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I love business systems. There's something about understanding needs, finding solutions, and implementing systems to automate a business that really get me jazzed up. While I normally get called in to help implement accounting systems for larger developers, flippers, real estate agents, and landlords, today I want to throw a bone to the smaller guys. I'm going to show you an insanely easy accounting system to use in your rental business. I know it works because I use it myself.
It should be noted that this system is quickly scaled out of. However, "quick" is relative. For purposes of this system, if you are scaling at a pace of one property per year, you will likely scale out of this accounting system within three years. It really can't support more than three properties without becoming convoluted. But until you reach that tipping point, this system will work wonders.
Before I reveal what the system entails, we need to go over some general housekeeping items.
Please keep in mind that none of the following should be taken as legal advice. I am not an attorney nor do I ever want to be one. So don't rely on my advice for anything legal!
You Must Master the Sub-Processes
Fact is, I can provide you with the sexiest accounting system out there, but it's on you to execute the sub-processes that feed the overall accounting system. The key is to hold yourself accountable to daily execution of these sub-processes. You can't let yourself get behind or you're toast!
The first sub-process you must learn how to master is record keeping. Record keeping and bookkeeping are completely separate functions of your business. Record keeping means "the keeping of your company records" whereas bookkeeping means "the keeping of your company books." One deals with the storage and maintenance of the hard copies of receipts and invoices while the other deals with the booking of your company's transactions.
All receipts over $75 should be kept per IRS standards. Receipts can be formatted as either hard copy or digitized. If you digitize a hard copied receipt, you can throw the hard copy out. I'm a proponent of keeping all receipts period. It's a good habit to get into and there's never any doubt over whether we should have booked an expense. Due to the ability to digitize receipts, this shouldn't add a large undue burden on the business owner. Snap a picture of the receipt, upload it to the receipt folder, and you're done!
Related: The Best Way to Boost Tax Savings
Every business will have a different record keeping processes and that's on you to figure out what yours is going to look like. For my rentals and business, I use ShareFile (which my clients have access to) and I have a folder called "Receipts" with children folders detailing the month and year (i.e. "09-2016"). Because ShareFile has an iPhone app, every time I have a hard receipt, I snap a picture and upload it to the appropriate folder. It's simple, and since I'm in the habit of doing this immediately upon receiving a receipt, I don't have to worry about missing documents when I do my accounting later on.
The second sub-process you must learn is segregation of personal and business expenses. Even if you aren't using a business checking account, you should open up a new personal checking account and run all of your business income and receipts through that account. For one, this accounting system in which I'm about to reveal won't work unless you do this. But another reason for adherence to this standard is that as you scale you'll be required by law to run your business this way. You may as well go ahead and build proper habits.
Master the sub-processes! Your business depends on it.
Notice that I am not telling you to master the accounting process. I'm telling you to master the sub-processes that feed the accounting process. Why? Because as you scale, you will likely find that you need to outsource your accounting processes in order to free up time to focus on your business while continuing to receive timely financial reports. Outsourcing the accounting is easy. Outsourcing the record keeping and segregation sub-processes is much more difficult. Even if you were able to outsource these two sub-processes, you will likely always still play some role in the execution of them.
So master the sub-processes! Your business depends on it.
The Nuts and Bolts of My EASY Accounting System
Now that you made it through my sub-process speech/rant, it's time to move on to the juicy part of the post. This is the accounting system I use for my rental properties. I do not use this accounting system for my business as my business requires a much more robust solution. Now, the moment of the big reveal. Are you ready?
Related: Hiring a CPA is Key to Your Success
There are three steps involved in this accounting system:
Step 1: Set up a separate checking and savings account per property;
Step 2: Make sure all income and expenses produced by your rental property flow through its checking/savings account that you set up in step one above;
Step 3: Reconcile at year end.
Three steps! That's it! It's so easy I should package this up and start a guru class where I'd charge you a small fee of $5,000 to attend and $10,000 to buy into the next class for the "insider" information. But I'm too nice, and providing value through free content is a cornerstone of my marketing strategy, so here we are.
Step 1: Set Up a Separate Checking and Savings Account Per Property
This is not a tough step but is crucial for the successful operation of this accounting system (or any accounting system). You will first want to set up a separate checking account for each property you own. If you own more than four properties, you have likely scaled out of this accounting system and need something more robust. Otherwise, you should be able to handle a handful of bank accounts.
The reason we want to set up a checking account per property is so that we can segregate income and expenses on a per property basis. We want to avoid co-mingling rental income and expenses with personal accounts or other properties. Note that the co-mingling issue becomes a legal case when you have business entities that hold property. For the purposes of this accounting system, avoiding co-mingling will simply make your life easier when it's time to reconcile everything and perform year-end accounting.
Personally, I have two distinctly separate checking accounts (complete with debit cards and check books) for my two rental properties. I make sure all income and expense items flow through the respective checking accounts. At year-end when it's time to compile my profit and loss statements, if I've done a great job at upholding the integrity of the sub-processes, it's very easy to quickly record my income and expense items.
Your checking accounts can be personal accounts, they don't have to be a business account (unless you are operating through an entity). Simplicity!
Why separate savings accounts? I'm an accountant so I like to earmark my funds for various future expenses, such as capital expenditures. Another reason for opening up savings accounts could be to hold your tenant's security deposits. Make sure to check the local rules on holding tenant security deposits in order to avoid penalties from your local municipality.
Step 2: All Income and Expenses Flow Through Your Property's Checking Account
I know I'm repeating myself, but that's how important this step is. Master the sub-process of segregating rental and personal expenses and your life will be easy. I promise!
Let me give you an example.
Early in your investing career, you wanted to keep things as simple as possible. You bought rental property and just had the income and expenses flow through to your personal account. You did a decent job of tracking everything in Excel and you know your process could be better but you are striving to keep things simple.
Related: Commingling Funds Can Sink Your Business
Now you own three properties and you hire a CPA to help you get organized and prepare your taxes. You haven't mastered the sub-processes of record keeping or segregating income and expenses. The CPA is appalled at your accounting system and charges you hundreds, maybe thousands of dollars to review your bank statements and segregate out your rental income and expenses to properly and accurately prepare your tax returns. A long time and a lot of money later, your taxes are prepared correctly and your CPA advises you to build out a more robust accounting platform.
So start TODAY! Don't set yourself up to get charged crazy fees for a CPA to sift through your old records and try to prepare your tax returns. Make it simple for everyone involved. Use one checking account per property and make sure all income and expenses flow through the property's checking account.
Step 3: Reconcile at Year-End and Relax on the Beach With All of Your Extra Time
Sounds pretty nice huh?
If you are the type of person that is scrambling at year-end to put together an income statement for your CPA, this system is made for you. If you properly segregate your expenses via the appropriate checking accounts, your year-end reconciliation will be a breeze. You'll save in bookkeeping and CPA fees and you'll be able to relax at year-end for the first time in years.
No one likes added stress and fees. Set up this system TODAY and guarantee yourself a relaxing tax season.
And remember, master the sub-processes!