An operator or owner of a small property management portfolio has many roles. At any given point in the day, he or she can wear different hats, from leasing apartments and keeping the books to swabbing the deck. Only with the luxury of having ample staff that specializes in each facet of business operations can the stakeholder really look at the overall health of the portfolio and make critical decisions.
And if talk to most small portfolio owners and operators, you’ll find that they aren’t in the business of property management to explore their inner accountant. Number crunching isn’t for everybody and requires a specialized skill set. The forte of many property managers and owners is managing occupancy and residents with the goal of making profit.
Without bookkeeping expertise, an owner may be resigned to practicing cash accounting – accounting for expenses as they are paid and revenue when payments arrive. But that doesn’t always give a true picture of company’s health, experts say. While the business may look good on paper by only applying cash or pre-paid transactions, the real story can be much different. Invoices that haven’t arrived or been paid aren’t reflected, creating a false sense of security.
The portfolio may show a nice profit for the month using cash accounting, but a $25,000 invoice for roof repairs that hasn’t been paid for one reason or another, for example, won’t truly reflect the full obligation and how the company stands month to month or quarter to quarter.
Picture of health is within the company’s true obligations
The true health of the company lies within accrual accounting, says Kim Kowalski, vice president of SmartSource Operations at RealPage. But many smaller property owners and managers can’t always make it happen. They may overlook it or not have accurate knowledge. Or they simply don’t have time.
“Owners have so many different roles to play in a small portfolio,” Kowalski said. “They can’t be an expert at everything. And as they grow, they may be outgrowing their knowledge in accounting.”
“Many truly small businesses need accrual accounting. Good owners and investors are looking at not just what the cash balance is but obligations and pre-paid expenses out there as well, which are all accrual based items.”
Providing an apples to apples comparison of revenue and expenses
Accrual based accounting reflects of the company’s obligations, whether it be debt payments, unpaid invoices or invoices that haven’t been received for goods or services that have been fully performed or partially complete.
In the scenario of the roofing job, the work may have been completed in a given month but the property hasn’t been billed as the month draws to a close. Knowing that the bill will arrive soon and must be paid, accruing the expense on the monthly balance sheet will give investors and partners a truer picture of the company’s obligation. It might be that the expense could be accrued over two or three months if the job takes that long to complete.
Accounting for the full $25,000 bill only when it’s paid 90 or 120 days later provides a jaded view of the financials leading up to the time when cash actually changes hands.
Also, accruals often soften the blow of larger expenses that must be paid up front but can be spread over a full year. An example is an insurance premium for 12 months of coverage that is paid in full at the first of the year. Because the premium is in effect for the whole year, not just for January, it can be spread over the remaining 11 months rather than skewing the financials for the first month of the year.
On the revenue side, accrual-based accounting shows payments that are due or being split out over a period of months but may not be paid cash in hand.
“The theory of accrual accounting is you account for costs in the period the event occurs,” Kowalski said. “So you eliminate the impact of timing in cash statements, it’s the matching principal for revenue and expense. You are accruing any transactions that are occurring but have not yet been completed. If you’re halfway through a roofing project and it’s the end of the month, you should probably accrue for half of that roofing project.”
Kowalski said accrual-based accounting provides an apples to apples comparison of revenue and expenses, which “provides a clearer picture of your business’s real obligations.”
An accurate representation of a company’s operation
Smaller owners and operators who may not be able to take advantage of accrual-based accounting have an option, Kowalski says. Just as outsourcing accounting can help portfolios scale as they grow, it can offer clarity into a business’s health by letting experts perform accrual based accounting.
SmartSource Accounting offers a full service, back-office management solution for multifamily owners and operators that includes accrual-based accounting. Once the accounting team learns the month-to-month pattern of expenses and revenue for the portfolio, the accounting goes like clockwork. Stakeholders will begin to see the shape of the business.
“We understand accrual accounting and we can book the appropriate entries to make sure you are recognizing expenses in the correct period,” Kowalski said. “As a result, you get reporting that more accurately represents your company’s operation on a monthly basis.”
Learn how SmartSource Accounting can give you a clearer view of your property’s accounting performance.