in the tourism sector.
In stark contrast to horizontal analysis, vertical, or common-size analysis examines each line item in relation to a baseline figure. For the balance sheet, total assets were taken as the baseline figure, whereas for the income statement, total revenues were used as the reference in terms of which all the other expense items were presented. As evident in Table 4, tangible assets comprise the bulk of long-term assets with proportions ranging from 78.05% in 2007 and steadily falling to 74.42% in 2017. Nevertheless, these percentages correctly depict the fact that in a hotel industry most hotels need land and buildings on prime locations in order to attract tourists. This claim is further corroborated by the growing proportions of real estate investment which reach 2.37% of total assets by 2017, pointedly as another risk measure to counteract the deteriorating proportion of buildings which fall to 45.8% by 2017 as well. Perhaps surprisingly, off-balance sheet items become a prominent feature of the balance sheet as time progresses, starting at 3.23% in 2007 and finishing at 6.09% in 2017.
In effect, most worrisome is the fact that from 2007 until 2015 total expenses outstrip total revenues even though the operating margin remains positive for the entire period. One of the reasons for this is that a number of hotel companies have not yet finished the transition process and are still under the auspices of the state, which is why they are operating at a loss, yet still remain in business. However, even though still greater than net income in absolute terms, net losses are decreasing, a sign that even those companies lagging behind in transformation are adopting well to a market-oriented economy.
The second part of fundamental financial analysis involves the process of comparing key financial positions from the balance sheet and income statement relative to another. For each ratio, correspondent values were computed for the entire observation period, while Table 5 presents only their descriptive statistics as well as the compound annual growth rate (CAGR). In order to make the analysis as precise as possible, the amounts for net income and net losses were collapsed into one by adding them together. The ratio analysis discovers certain financial aspects of the hotel industry which run contrary to the popular belief.
First, Net working capital, a telltale measure of short-term liquidity, is negative during the entire time horizon of the analysis, a fact corroborated by both the mean and the median. Moreover, a strong 4.66% compound annual growth rate may significantly widen this gap if such trend continues. The current ratio is below 1 and in line with the above claim that the Croatian hotel industry overall does not have enough resources to service its current obligations. The financial stability ratio is in turn relatively high with a mean of 1.15, indicating that the contribution of working capital is low, threatening the financial stability of the entire sector.
Second, from a solvency perspective, the debt ratio with a mean value of 0.54 indicates that a little bit over half of the sector's assets are financed by debt. This is confirmed by the mirroring equity ratio with a mean value of 0.45. The financial leverage, or debt-to-equity ratio, measures the level of debt used to finance the industry assets relative to the value of shareholder's equity and represents one of the most important financial metrics as it indicates potential risk. In this case, a value of 1.21 signals a relatively high risk of bankruptcy if tourism demand declines.
Third, activity ratios measure the overall efficiency in terms of assets used for generating revenues. The Total asset turnover ratio's mean value is 0,21, indicating that for 100 HRK in assets only 21 HRK are generated in sales. The efficiency ratio, being below 1, confirms that the entire sector operates at a loss. The operating activity ratio, with a mean value of 1.06, indicates that the hotel business, net of all other burdens is in fact profitable, but not by much.
Finally, the profitability ratios show that at the industry level, the hotel business has a negative net profit margin of 5%. Both ROA and ROE are negative as well with -0,01 and -0,02, respectively, indicating poor use of assets and stockholder's equity.
In order to better understand the characteristics and behavior of each ratio subsample, a univariate time-series analysis was performed. The univariate tests show that the Total asset turnover ratio, activity ratio, net profit margin, ROA and ROE are all significant at p 0.01, while the equity ratio is significant at p 0.05. Both Net working capital and financial leverage are significant at p 0.1. The coefficient of determination is the highest for the activity ratios, closely followed by the profitability metrics. While univariate time series analysis is an appropriate statistical technique, it must be noted that the time period under observation is relatively short which may affect the underlying statistical assumptions.
5. Concluding Remarks
Various types of fundamental analyses have long been used by investors and financial institutions to assess companies' health and performance based on the data contained in their financial statements. Using cumulative financial statements data for the entire hotel industry in Croatia from 2007 to 2017, this study employed four different types of analyses – descriptive statistics, horizontal and vertical, ratio, and trend – in order to better assess the potential for any financial risks occurring based on the information embedded in the balance sheet and income statement.
In general, this paper reveals a number of findings that run contrary to popular belief. While tourism as an overarching sector has experienced spectacular growth in Croatia for the period under observation, the hotel industry has struggled to keep pace. This is especially obvious with regards to the industry's Net working capital which has been negative during the entire time, signaling an overall inability to use assets in an efficient manner. Poor liquidity appears to be a sector-wide problem and may indicate a general need for additional capitalization, a problem which may be solved by privatizing the remaining hotels under full or partial state ownership.
Another warning sign is the fact that from 2007 until 2013 total expenses were higher than total revenues. Given that this trend was reversed in the subsequent period, the negative results can be attributed to the aftershocks felt following the Great Financial Crisis. Nevertheless, poor utilization of available assets signals problems with operating efficiency and poses a constant risk to the sector. This, in turn, affects the overall profitability of the hotel companies and makes them an unattractive investment proposal for potential suitors. In terms of indebtedness, the sector is highly leveraged when compared to its peers, again signaling a potential source of risk if debt accumulation continues with the same pace as before.
From all of the above it can be concluded that fundamental financial analysis, combined with descriptive statistical analysis, can provide a holistic financial risk management approach for industries as above. Its biggest advantage is that the study can be replicated on other sectors and industries within the economy, pending available data.
Nevertheless, while revealing a number of specific patterns, this study is not without its limitations, especially in terms of the short time series horizon, the low frequency of data as well as the lack of available information on similar industries which can serve as a benchmark for comparative analysis.