Bottlenecks to Profitability: Poor Accounting
Welcome to The Property Management Show’s second episode in our multi-episode series entitled Bottlenecks to Property Management Profitability. Today, we’re talking about property management accounting.
We’re joined by Daniel Craig from Profit Coach. He is sharing some juicy details on property management accounting and how it impacts profitability. There’s a lot that can go wrong for property management companies when it comes to accounting, and we’re talking about what you should be doing to get to profitability, and the tools you need to get there.
Most of you probably know Daniel. But if you’re a new listener, let’s hear a bit about why his opinions on accounting matter so much.
Property Management Accounting:
Introducing Daniel Craig and Profit Coach
Daniel came from a traditional accounting background. He has always done business with the intent of owning outcomes for the entrepreneurs he works with. Daniel understands that entrepreneurs are in business because they want to be free. They’re seeking freedom in finances, time, relationships, and purpose. Most entrepreneurs think of accounting as a simple way to file taxes and comply with the IRS.
But, accounting is so much more than that, and Daniel’s passion is to show entrepreneurs how accounting can help you know if you’re achieving your goals. It can help you measure financial performance, get clear on where you want to take your business, and achieve your goals. Daniel and his company want to help you use your resources to achieve your purpose.
He soon realized the property management industry is a great business to be in, and a lot of companies were doing great. But, he also noticed a trend where a lot of property management owners were working hard and not making a lot of money.
His goal is to help the industry rise and break through to larger profits.
Daniel worked with Lead Simple to do a financial benchmarking study for the property management industry, and NARPM noticed. They enlisted Daniel’s help to write national accounting standards for the property management industry.
The Purpose of Property Management Accounting
A lot of people find accounting to be less than exciting. As the owner of a property management company, you might think of it as dirty work that someone else in the company is responsible for doing. You just want to know your financial statements will keep you out of trouble and appease the IRS.
But, the primary purpose of accounting is to measure financial performance. You’ve probably heard the phrase ‘what gets measured gets managed.’ Daniel believes that anything which gets measured, also gets improved.
You’re in business to make a profit. Accounting measures that goal and gets you clear on your company’s financial performance.
Bad accounting creates bottlenecks to profitability and prevents clarity. You need that clarity.
Remember this: Clarity Drives Commitment and Commitment Drives Change.
If you have goals but you’re not clear about where you are today, then you can’t possibly know what it will take for you to achieve those goals. You cannot allow yourself or your company to stay in a financial fog. It leads to uncertainty and keeps you noncommittal. If accurate accounting can deliver clarity, you will be able to make a commitment and reach the change that’s necessary for you to achieve the outcomes that you want.
People think either they’re profitable or they’re not. But, it’s not black and white. There are degrees of profitability.
If you’re not making money – that’s an obvious bottleneck. But, if you’re not making as much as you could be, that’s another bottleneck and you might not know how to solve it.
PM Grow Summit Sponsorship
Assessing Your Need for Accounting Clarity
It’s possible your property management company isn’t making any money on management services but you don’t know it because your brokerage division or maintenance division is bringing in all the profits. You need to know the performance of each division. If you’re not making good money managing properties, why aren’t you?
Assess where you are with your accounting by answering these three questions:
- What is your average profitability over the last 12 months? If you don’t know the answer, you have a bottleneck to profitability. Or, you’re not paying attention or calculating your metrics. This is a number you need to know. Having money in the bank doesn’t mean you’re profitable.
- Do you know the relative profitability of the various divisions in your company? You should. It’s important to separate the profits coming in from management, brokerage, maintenance, and any other ancillary businesses. You need to know what each division is doing and if you don’t, there are reporting issues causing bottlenecks.
- Do you regularly review your financial statements and gain insights that change how you do business? If you don’t change as a result of looking at your financials and the statements aren’t clear, you have an accounting problem. Those statements should drive change in your organization.
Average Profitability in Property Management
The benchmarking study last year demonstrated that the average profitability shown on the books for property management companies was 10 percent. That’s okay for a small business. When a second level of analysis was conducted and owners were asked how they compensate themselves as owners, it was discovered that not all owners pay themselves a market-based wage. This can affect the reliability of your financial statements.
A lot of owners pay themselves sub-par wages, if they pay themselves at all. The results of the benchmarking study were adjusted to show an average profitability of six percent. That’s not great, and if you listen to a lot of small business experts, you’ll know that five percent profitability is necessary just to cash flow.
So, a lot of you are probably working off the belief that you’re making a great profit when you actually aren’t.
Far too many people aren’t making enough money.
Don’t forgo taking a salary just because you think you’re fine with the leftovers. As an entrepreneur, ask yourself if that’s why you’re in business. Salaries compensate owners for their time. Beyond that, you want to build an asset that accrues value outside of what you’re putting into the business. Pay yourself a salary so you don’t distort your financial picture.
Baseline Mechanics: Adopting the NARPM Accounting Standards
The most practical thing you can do to achieve more clarity is to adopt the NARPM accounting standards in your business. This is going to be the framework to provide a common language for property management entrepreneurs. You can get clarity on the performance of your business and compare it to the way other companies are performing.
The accounting standards have four components. We’ll discuss three of them here, and the fourth will come later.
- You need a standard chart of accounts. This is the baseline. You need to organize the data and transactions of your company into a framework. Organizing financials this way will help you get clear on your business performance. It helps you to see the forests from the trees. Your financial statements may have 50 accounts or they may have 400 accounts. In any case, you need to see high level categories. There should be five to six key categories and expenses. Look at how those are tracking over time and then drill down into specific accounts when you need to see what drives any noteworthy variances.
- Attach a set of metrics to those standards. This is critical. Specific definitions are used so you can build off your chart of accounts. Do you know your revenue per unit? When you start to peel back the onion layers, you can calculate your metrics in a consistent way. It facilitates these true apple-to-apple comparisons between you and the benchmarks.
- The third component is a set of standardized benchmarks which are used to see how your company is performing compared to others. You can see how much is being spent on rent and how that compares to national averages or other property management companies. You can absolutely get clarity by comparing.
Those are three primary components of the NARPM accounting standards. It’s a high level overview of the system that helps you establish financial clarity and accountability. Every residential property management company should implement them, and you can share them with your accountant. You can get the accounting standards free as a NARPM member and once you have them, you can start the initial steps of adopting a chart of accounts, using metrics definitions, and then comparing where you are.
Customizing the Chart of Accounts for Your Company
Part of adopting the NARPM standards is the freedom to customize your own chart of accounts.
Everyone needs different levels of granularity. You can add details or not use all of them. Sometimes people look at a chart of accounts and it’s not what they want. That’s okay; you’re only going to use the structure. You don’t need all the granular accounts. Some people want them, but not everyone. Follow the customization procedure.
Key Property Management Accounting Pitfalls to Avoid
Whether you’re just starting a property management company or you’ve been doing this for a long time, there are several key pitfalls that are fairly common.
First, there’s tolerating a lack of clarity.
Don’t tolerate it. You need the clarity, so don’t let yourself stay in a financial fog. Hold your finance team accountable for delivering accurate, timely, trustworthy, and clear statements.
It’s also a big mistake to not pay attention to your numbers. As the entrepreneur, you don’t have better things to do. Have you listened to our episode “Bottlenecks to Profitability: Focusing on the Wrong Activities”? In that episode, Kasey McDonald breaks down how to get clarity on tasks that truly need your attention. Your financial statements are the most important use of your time. Dial into your finances and see what the numbers are telling you. Then, use that message to enact change.
The biggest mistake is not holding yourself accountable to your numbers.
During Daniel’s presentation at PM Grow in Austin, he asked a few questions:
First, he asked how many people wanted to grow the number of doors they managed. Everybody raised their hands. Then, he asked who wanted to grow profits. Again, every hand was raised.
Then, he asked how many people had a financial game plan articulating specific and measurable growth and profit goals for the end of 2019 that mapped out monthly door commits, anticipated churn, and financial implications month by month.
Perhaps 10 percent of the room raised their hands.
That’s because we think we have better things to do. But, we don’t. Hold yourself and your team accountable to your financial numbers. Bring leadership to those goals and make this something you engage the whole team with.
Accurate Bookkeeping Standards
You must be doing accurate bookkeeping. The standards will only work if everything is coded appropriately. So, a few things to note:
Understand the cadence of financial reporting for your company. Define the timeframe. How many days after month-end do you want books closed out? Define it and organize all the planning and the meetings that should come once the reports are available.
Reconcile the bank accounts. Your bookkeeper should be doing this so your books are reconciled to your bank accounts. It seems like a no-brainer, but reconciliations are important on both the trust and corporate side. If you’re not reconciling, you don’t know if statements are accurate. It’s critical that someone is doing a check.
Make sure there’s a hollow assessment of transaction coding. From time to time an owner or someone in a high level finance position should print out detailed Profit and Loss statements and review the details. Make sure it’s accurate.
Risks of Bad Accounting
Low profitability is the main risk to doing things the wrong way with accounting. But, that’s not the only risk.
One of the more dire risks is that you’re exposing yourself to significant losses. This leads us to the fourth component of the NARPM accounting standards which we did not address earlier: a financial controls guide. This is the proper flow of money. It’s your checks and balances. Internal financial controls are critical. You don’t want to wake up one day and realize you’ve lost a lot of money.
Remember that as a management company, you’re not responsible for your own money; you also have millions of dollars of trust funds that you’re managing for your clients. If you don’t have checks and balances in place thanks to great accounting, you could expose yourself to a serious nightmare.
Daniel has talked to a former owner who lost almost a million dollars due to fraud and internal errors. He had to shut down.
This is horrible and sad. If you’re not paying attention to financial controls, you’re not doing yourself a favor. You’re exposed and unprotected.
The biggest risk to bad accounting might be this: you’ll find you’ve been working hard for years and years without ever realizing your entrepreneurial dreams. That’s the biggest risk.
Often, entrepreneurs don’t slow down and revisit the big picture.
Revisit your why. Why are you in business?
Get clarity about what your goals are and what kind of changes are needed to achieve your why. There’s a role for accounting to play. Map your progress and celebrate your gains.
If you have questions about the NARPM standards or anything Daniel discussed today, contact him at the Profit Coach. You can always reach us at Fourandhalf with any questions as well.