A few years ago, I spoke to an investor who owned 30 rental units with some joint venture partners.
This investor needed to keep track of the finances for her investments, so she purchased a software package called Quickbooks to enter accounting transactions and keep track of everything.
A good accounting system not only allows you to enter your bookkeeping transactions, but more importantly, it allows you to run reports that give you an inside view on how your real estate investments are performing.
Financial Reports Are Key
What sort of reports was she trying to run? Here are the 3 main types of reports that are required for a managing a real estate investment (or any business for that matter)
- Profit and Loss statement (also called an Income statement) – This report shows you if your investment has made or lost money. This is a very important report and is probably the one most people are familiar with.
- Balance Sheet – This report shows you the total of all your assets (e.g. land, property), your liabilities (e.g. mortgages, loans), and your equity (e.g. down payments, cash contributions to cover shortfalls)
- Cash Flow Statement – This report shows where you cash went and if your investments produced a positive or negative cash flow, which is different than a profit or loss statement.
These reports are like the ‘dashboard’ on a car that allows you to see how your investment is performing financially. If you don’t know how to read each of these, you should learn how. Check your local bookstore for beginner accounting books to give you a more detailed explanation.
Admittedly, this investor I spoke to was not an expert at bookkeeping, so she interviewed a few bookkeepers and hired one who said she had experience with real estate.
After some time, she tried to run reports for her joint venture partner and she discovered a problem…
All her properties’ transactions were co-mingled,
making it virtually impossible to generate
accurate accounting reports for her JV partner.
There were several issues that contributed to this problem. Here’s how I recommend to solve each one…
Problem #1 – Garbage In, Garbage Out
In the computer programming world, there’s an acronym many programmers learn early in their career – GIGO, which means Garbage In, Garbage Out. It refers to the fact that a computer program’s data output is only as good at the data being input.
This principle can also be applied to bookkeeping. Although most bookkeepers may think of themselves as being accurate when it comes to data entry, the fact is, if they aren’t working full time on your books (or worse, they have multiple clients), they will not always fully understand every receipt or transaction they handle.
If you have multiple companies, joint venture partners, and bank accounts, it can get very confusing for anyone who is not working on it every day. In addition, they may not understand the type of information you want from the reports, which can impact the way data is entered in the books.
What’s the solution? Provide up-front training about…
- The reports you expect to produce (Profit & Loss, Balance Sheet and Cash Flow Statement at a minimum)
- How you want things done (setup your chart of accounts in a way that makes sense to you)
- Constantly review the work being performed
Problem #2 – Not Enough Bank Accounts
Many investors start investing by purchasing their first few investment properties on their own. Quite often they put all the income into one bank account, and pay all the bills from that same account.
While this method technically works, it can sometimes make separating income and expenses on a per-property basis much more difficult.
For example, some municipalities will combine all pre-authorized payments coming from a single bank account (for multiple properties) into a single account debit.
This becomes a problem when you attempt to do your bookkeeping and the water bill for a particular property has changed. You have no idea what the water bill breakdown is for each property, and you have to contact the billing department to ask for the numbers. What a waste of time.
The solution for this problem (and many others) is to use a separate bank account for each property. Then all you need to do is login to your online banking, download all the transactions, and you or your bookkeeper can categorize each one.
Yes, you’ll pay extra bank fees, but the cost is insignificant compared to the time you will save constantly trying to split up the numbers across your properties.
Problem #3 – Only One Accounting File
Many investors who use Quickbooks want to run reports and display information on a per-property basis. After searching Google, they may discover a feature called ‘classes’ that allows you to do that.
What they don’t know is that one of the biggest problems with Quickbooks (that is not well publicized) is that the ‘classes’ functionality is not properly implemented for Balance Sheets. In fact, before Quickbooks 2011, it wasn’t implemented at all — only for Profit and Loss statements.
Why should this matter?
Well, if you have multiple JV partners and you decide to put all the properties into one Quickbooks file, you’ll discover you can’t run Balance Sheet and Cash Flow reports for each joint venture partner’s holdings separately.
This is a big problem because you don’t want Joe to see what Harry owns, and vice versa.
- Use a separate Quickbooks file for each company
- Use a separate Quickbooks file for each Joint Venture
So if you have 3 joint venture partners, each with different holdings, you would create 3 Quickbooks files.
If you also have a separate company holding your ‘share’ of each joint venture, you would create another file as well.
While it may seem like extra work, this is the only way to generate all 3 reports (and more) independently for each Joint Venture or each company.
Is It Too Late?
If you’ve already started using Quickbooks and have not implemented these solutions, don’t worry… the first two can be implemented at any time. However, the third one (separate files for each JV) can be a lot of work if you try to separate properties already entered in the system.
My recommendation: Start a clean file and transition to it on January 1st, but make sure you have those separate bank accounts setup for each joint venture.
These simple solutions go a long way to ensuring you can prepare accurate financial reports not only for yourself, but for each joint venture investor you may have.
Start implementing them today and you’ll be thankful at tax time when your financial reports will be easy to generate, instead of being a constant source of frustration and stress.