As a rental property owner, you have made a significant investment and understanding its financial performance is essential. Each month, you receive financial statements from your property management company. These statements provide a snapshot of how your investment is doing, showing income, expenses, and overall profitability.
However, if you're not familiar with accounting, these financial statements can be confusing. This article aims to make it easier for you to understand and interpret your monthly financial statements. By the end, you’ll have a clearer picture of your property's financial health and know what to look for when reviewing your statements.
Key Takeaways:
✔ What Accounting Method is Being Used: Knowing the difference between cash-based and accrual-based accounting is essential. Accrual-based accounting records revenue and expenses when they are earned, incurred or invoiced; cash-based accounting records revenue and expenses when cash changes hands.
✔ Key Components of Statements: Understand the differences between an Income Statement and Income Payout Statement. The Income Statement shows profitability using accrual accounting, while the Income Payout Statement reflects actual cash flow during a given period. Given the difference in accounting methods, reported revenue and expenses will not always align.
✔ Verify Reporting Periods: Always check the dates covered by your statements to ensure you understand the specific financial activities included. This way you can understand if there are gaps from previous reporting periods, or if there is revenue or expenses that have been recognized, but not paid.
✔ Review Revenue and Expenses: Analyze revenue recognition and expense reporting to assess profitability and identify cost areas that might need attention. Use available tools, such as the Resident Portal, for additional transaction details.
✔ Understand Cash Flow: Differentiate between net income (profitability) and actual cash flow. This helps you manage liquidity, plan for expenses, and understand the financial stability of your property.
✔ Communicate with Your Property Manager: Maintain open communication to clarify any questions or inconsistencies in your statements. Regular dialogue ensures you stay informed and can address financial issues proactively.
Understanding Methods of Accounting
Before we dive into the different types of statements, it’s important to understand that how financial information is presented depends on whether the method of accounting in which it is recorded is accrual-based or cash-based.
Cash-Based Accounting
Cash-based accounting records revenues and expenses only when cash transactions occur, without regard to when revenues are earned or expenses incurred. This approach simplifies financial reporting by focusing solely on actual cash flows in and out; revenue is recognized when cash is received, such as rent payments from tenants, and expenses are recorded when cash is paid, such as utility bills or maintenance costs.
While straightforward, cash-based accounting may not accurately reflect the timing of income generation and expenses, potentially leading to discrepancies in assessing the true profitability and financial health of a property over time.
Accrual-Based Accounting
Accrual-based accounting records revenues when they are earned and expenses when they are incurred, regardless of when cash is received or spent. This approach adheres to the matching principle, aligning expenses with the revenues they generate to better reflect the true costs and benefits associated with business operations.
For example, rental income is recognized when it is earned (i.e., when tenants owe rent), regardless of when the actual payment is received. Similarly, expenses like property maintenance or management fees are recorded when incurred, not necessarily when paid.
By recognizing revenues and expenses when they are earned or incurred, rather than when cash changes hands, accrual accounting offers a clearer view of profitability and financial health over time.
Why Accrual-Based is Best
The accrual-based method is preferred for property management accounting primarily because it provides a more accurate and comprehensive view of the financial health and performance of rental properties over time. Here are a few key reasons why:
- True Financial Picture: Accrual accounting ensures that financial statements reflect the true costs and benefits associated with operating rental properties. This includes revenue earned but not yet received (e.g., rent owed by tenants) and expenses incurred but not yet paid (e.g., maintenance costs). It provides timely insights into financial activities and trends, and facilitates more effective tracking of outstanding receivables and payables.
- Better Financial Planning: By recognizing revenues and expenses as they occur, accrual accounting helps with forecasting future cash flows more accurately. This is necessary for budgeting maintenance expenses, planning for property improvements, securing financing, and ensuring sufficient funds are available to cover operational costs and investments.
- Accurate Profitability Assessment: Accrual accounting provides a clearer picture of the profitability of your rental properties. By matching revenues with the expenses incurred to generate those revenues, property managers and owners can assess the profitability of individual properties and make informed decisions regarding rent adjustments, expense reductions, or further property investments.
Key Components of Your Monthly Statements
Income Statement
The Income Statement provides a summary of your rental property's financial performance over a specific period, typically a month. It includes:
- Revenue: This is the total revenue earned from your rental property, such as rent payments from tenants and any other sources of income.
- Expenses: These are the costs incurred for operating and maintaining your property. They may include property management fees, maintenance and repairs, utilities, property taxes, insurance premiums, and other relevant expenses.
- Net Income: The Net Income is calculated by subtracting total expenses from total revenue. It shows whether your property is generating a profit (positive net income) or incurring a loss (negative net income) during the period.
With accrual-based accounting, it’s important to note that revenue and expenses reported on an income statement during a given period may not have had an associated cash transaction. For example, rent revenue may have been recognized or earned as of the first of the month, but the tenant is late paying rent so cash has not been received; or perhaps expenses like repairs or management fees were recorded when incurred, but have not been paid as of the reporting date.
This means that the Net Income reported on the income statement may not equal the income that was paid out to you by your property manager.
Income Payout Statement
The Income Payout Statement provides a detailed breakdown of the cash flows and financial transactions related to your rental property. If you have received payout or income from your rental property, this report details how that amount was calculated for distribution.
Depending on activity within the reporting period, the Income Payout Statement includes the following sections:
- Cash Flow Summary: An overview of the cash inflows (income received) and outflows (expenses paid) during the month along with a summary of future cash obligations. It shows whether there was a net increase or decrease in cash for the period.
- Revenue and Funds Received: All income received, including rent payments and any other funds collected. This helps you track the actual cash coming into your property.
- Owner Contributions: Funds injected by you as the property owner to cover expenses, fund improvements, or address cash flow shortfalls. This reflects your additional investment to support property operations.
- Expenses Paid: All bills and expenses paid, such as management fees, repairs, utilities, and other operational expenses. This shows where your money is going.
- Owner Distributions: Any profits or cash distributions disbursed to you as the property owner after accounting for expenses and reserves. This indicates how much money you're receiving from your property.
- Prepayments for Future Rent Invoices: Any rent payments received before the rental due date. Depending on your arrangement with your property manager, these funds may be held until the following reporting period to cover expenses as needed.
- Outstanding Bills to be Paid: Any expenses incurred during the period that have not yet been paid. This provides transparency for why funds were held back or helps you anticipate upcoming financial obligations.
- Property Reserve: Funds held to cover future or unforeseen expenses. This ensures funds are available for unexpected costs.
Common Questions and Clarifications
Revenue Reported on the Income Statement Does Not Match the Revenue on the Income Payout Statement. Why?
The difference between revenue on the income statement and revenue received on the income payout statement arises from how income is recorded:
- Income Statement (Accrual Accounting): Revenue is recorded when it is earned or invoiced, regardless of whether payment is received immediately or at a later date. For instance, if rent is due during the reporting period, it is counted as revenue for that period, even if the tenant pays late.
- Income Payout Statement (Cash Accounting): Revenue is recorded when funds are received from tenants as rent and from other income sources. It reflects the money that has actually come in and gone out during the reporting period.
Understanding this distinction helps property owners track both their financial performance (income statement) and cash flow (income payout statement) effectively.
Let’s look at an example to illustrate why the income statement might show higher revenue than the income payout statement.
Your property manager provides your property statements on the 10th of each month. One month, your tenant doesn’t pay rent until the 13th. In this case, the rent revenue will be recorded on the income statement because it was invoiced and due prior to the 10th. However, the income payout statement will not show this rent payment because it happened after the reporting period.
Why is Net Income on the Income Statement not the same as the amount I received as an income payout?
The difference between Net Income on the Income Statement and the amount received as an income payout is rooted in how these amounts are calculated on their respective reports:
- Calculating Net Income on the Income Statement : Net Income is calculated by subtracting all expenses (including depreciation, taxes, interest, etc.) from total revenues earned during a specific period. It reflects the profitability of the rental property based on accrual accounting principles, where revenues are recognized when earned, regardless of when cash is received, and expenses are recorded when incurred, regardless of when they are paid.
- Calculating Owner Distributions on the Income Payout Statement: Your income payout or owner distribution is determined by calculating the difference between cash inflows (rent payments, other income) and outflows (expenses paid, management fees, outstanding payables) during the reporting period.
Therefore, Net Income on the Income Statement may differ from owner distributions on the Income Payout Statement for several reasons:
- Timing Differences: Net Income includes revenues earned and expenses incurred during the reporting period, which may not align with actual cash movements within the same period. For instance, if rental income is recognized on the Income Statement but not yet received in cash, it won't be reflected in owner distributions until the cash is actually received.
- Non-Cash Items: Items such as depreciation, amortization, and non-cash expenses impact Net Income on the Income Statement but do not affect cash flow directly, leading to discrepancies between Net Income and cash available for distribution.
- Accrual vs. Cash Basis Reporting: Accrual accounting used in the Income Statement aims to match revenues and expenses to the period in which they are incurred, providing a more comprehensive view of financial performance and profitability. In contrast, the Income Payout Statement focuses solely on cash transactions, emphasizing liquidity and actual cash available for distribution to owners.
Why Does the Opening Balance Not Match Previously Reported Ending Balances?
The discrepancy between the opening balance of a reporting period and the previously reported closing balance can occur for several reasons:
- Timing of Transactions: Transactions occurring shortly before or after the end of the previous reporting period may not have been included in the closing balance. For instance, if rent payments or expenses were processed just after the cutoff date of the previous period, they would impact the opening balance of the subsequent period but not the closing balance of the prior period.
- Reporting Period Windows: It’s essential to consider the specific dates covered by the reporting period. If reports only encompass part of a month, any revenue earned or expenses incurred outside that timeframe won't be reflected. For example, if statements only cover activities from the 1st to the 15th of the month, financial transactions occurring in the latter half of the month won't be included.
- Adjustments and Corrections: Periodic adjustments or corrections to previous period balances may be necessary due to errors or updates in financial records. These adjustments can affect the reported closing balance of one period and subsequently influence the opening balance of the next period, ensuring accuracy in financial reporting.
Why are Funds Being Withheld?
Property managers may withhold funds from your distributions to cover outstanding expenses or anticipated future costs, such as upcoming maintenance or repairs. This ensures that sufficient funds are reserved to meet financial obligations without causing cash flow issues or unexpected expenses. It is recommended to connect with your property manager with any questions about withheld amounts to ensure you understand their purpose and can plan your finances effectively.
Practical Tips for Reading Your Statements
Reading your property management statements is critical for gaining insights into the financial health and performance of your rental property. Understanding these reports allows you to effectively monitor profitability, manage cash flow, and optimize returns on your investment. Here are some practical tips to help you navigate and interpret your statements effectively:
Verify Reporting Periods
Begin by verifying the reporting periods covered by your statements. Knowing the specific time frame is important for aligning financial data with actual events and activities related to your property. For example, if your statements are monthly, confirm whether they cover the entire month or a specific period (e.g., 1st to 15th). This clarity ensures that you capture all relevant financial transactions and activities.
Review Revenue and Expenses
Carefully review the revenue and expenses reported in your statements. Note when income is recognized—whether it's when rent is invoiced or received—as this affects your understanding of income inflows. Similarly, examine incurred expenses, including maintenance costs, management fees, and other operational expenses. Taking the time to review these line items helps you assess profitability and identify areas where costs may be higher than expected.
If questions arise, consider checking the Resident Portal for additional information. The Resident Portal provides transparency with access to financial records, including detailed expense listings, management fee invoices, and maintenance request details. Property managers can also directly share other reports and documents with owners.
Understand Cash Flow
Differentiate between profitability (Net Income on the Income Statement) and actual cash flow (Income Payout Statement). The Income Statement reflects accrued revenues and expenses, providing a comprehensive view of your property's financial performance over time. In contrast, the Income Payout Statement shows cash inflows and outflows within the reporting period, offering insights into your property's liquidity and available funds for distribution. Understanding both perspectives informs decisions related to managing expenses, planning improvements, and assessing financial stability of your property.
Communicate with Your Property Manager
Maintain open communication with your property manager regarding any questions or concerns about your statements. If something seems unclear or inconsistent, ask for clarification. Your property manager can provide additional insights into specific transactions or adjustments. Regular communication ensures that you stay informed about your property's financial status and enables proactive management of financial challenges or opportunities.
Final Thoughts
Understanding your property management statements and the underlying accounting methods is crucial for effective management of your rental property investments. These financial documents provide valuable insights into your property's financial health and allow you to track revenue trends, monitor expenses, and assess the overall financial performance of your investment.
Regularly reviewing your statements is important for staying informed about your property's financial status and making informed decisions. This proactive approach not only helps you identify opportunities to enhance profitability but also enables you to address challenges promptly, ensuring the long-term success of your rental property.
We encourage you to utilize the practical tips provided in this guide to navigate your property management statements effectively. Empower yourself with financial knowledge, stay engaged with your property's financial data, and leverage these insights to maximize returns and sustainably grow your rental property portfolio.
If you are a property manager or landlord who is seeking clarity on property management accounting and the financial health of your portfolio, we’re here to help! Propra offers comprehensive accounting packages that include support for monthly bookkeeping, account reconciliations, detailed financial reporting and more. Contact us today to discover how Propra can support your property management success!
