As a landlord, your goal is to make a profit and keep a stable income coming in quarter after quarter and year after year. But as your landlord business grows, it is often harder to keep everything straight and ensure good, organized accounting.
To help you understand your profit margin and boost it, you should consider using the slightly more complex, but ultimately beneficial accrual method of accounting. Why? And How? Here's a short guide to get you started.
What Is Cash and Accrual Accounting?
Business owners have two methods to choose from for keeping their business books: cash and accrual. The cash method of accounting records income when you actually receive the money and expenses when you actually pay the money. This method is simple, so many landlords begin with this method when they acquire their first rental unit or two.
While cash accounting is simple, it does have some drawbacks. If you get a large sum of prepaid rent money in December, for instance, your books would show a huge profit in that month but no income for the next few months. The same can be said of expenses. If you prepay your insurance for the year in January, you have a large expense in one month and then no insurance expense for the next 11 months.
This situation makes it hard to tell what your actual expenses are and what your real profit is from month to month or from year to year.
The answer to this dilemma is called accrual accounting. In this method, your business records income and expenses when they're earned rather than when the money changes hands. In accrual accounting, you would spread out that prepaid insurance cost over all 12 months, resulting in more balanced profit margins.
Why Choose Accrual Accounting?
For landlords, the accrual method makes a lot of sense. As you see above, it evens out both income and expenses throughout the year.
A property owner pays a number of expenses on an irregular basis, including property or liability insurance, seasonal maintenance, property taxes, and management fees. By spreading these seasonal or quarterly costs across multiple months, you get a better picture of what your rentals are really costing.
Similarly, you may get prepaid or post-paid income on various occasions. You may request some amount of prepaid rent, get paid previously owed rent, or have tenants that consistently pay the rent late. In all these situations, recording income when the check arrives gives a distorted report of when your unit earned money.
Banks and potential lenders also know this and may find accrual-based books more valuable for determining credit as well.
Even if you choose the accrual method for accounting in order to even out your expenses, you can still use the cash method for reporting income taxes. Since many landlords of smaller facilities aren't required to use the accrual method by the IRS, opting for it in your regular books gives you options for filing taxes under both methods.
Where Should You Get Started?
Do you think that the accrual accounting method might work better for you than your current system? Work with an experienced accountant or bookkeeper to determine if you should switch. While you can switch methods at any time, doing so at the beginning of a fiscal or calendar year is often best and easiest.
Changing accounting methods is somewhat complicated - likely involving informing the IRS - and should be done with the assistance and direction of professionals. At Quality Bookkeeping Services Inc., our accounting professionals can help you determine the best way to report all your operations. Call today to make an appointment.