When you first get into property management, you will need to decide between two main accounting methods: cash and accrual. Even if you don’t have an accounting background, you will need to understand these basic principles.
There are a number of differences, but the main one is that with cash accounting, the arrangement used by most property managers, recording of transactions is done as soon as money changes hands, whether that’s money that’s coming in or going out.
For example, rent received in May will be recorded as income for May, even if it is being applied to the June rent. The same will apply to any bills you have to pay for building upkeep or utilities. Expenses are recorded when they are paid, not when the bill is received.
With accrual accounting, expenses and income are recorded as they occur, not when they are actually paid. This method is about tracking transactions rather than cash flow. Rent due on a particular date, for example, is recorded when it is due, irrespective of whether your tenants are being a little late paying or not.
Accrual Accounting Benefits
- Because money going in and out is recorded in the same month as their due date, many argue that the resulting financial statements are more accurate and give a better idea of what to expect on future financial reports. For example, if you have paid a plumber for some work, the money is still earmarked and accounted for, even if the plumber hasn’t actually cashed the check yet. With cash accounting, the picture of long-term profit can be misleading.
- As a property manager, you can also use accrual accounting to record other items in your financial statements, including things like long-term assets, retirement funds and staff benefit funds.
- This method tends to suit larger property management organizations better.
- With this methodology, a business analyst can look for financial trends while cash flow statements can also be computed regularly so that everyone stays as up to date as possible.
- Because things are done in real time and you’re not waiting for actual receipt of cash to see your profits, you can look at ways to generate more income as you notice financial plateaus.
- It incorporates a number of forms of error checking that may not be present in cash accounting.
- A cash system may not provide detailed enough records for public companies and others who need to file audited financial statements.
Cash Accounting Benefits
- Cash accounting has the great advantage of simplicity. It is an easily understood system, even by those without an accounting or financial background.
- This system is often better for small property management businesses.
- It gives an accurate picture of how much cash your organization has on hand at any given moment.
- It may work well if you have no or few employees and comparatively few daily financial transactions.
- This method can often be set up without the services of a trained accountant or bookkeeper.
Ultimately, you must be consistent with whichever method you choose. It will make a significant difference to your resulting financial statements.
Which system is right for you? It’s entirely up to you and will depend on your individual organizational needs. Whichever system you choose, you must tell the IRS and get them to approve the change if you later decide to alter systems.