Finances are one of the most important and difficult aspects of property management. If you are hoping to improve the financial health of your business, it is imperative to know the property management accounting basics to help you create the thriving business that you desire.
Property Management Accounting Fundamentals
What is property accounting? Property accounting is the process of preparing, reviewing, and maintaining the financial records of a rental property, be it residential or commercial. Property management accountants typically perform accounting tasks for rental properties. Though, there are also a number of property management accounting software that you can use to stay on top of your financials.
Whether or not you employ an accountant, use accounting software, or do it yourself, it is essential to understand the basics of property management accounting. In doing so, you can have a better grasp of your overall financial health and avoid expensive miscalculations.
Types of Accounting Methods
How do you do property management accounting? The first step is to choose the basis of accounting you will use. There are three types of accounting methods: Cash Basis, Accrual Basis, and Modified Accrual Basis. Most property owners use either the Cash Basis or the Accrual Basis.
Cash Basis vs Accrual Basis
One of the most difficult decisions is whether to use a cash-based or accrual-based account system. The basic difference between the two is that cash accounting records transactions at the time that money actually changes hands. Accrual-based accounting records transactions at the moment of completion of a service.
Most small businesses use cash accounting due to its simplicity. But, unlike accrual accounting, cash accounting does not give you an accurate look at your financials. Using a cash-based method can lead you to believe that you have more money than you actually do. This is why accrual accounting is considered the best method. It is also the only method that complies with the Generally Accepted Accounting Principles (GAAP).
Of course, you should still consider your own circumstances to find the best system that suits your needs. Additionally, always be sure to reference local laws when choosing.
Setting Up Your Chart of Accounts
A chart of accounts is your master list of all accounts. You use it to classify transactions as well as your assets and liabilities. Accounts are typically classified according to one of five primary types:
- Asset. These are items that you own that have value. Assets can be further grouped into Current Assets and Fixed Assets. Current Assets are assets that you can easily and quickly liquidate (in 12 months or less). Inventory and Accounts Receivable are examples of a Current Asset. On the other hand, Fixed Assets are the opposite. They typically have a lifespan of 12 months or longer. Examples of Fixed Assets include Land, Machinery, and Vehicles.
- Liabilities. These are your financial obligations. In other words, liabilities are money that you owe. These can be further categorized into Current Liabilities and Long-Term Liabilities. The main difference is that you can pay off Current Liabilities in 12 months or less and Long-Term Liabilities in 12 months or more. Accounts Payable is an example of a Current Liability, while Capital Leases and Long-Term Loans are examples of Long-Term Liabilities.
- Equity. This is your financial share of the business. Equity can take the form of cash or assets such as equipment and buildings. Retained Earnings is an example of an Equity account.
- Income. Otherwise known as revenue, this is the money that you earn. Examples of Income accounts include Rental Income, Interest Income, and Sales.
- Expense. This is the money that you spend on bills. Examples of expenses accounts include Utilities, Maintenance Expense, and Office Supplies.
Single- or Double-Entry Bookkeeping
Property management bookkeeping can fall under one of two kinds: Single-entry or double-entry.
As its name suggests, single-entry bookkeeping records only one entry per transaction. You enter the account title and input either a positive or negative amount, depending on whether you earned or spent money. This type of bookkeeping is only recommended for small businesses with not much activity.
Double-entry bookkeeping, on the other hand, records two entries per transaction — one in the debit column and the other in the credit column. Most property owners use this method of bookkeeping because you can accurately determine your profit or loss and easily catch discrepancies or fraud. Additionally, with double-entry bookkeeping, you can prepare financial statements straight from your books.
Understanding Debits and Credits
A common misconception about debits and credits is that the former is always positive while the latter is always negative. This is not the case. Here is what you should remember when it comes to debits and credits:
- Raise asset and expense accounts
- Reduce liability and equity accounts
- Reduce asset and expense accounts
- Raise liability and equity accounts
For example, you charge a tenant, Bob, $1,000 for rent. Under the accrual basis of accounting and using the double-entry bookkeeping method, you would debit Accounts Receivable by $1,000 and credit Rental Income by $1,000. Keep in mind that Bob has yet to pay rent. You have only just charged him. This is why you have increased your Accounts Receivable — because you are expecting to receive money from Bob.
What Is a General Ledger?
A general ledger, known alternatively as a nominal ledger, is where you record transactions. The accounts you input in your general ledger follow your chart of accounts. Your general ledger acts as a master repository for all of your accounting data, financial or non-financial. Major financial statements are obtained from your general ledger.
What Are the Essential Financial Statements?
Although these can vary from organization to organization, there are three fundamental financial statements that you should understand: the Balance Sheet, the Income Statement, and the Cash Flow Statement.
- Balance Sheet. This financial statement reports your business’s assets, liabilities, and shareholders’ equity. When preparing your Balance Sheet, it is important to keep the following equation in mind:
Assets = Liabilities + Equity
- Income Statement. This financial statement lets you know how much money you earned in a given time period. It deducts your total expenses from your gross revenue to arrive at your net profit or loss. Typically, businesses prepare this statement every month and year.
- Cash Flow Statement. This financial statement reports the amount of cash (and cash equivalents) that goes in and out of your business.
You can try to generate these financial statements on your own, but it is better to receive help from an accountant. Alternatively, many property management accounting software come with the ability to generate financial statements in real-time.
Which Property Expenses Are Deductible?
Part of property management accounting procedures is knowing which expenses are deductible. This will allow you to get a good handle on your taxes, though you may still need help from a tax professional. Some of the expenses you can deduct include but are not limited to:
- Management fees
- Repair costs
- Legal fees
- Real estate taxes
- Mortgage interest
- Professional accounting expenses
- Tax preparation expenses
- Maintenance and cleaning supplies
The IRS website also provides small businesses with plenty of information about real estate income and deductions.
Additional Rental Property Accounting Tips
1. Open a Business Account
Separating your personal affairs from your business affairs is paramount to success. Thus, you should open a business checking account for your rental property. In doing so, you can avoid mixing up your own finances with your rental property finances. If you are managing more than one property, it is a good idea to open a separate account for each one. This way, you can track each property’s finances easier.
2. Focus on the Reserve Fund
Thinking ahead is one of the qualities of a successful property manager. Large future projects should always be a consideration while budgeting.
Setting up a reserve fund will prevent you from having to raise resident fees unexpectedly for an unexpected repair, and allows you to save up for expensive repairs and projects both expected and unexpected.
3. Budgeting with a Big Picture View
Successful accounting occurs when you not only look ahead to future expenses but when you also look behind. Looking at past budgets can give you a good sense of the areas that need to be changed on the budget as well as the areas that have been managed well. Always keep the past three years of budgets on hand to reference as you work on the current year.
4. Reconciling With Your Bank Account
Bank reconciliation is important because it is a method of checking and double-checking your finances. Not only does it protect your business in the event of an audit, but it can also help you find bank errors, duplications, or missing items. This is one of the best ways to ensure a perfect report. Although it can seem tedious to some, reconciling your bank account each month only takes a couple of hours and can even be set up to be automated.
5. Research State Laws
When managing property finances, it is extremely important to learn the rules and then abide by them. Whether these laws are primarily on a local or a state level, successful property management accounting requires research of the rules and careful implementation as well.
Property Management Accounting Summary
How do you keep books for a rental property? Start by choosing your preferred accounting method, and then move on to setting up your chart of accounts. From there, you can either go with single-entry bookkeeping or double-entry bookkeeping. For double-entry bookkeeping, record two entries per transaction — one for debit and one for credit — in your general ledger. From your general ledger, you can then prepare your financial statements.
If you need help, you can seek property management accounting services from professionals or invest in accounting software. Condo Manager provides HOA management companies and self-managed communities with comprehensive solutions at an affordable rate. Call us today at (800) 626-1267 or contact us online for a free demo.
- HOA Accrual Accounting: Why It’s The Best For HOAs
- How To Find And Keep Good Rental Tenants
- 5 Ways The Condo Manager Software Improves HOA Communication