We're a week into 2017 which means you've thought about or already set your New Year’s resolutions. Because you are in the business or real estate industry, you've likely heard, and potentially subscribed to, the fact that many New Year’s resolutions fall flat. Today I’m going to help you set in motion changes to your real estate accounting system allowing you to ensure your resolutions are met.
While I don't set New Year’s resolutions, I do update my goals at the turn of the New Year. The difference is that my goals are not drastic life changes and, while I certainly have stretch goals, I have action steps needed to meet all of my goals.
The key in making progress towards your goals is to take each goal one step at a time. If you take too big of a bite, you won't actually change any of your underlying habits because you'll be overwhelmed with new information and triggers.
This article will be broken into stages and will apply to literally every business owner or real estate investor out there. Read on and be enlightened!
Stage 1: No Documentation System In Place
You are operating a Stage One accounting system if you don't have any formal process to document receipts. You subscribe to the "shoebox" method and think paper receipts are critical to maintaining your documents. Or you are flipping houses and pay cash to your contractors without ever receiving any sort of receipt from them.
Stage One accounting systems subject the business owner or real estate investor to an insane amounts of risk. You have no idea how your business or investment is performing throughout the year, you can't substantiate your deductions, you're probably missing expenses come tax time, and if ever audited you'll pay a premium for the CPA to retroactively construct financial statements.
If that sounds like you, make it a goal this year to get your documentation system under wraps. I'm not asking you to implement a full blown accounting system (that will come later). All I'm asking you to do is to implement a better documentation system. Baby steps.
A key part of implementing a better documentation system is making sure all necessary documents are filed and stored. Below are suggestions on how to do that:
- From now on, no contractor performs work for you unless you have a completed W-9 form and proof of insurance. Additionally, all work and payment will be documented via a signed contract.
- You will no longer make cash payments. Checks are fine, cash is not. If you absolutely must make a cash payment, you will have a signed receipt from the vendor or contractor.
- You will utilize smart phone apps that allow you to scan receipts and store them on the cloud. One such app we suggest to use is Expensify.
- You will scan every single receipt you receive and store it on the cloud or your computer. Once you scan the receipt, you will throw out the paper copy as it is no longer needed and only provides for more clutter.
- You will create a folder hierarchy that allows you to easily find and sort receipts (we recommend creating a new folder per month and having all of those monthly receipts be inputted into that folder).
The above items are solely centered on getting you to keep better records. Notice that there is nothing in there about using spreadsheets or accounting software. Software will be absolutely pointless if you can't even document your transactions in the appropriate manner.
Ideally, you will have a streamlined documentation system in place by April 2017.
Stage 2: Documentation System In Place, No Need for Accounting Automation
This is where most real estate investors fall - Stage Two. In this stage, you are great at maintaining documentation on a consistent (monthly) basis. You utilize technology to help you scan, organize, and file your receipts and contracts. Now you're looking for a way to generate financial information so that you can measure business or investment performance.
When you're running a Stage Two accounting system, your business or investment holdings don't quite call for an automated accounting system but you do need financial information for personal and bank purposes. You'll use a combination of spreadsheets and banking techniques to make your job easier. I've listed suggestions on how to do this below:
- Create a separate checking account per rental property or business unit. Make sure all income and expenses flow through the respective account. Doing so will segregate your transitions and make it extremely easy to develop financial statements. Compare this to leaving everything in your personal account and having to sift through hundreds of business and personal transactions to create financial statements - what a mess!
- Obtain a debit card per checking account and write, on the card, which property or business unit the card applies to.
- On a quarterly basis, log your income and expenses on a spreadsheet. You can log income and expenses on a monthly basis if you choose to do so, however it is likely not required at this stage.
- On a quarterly basis, perform a bank reconciliation between what you are logging on your spreadsheet and the transactions that are recorded on your bank statements. We just want to make sure the spreadsheet has captured all transactions on the bank statement.
- Shortly after year-end, review your spreadsheet with your accountant.
As you can see, Stage Two is merely taking the document system you developed in Stage One and building out financial information. The above steps assume that you are already maintaining appropriate documentation.
Stage 3: Spreadsheets Are Becoming Hard To Manage, Accounting Automation Needed
You are ready for a Stage Three accounting system if you already have a great documentation system in place and you can pull a spreadsheet within the next one minute that will show your business's or investments’ financial position as of last month. Unfortunately, the spreadsheets are becoming hard to maintain and navigate. You are spending a lot of time writing formulas and entering data. You may even be dreading the monthly process of entering transactions into your convoluted spreadsheets.
If this sounds familiar, you are ready to develop an automated accounting system. Such a system will cost money (gasp!) but will free up your time. Time is a most precious resource and if you ever want to build a large business or investment portfolio, you will quickly realize that you need as much of your time as you can get.
Steps to an automated accounting system:
- Test our out QuickBooks Online and Xero and choose which one will be the basis for your accounting system. If you are a real estate developer or flipper, you must use QuickBooks Online as Xero does not currently have the cost tracking abilities you need for your projects. Xero, however, has a friendlier user interface.
- Link your business bank account(s) to QuickBooks Online or Xero. This will automate the posting of your transactions.
- Get a business credit card and link this card to QuickBooks Online or Xero.
- Develop a chart of accounts and learn how to book transactions, set rules, set recurring transactions, and record journal entries.
- On a weekly or bi-weekly basis, log into QuickBooks Online or Xero and record transactions as required.
You'll notice that we aren't suggesting you fully automate your accounting system at Stage Three, although we are wanting you to develop the basis for what will later be a fully automated accounting system.
Many clients ask me whether they should buy Quickbooks Desktop or QuickBooks Online. We suggest utilizing cloud technology whenever possible. The reason for this is that the cloud technology is scalable, meaning that as time goes on, more applications will be developed that will integrate with cloud based solutions, not desktop based solutions. We're so adamant about utilizing cloud technology that we no longer support the QuickBooks Desktop version.
Stage 4: Take Automation A Bit Further By Outsourcing Your Accounting
Once you reach Stage Four, you're moving up into the big leagues. The key to a Stage Four accounting system is that you are now completely offloading accounting duties to a qualified professional. You will still need to maintain your documentation, but you'll work with your professional to make the documentation process as efficient as possible.
A Stage Four accounting system gives you back your time. It's expensive, but allows you to focus on your highest value tasks while still receiving accurate and professional financial reports.
To move from Stage Three to Stage Four, you must do the following:
- Determine how much you are willing to spend on outsourced accounting. As a general rule of thumb, you should be spending around 3-6% of annual gross revenues on your accounting.
- Interview bookkeeping and CPA firms and ask about their process, who completes the bookkeeping, what types of reports they will provide you and how often, and what your involvement will be in the process.
- Hire the firm you believe will provide the most value and integrate them in your organization. Establish clear objectives and requirements.
- Within three months of outsourcing your accounting, you should largely be removed from the process. If you are still heavily involved, one of two problems is occurring: (1) your processes weren't well established prior to outsourcing your accounting and as a result it's taking much longer to build them out; or (2) the firm you've hired is the wrong fit.
Once you are largely removed from the process, you will have much more time on your hands to manage the growth of your operations, not to mention you'll totally sleep better at night.
Stage 5: Hire A Controller And Outsource CFO Functions
Many businesses make it to the stage of outsourcing their accounting functions but few make it to the stage of needing to hire a full time controller and outsource CFO functions. You know you are at this level when you are either grossing $2MM per year or seeing net profits of $1MM per year. I'm giving you this "either or" because I have several flippers/developers as clients who gross $5MM in sales but profit around $500k after all is said and done. These guys aren't quite to the stage of hiring a full time controller and outsourcing their CFO duties.
You may be wondering what the difference is between a controller and a CFO.
Think of a controller as a bookkeeper on steroids. This is someone who is great at maintaining the financial system and following and perfecting current procedures. Controllers deliver financial reports on an ongoing basis and are keenly aware of the company's financial metrics.
On the other hand, a CFO is one that helps you create financial processes and controls, strategize for the future, provide forward thinking financial perspective, help establish budgets, and lead the overall financial operations of the company. A CFO is highly qualified, usually an MBA and a CPA.
Related: Hiring a CPA is Key to Your Success
When you are looking to move into a Stage Five accounting system, hiring a controller and a CFO may seem like a daunting task. I recommend that you outsource the hiring of a controller if you don't already have an HR function in place.
I'm also going to recommend that you look into outsourcing the CFO tasks rather than bringing on a CFO full time. CFOs can often fetch salaries in excess of $100,000 annually, whereas an outsourced CFO firm may only charge you $30,000 annually. Additionally, you will be tapping into the firm's knowledge base and all of the experience they have built over the years they have been in business. This is an extremely awesome way to maintain scale while getting a ton of expertise for a fraction of the cost.
Once you surpass Stage Five, you're moving into the area of needing to establish an executive management team. Unfortunately I can't really help you with that one because I've not been there myself (yet!). But at that point, hiring a full time CFO will likely be the least of your worries.
Make 2017 Great By Taking Action
I've given you plenty of action steps throughout this article to improve your real estate accounting system regardless of the size of your operations. Remember, we don’t want to jump from a Stage One accounting system to a Stage Four accounting system even if your revenue is demanding it. It's all about taking small steps to improve the overall whole of your operation.
Of course, we offer accounting services for our clients at reasonable rates. We are more than happy to set up a consultation with you to go over your real estate accounting system at your convenience.
Best of luck in 2017!