Bookkeeping and Accounting 101

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About This Episode

Episode #276 – Real estate investors have a dirty secret – most of them don’t know how much money they’re actually making. But small, easy improvements to accounting and bookkeeping best practices can fix that. In this episode, Coach Carson explains how he does accounting and tracks the numbers in his real estate business.

Episode Transcript

[00:00]

I’ve been teaching and coaching real estate investors since 2009, and I’ve learned a dirty little secret. Most real estate investors don’t know how much money they’re actually making.

 

[00:18]

You know that guy you met at the real estate meetup who said he was making $500 per month and positive cash flow on his rental property? Or the other investor who said they sold a property and made $50,000 in profit? They were just guessing. They don’t really know. The truth that I learned by looking behind the scenes at a lot of real estate investors is that most of them are doing a very bad job at bookkeeping or real estate accounting.

 

[00:40]

And for that reason, they don’t really understand the numbers in their business. There’s really two parts to real estate investing. There’s the part where you go out and find properties. You buy them, you get financing, you collect rent that’s playing the game. But then there’s the other part, the accounting, where you track what’s actually going on within the game.

 

[00:58]

It’s your scoreboard. And playing the real estate game without the scoreboard is kind of like watching the Super Bowl. And there’s a quarterback who throws an amazing pass. The receiver catches it in the end zone for a touchdown. The crowd goes wild, everybody’s screaming.

 

[01:11]

And then they all look up at the scoreboard, and it’s blank. No one knows if you’re winning, if you’re losing. What’s the score? What’s the point? Bookkeeping and accounting is just something I’ve gotten good at over the last 20 years as a real estate investor.

 

[01:25]

My accountant, who advises me on taxes and my business always tells me he wishes his other clients did their bookkeeping as well as we do. So in this podcast episode, I want to give you a crash course on bookkeeping and accounting. I want to teach you how to keep score as a real estate investor. Welcome to the Podcast Real Estate Investing with Coach Carson. I’m your host, Chad Carson.

 

[01:45]

You can also call me Coach. And this is a show all about helping you build a thriving rental property business so you can get out of the financial grind and do more of what matters. Before I get into the nitty gritty advice of the episode, I want to emphasize how powerful good accounting can be for you as a real estate investor. I sort of look at it like a secret superpower. It’s like you becoming Neo in the movie The Matrix.

 

[02:08]

When Neo finally got it, he finally understood what was going on around him and The Matrix. Things started slowing down. And so for you as a real estate investor, when you get it, when you know what’s going on, your business slows down. Everything that happens, every transaction, every property has a stream of numbers attached to it. Knowing your numbers is knowing the truth.

 

[02:31]

And when you know the truth, when you understand what’s going on, you can play the real estate investing game at a higher level that most investors can’t. To make that more concrete, I want to share six benefits to having good accounting in your real estate investing business. And the first one is that you understand your performance. So you understand if a property or your overall business is making cash flow, positive cash flow, how much cash flow you’re making, whether you’re getting a positive return on investment and how much of a return on investment you’re getting. And knowing that allows you to do more of what’s working and less of what’s not working.

 

[03:06]

So it’s a strategic helpfulness and it also lets you plan for the future. So a big part of what I talk about in this podcast is achieving financial independence. Well, how do you know if you can live off your properties? How do you know if you can live off of that cash flow and that income? By having good books.

 

[03:22]

It might take a while to really season your properties and really understand how well they’re doing. It might take a year or two to get some good books underneath you. But knowing that gives you confidence, it lets you have confidence. You can take that cash flow and use it and replace your salary with it eventually, or use it to reinvest, to buy more properties. So from a strategic business standpoint, it gives you knowledge that helps you improve your real estate investing business.

 

[03:46]

So the second benefit is related, but you can test strategies, the theory of the strategy and the actual performance of a strategy. So if you want to use the bird strategy and you think it can make sense, how do you measure whether that works for you or not? Whether the numbers made sense? If you want to flip a property, if you want to own long term rentals or short term rentals, that’s the strategy that works in a podcast. It works in theory, but you can test it by having good accounting.

 

[04:10]

A third benefit that I really have enjoyed over the years is that you can prune back the bad performers. The properties that don’t work is kind of like pruning in a garden or cutting off bad branches on a fruit tree. You can prune back the bad properties because the numbers don’t lie. They tell you that that property, although it seemed like a good deal in the first place, is not working right now. It’s not growing, it’s not making so much cash flow.

 

[04:31]

And so over time, we’ve strategically pruned back properties so that the properties we have left are much better in the end. And we do that by having good accounting. A fourth benefit is for those of you who self manage your properties or you just get your hands dirty and running the business. It helps you pay bills on time, it helps you collect rent on time by knowing what’s happening in real time with your bookkeeping. A fifth benefit is tax prep.

 

[04:55]

Time. So a lot of us think of accounting and bookkeeping just with our taxes, and it is a big part of it. You have to report to the federal government and the state government, in some case local governments, what’s going on with your business, and if you keep track of it, well, it’s just a necessary thing, you have to do it. We all have to pay taxes. And to the extent that you can make it easy and seamless and painless so that when you give it to your accountant to do the bookkeeping or the tax return for you is not a painful process equivalent of you handing them a shoebox, you’re actually giving them a report that you can have a discussion around.

 

[05:28]

And if you get audited one of these days, either internal audit or the IRS audits you having good books will help you make that not fun process much easier, and also make it more accurate so that they look at your books and say, okay, they did things right. And here they are, and they’re not digging and digging and digging because they look so bad in the first place. And then a 6th benefit is those of you who want to raise capital from private investors, from banks by having good books, you can show them reports. Here’s what’s going on in my business. Here’s the success of my last deal.

 

[06:00]

Here’s the success of the last few years of my business. Having good books is impressive to people who like numbers, people who are bankers, people who have private money to lend. They like to see that you know your numbers and that you keep track of your numbers. It shows kind of like you keeping a tidy shop if you’re a craft person, if you’re a woodworker or something, by you having a tidy shop shows that you take pride in your business and you know what you’re doing, and they’re more likely to give you money as a result. Now, bookkeeping doesn’t have to be complicated or difficult to understand.

 

[06:28]

I’ll give you the one on one version of how bookkeeping works. There’s really two parts. Number one are the actual books. These are your records, which used to be kept in actual books. So pieces of paper people would write down things on what’s called a ledger these days, they’re usually digital, but the books are the records of all of the transactions in your business.

 

[06:48]

So every time you spend money, every time you receive money, that’s a transaction that needs to be recorded in these records. You can keep it really simple by just using a spreadsheet. Like my wife and I have a rental property that we manage ourselves, and we just keep it in a spreadsheet. So that’s the kind of basic version of that use of Google Sheets or an Excel spreadsheet. You could also go to a software solution.

 

[07:10]

My business partner and I have been using QuickBooks for 20 years now. And I really like QuickBooks adapted for real estate investing. There’s also other software out there, some of it more customized for real estate investing. Whatever you use, the point is that you want to keep track of all of the transactions. You’ll take your bank account, you’ll take your credit card when you write checks, and you want to record them in this digital record keeping system.

 

[07:32]

So that’s part one of bookkeeping. Part two is that you need to have supporting documentation for each one of those transactions. So think about when you spend money at Lowe’s or Home Depot, you have a receipt for that money that you spent in your business. And so you’re going to have a record of that, a piece of paper, a receipt that you want to get a digital copy of that. I used to say that in paper 20 years ago, and it had in a file folder.

 

[07:55]

These days, get a digital copy of that and organize it online. Somewhere in the cloud. I use Evernote to save all of our records. You can use any other file system that works for you. You want to keep a scan copy and organize that because that’s the proof that you actually had that transaction.

 

[08:11]

So what’s not to say you couldn’t just make up a $10,000 expense in your business and make less money on paper with IRS and other people who had audit. You would know that. And so you need to be able to prove that you actually had that $10,000 expense or that you actually bought this property for what you paid for it. And so those records in your digital records need to be backed up by a record keeping system, a paperwork system that you can scan and save online. And those two work together.

 

[08:36]

The books and the supporting documentation are just two sides of the exact same coin. If you had really good books but you had bad supporting documentation, you would get in trouble in an audit. But if you had really good supporting documentation, that’s the equivalent of having, like a shoebox full of receipts, and you hand that to your CPA, that is a mess. You need to also have the records that are well organized and labeled, and I’ll talk a little bit more about how that works. So just want to kind of give you the one on one version of what bookkeeping is.

 

[09:04]

So now that you know what bookkeeping is and also why it’s so important, I want to go through five best practices on how you can implement good bookkeeping and accounting in your own business. And just as an aside, this is going to sort of be a higher level principles of how to do bookkeeping. I’m thinking about in the future doing maybe a workshop where I actually help you implement it. And step by step, here’s how you do it. Here’s how you put your books together.

 

[09:26]

Let’s set up your file system. Let’s set up your organization and record keeping system. So if you’re interested in that in the future of me doing a live workshop on that, send me an email at [email protected] or if you’re watching this on YouTube, let me know in the comments if that’s something that might be helpful for you down the road. So best practice number one is that you need to keep your personal finances and your business finances separate. So even if you don’t have a company set up yet, if you’re a new real estate investor and you’re buying one or two properties and you’re keeping them in your personal name, you still should keep everything separate.

 

[10:01]

So putting your money together, personal business together is called commingling and it’s a bigger story but it’s a dangerous thing to do. It’s a problem, it could be a problem with the IRS, with your tax services because if you are mixing up things, how do they know what’s personal and what’s business and how do they know to allow you to have a deduction and actually have expenses in your business? You can get into some trouble not getting some of those deductions in your business that you really want because you’re mixing things. So rule number one both for that reason also other reasons, if you have a company there can be some liability problems by mixing the money and so you just don’t want to do it. And it’s a really bad sloppy practice to mix your personal and your business but it can be really simple to solve this.

 

[10:41]

So best practice is just open up separate bank accounts. Bank accounts are cheaper free these days to do. You can open up a lot of them and so have a separate checking account for your rental property business. That’s part number one. You could also have a credit card just for your rental property business as well.

 

[10:59]

And I’ll give you a kind of a pro tip for beginners in the real estate investing business or small investors, if you have one to five properties, it’s small and manageable. My advice would be to have a separate bank account for each property. So if you just want to really kind of hack to keep the bookkeeping simple, do all of your transactions for that one property in that one bank account and you can even have a credit card for each property as well. And you could just in a sharpie write it on the credit card, this property number one. Property number two, when you go to Home Depot, you only spend stuff money on that property on that credit card and you only write checks for that property out of that checking account.

 

[11:36]

And so that’s a best practice just on the back end. Organizing your books, which I’ll talk about a little bit more in a second, would be so much easier if you have those separate accounts as you get bigger and I’ve kind of outgrown that for myself. In my rental property business, you have to start consolidating having one bank account or two bank accounts and then labeling those on the back end inside your bookkeeping. But a best practice for all of us is not to commingle have a separate business account. Treat that separately from your personal finances.

 

[12:05]

Best practice number two is to track everything and categorize everything. So you want to track every single financial transaction in your business. So anytime money comes in, anytime money goes out, you just want to have a record of that. And in the digital age, this is pretty simple to do. If you use a credit card, if you send digital payments, if you receive digital payments, there’s automatically a tracking of that transaction.

 

[12:28]

The problem will be if you use cash. So in old school kind of business, people would pay in cash, they’d receive in cash. It’s just not a best practice. If you want to keep good bookkeeping, it’s really difficult to track, and I’m assuming most of you aren’t trying to launder money or do something illegal or criminal. That would be the best way to avoid being able to be tracking is using cash.

 

[12:48]

But for us, we are trying to do things above board. We’re also trying to have a business that we understand what’s going on. And so doing everything digitally and tracking is much, much easier. So once you have it tracked, you have a bank statement or a credit card statement that shows all of your transactions, that’s a nice start. The second part of that, the best practice, is to categorize all of those.

 

[13:08]

So within your business, at least within my own business, I like to categorize it two separate ways. Number one by property. So I want to know each transaction, which property it was associated with. If you had five properties, you want to know that the rent on this property was this much, the rent on this property was this much, and be able to compare them to one another and also compare each property year to year. So that’s part number one of categorizing.

 

[13:30]

Part number two is each transaction should be labeled based on a category of either income or expense. And this is a bigger topic. There’s a lot of different ways to organize your expenses and your income. A simple way is just to match the IRS tax return expense categories. So you can just google that, look up business expense expense categories, IRS, and you could match those up.

 

[13:54]

It just makes it nice and simple when you do your taxes at the end of the year. But you could also do other categories that make sense for you and your business. The point is, all those transactions have to be labeled or organized. And this is really where the rubber meets the road. The work of bookkeeping is categorizing and organizing all of those transactions.

 

[14:13]

So you just want to have some sort of system. You want to stick to that system, and you also want to do this categorizing as soon as possible on the front end of these transactions, which is what I’m going to talk about in the next best practice.

 

[14:32]

The third best practice is to have a paper trail, a set of records that back up all of the transactions of your business. So, for example, if you hire a contractor to install some windows for you and a rental property, they’re going to have an invoice. So they should have an invoice before you pay them. You need to have a record their name, who they are, what work they did, how much it was, and then you pay them once they give you that invoice. That’s pretty typical.

 

[14:57]

But you want to have that best practice. And then once you get that invoice so don’t just stuff that somewhere in your car. Don’t just throw that away. You want to scan it. Take a picture with your phone and any of the online software that you use for Bookkeeping these days, QuickBooks or any of the other ones, usually have something with just an app on your phone where you can take a picture of it, scan the receipt, it gets uploaded into your bookkeeping software, and then you’re done.

 

[15:21]

If you do do it with Google Drive or something and it’s using a spreadsheet, you can just take a picture and save it in Google Drive. It’s so easy with your smartphone these days. But the point is, you want to save it somewhere, and then that gets uploaded. It’s on the cloud. You have that record.

 

[15:35]

You could throw that piece of paper away, but that you’re not done yet. The important part here, again, is organizing that paperwork. So if you’re using a piece of software, we use something called Evernote to save all of our paperwork. When we take a picture of it, you want to label it and describe it as well as you can on the front end. And this is where your job will be a lot easier.

 

[15:54]

If you take a little, just a few more seconds every time you have a receipt, every time you go to Lowe’s, just write on the receipt, what was that? This was a plumbing repair for property number one. And then you write that on the receipt. You take a picture of that. We use Evernote to do that, and then we’ll title that picture inside Evernote property one plumbing repair.

 

[16:17]

Put the date on it. If it was an invoice, you put the contractor’s name, what it was. The point is, just describe it as much as you can. You don’t have to get fancy with that. And then later on, that’ll be a documentation.

 

[16:27]

If you need to go, say, I wonder what that $500 expense was on my Lowe’s bill, you can go back. You look at that receipt, you got a description on there, and it’s done. So this one practice on the front end, this is, again, the work of bookkeeping, is just being disciplined about taking pictures of that, describing it well in the front end, if you do that, it takes a few extra seconds, you’re done. But then when you’re doing your bookkeeping at the end of the month, the end of every quarter, you’ll be able to go back and have good records. It could be years later, you’ll still have those records and be able to use them for whatever you need them for.

 

[16:57]

Within your bookkeeping, the fourth best practice is to have a regular time where you clean up your books and get organized. Now, this could be on a weekly basis if you’re really on top of it. I’m not necessarily that on top of it. It could be on a monthly basis or maybe a quarterly basis where you schedule time, you set it aside to go look at your books and to do a few different things to make sure everything’s in order. Number one is you want to reconcile your books, your records with your bank accounts or your credit card statements.

 

[17:27]

So reconciling means just making sure they match up. So it’s possible that what if your credit card company put an extra charge on there that you didn’t actually make? You’d want to know about that, right? Hey, what’s that $500 charge on my credit card? I didn’t make that.

 

[17:39]

And so you would have to dispute that or find out what’s going on. Maybe you forgot about it. It also when you’re in the old school kind of bookkeeping, when you write checks, you write a check to somebody and they didn’t cash them. That still happens today. We still write checks as well.

 

[17:52]

If they don’t cash that check and they held onto it or they lost it, you would have in your bookkeeping, you’d have a $500 expense, but on your bank statement, it wouldn’t be there. And so those kind of things that fall through the cracks, you’ll find out about when you clean up your books. And then you can also take time to label things correctly if you didn’t do it on the front end. If you have a bunch of miscellaneous things, you don’t want to have a miscellaneous you want to put them in some kind of category, and it’s just tidying things up, cleaning it up. Kind of like your house gets messy throughout the week, and maybe at the end of the weekend, you’re like, all right, I’ve had enough.

 

[18:22]

I’ve got to clean this kitchen up. I got to clean the house up. That’s what this best practice is all about. You want to tidy it up, and if you do it regularly, it won’t take forever. And you want to do this as soon as you can, because you forget about things.

 

[18:34]

If you do it a year later, you’re not going to remember what that little transaction was at Lowe’s. That just happened in the busy part of your week. You got to do this as soon as you can stay on top of it. Eventually, if you grow your business, you can hire other people to help you do this. You can have a bookkeeper who reconciles it for you.

 

[18:49]

They’re probably still going to have to ask you questions here and there, but this can be outsourced. At some point, we’ve hired bookkeepers to help us do it as well. But if you’re a new investor, or if you’re just a small investor doing a lot yourself, this will be something you do. And I still do this myself, in fact, every once in a while to clean up your books, make it look organized, which will lead you to the next best practice that I want to talk about. The fifth and final best practice is to run reports.

 

[19:13]

So you’ve done all this other work, and remember, the metaphor for bookkeeping is that you’re keeping score for the actual real estate game. So you’ve done all this work of kind of preparing, but you actually want to run some reports, which are the scoreboard of your real estate investing business. So whatever software you’re using, if you’re using spreadsheets, you can create your own reports. You can create reports that tell you things like the profit and loss of your whole business. You can run a profit and loss report for your particular property.

 

[19:42]

You can also run a report for cash flow, because cash flow is not always the same as your profit and loss. Believe it or not, when I was a beginner investor, I didn’t understand why that was the case. And let me give you a real simple example. When you make your mortgage payment, you pay $1,000 a month on your mortgage. Maybe $300 of that is principal, and $700 is interest.

 

[20:02]

So that $1,000 went out of your pocket, right? That was negative cash flow for you, but only 700 of that was an expense. The interest. The other 300 was a principal payment. So that’s actually part of your profit.

 

[20:14]

You made a profit on your tax return of $300, even though that was a negative cash flow. So you might want to have a profit and loss report to show you how much money you’re making. But you also want to have a cash flow report showing you how much money is coming in and out of your business. So those are things you can do. Once you have tidy, clean books, you can have a profit and loss report.

 

[20:33]

You can have a cash flow report. I also like to run a balance sheet or just look at how my properties and my overall business, how much wealth I’m building, how much equity I have. And so this could be something where you have you keep up with the values of your properties every quarter, every year. You keep up with the debt balance you keep up with the overall financials of each property. And it’s really nice to have a concise scoreboard for your properties, for your business.

 

[20:56]

This is where the magic happens. This is where you can make decisions based on, hey, did I do a good job with this property? Did I not do a good job with this property? I did a burst strategy on this one, or I flipped this house. Which one was better?

 

[21:07]

What kind of return on investment did I get? This is where the business decisions, the strategic decisions, happen when you have these reports. So that could be a lot of fun, actually. It can be interesting. You can learn a lot.

 

[21:17]

But all of that is kind of the prerequisite for all of that is all of the work on the front end, to have good books, to take all those steps, to do that kind of dirty work on a day to day basis, of saving your receipts, of tracking, of categorizing, of having separate bank accounts. All of that pays off when you get these reports in the end. So these five best practices are how you keep score and real estate vesting. This is how you know if you’re winning the game. Number one, you keep your personal and your business separate, no commingling of funds.

 

[21:47]

Number two, you track everything. You categorize everything. Number three, you track all of your paperwork, your receipts, the supporting documents. You save that. You scan it.

 

[21:56]

You enter all that on the front end to make your job easier on the back end. Number four, you have some time. You set it aside every week, every quarter, every month. Perhaps when you clean up your books, you tidy them up. You reconcile your bank accounts with your bookkeeping.

 

[22:10]

You just make it organized so that you can go to step number five, which is to run reports and actually think about your business from the higher level. I love the book called The EMyth by Michael Gerber. It was one of the first business books I read. And his advice there was that not only you need to work in your business, you need to work on your business. And that’s really what this is all about, to be like that neo superhero who can make the whole business slow down and things look like so you understand what’s going on inside your business in the numbers that’s working on your business.

 

[22:39]

That’s not just doing the day to day tedious stuff, which is great, which is important. But if you want to be a successful real estate investor who makes decisions that actually move you forward, that makes more cash flow, that builds more wealth, that eventually gets to financial independence, you’ve got to slow it down. You’ve got to see your business from a distance, from above, not just doing the work in the business. And that’s what having good bookkeeping will do. Having good accounting will do.

 

[23:04]

It’ll make. You the superstar, the hero of your business. And it does take a little bit of work. It’s kind of tedious at times. I’ll admit that you have to have a little bit of a temperament that likes cleaning things up every once in a while.

 

[23:16]

So maybe if you’re not this is not your thing, hire it out, right? You have to have a book keeper who helps you out, pay for it. But somebody has to do this in your business. And if you do the pay off, the benefits are really big. I found it to be a key integral part of my own growth as a real estate investor, and the people I coach and teach who have seen be successful have done the same thing.

 

[23:34]

So I encourage you to do it. If you have questions, I would love to hear from you. I’d love to hear what your thoughts are on these steps or it’s anything I didn’t mention or that you want me to follow up on, let me know in the comments below. If you’re watching YouTube, send me an email at [email protected]. If you’re listening on the podcast, I’d love to hear from you.

 

[23:52]

So one other comment I have about this topic of bookkeeping and really just the details of being a rental property investor is one of my goals with this show, with the podcast, with the YouTube channel, with a book. That’s coming out, the small mighty investors coming out in August and also other offerings I’m going to have that I’m excited to talk about with some courses and other things behind the scenes is that the theme that I want to focus on in 2023 and beyond are the details of building a thriving rental property business. So there’s the higher level stuff which I like to talk about as well, what’s the strategy to achieve financial independence and the big picture of philosophy. But I also want to get into the details and I want to show the details and show you what’s happening in real rental property businesses, not both my own, but also other people. So I’m going to be interviewing real property owners, showing how they’re analyzing deals and going on some deep dives with them on their deals.

 

[24:42]

And I’m going to be getting into topics like this, like we talked about today, that are sometimes behind the scenes and neglected a little bit, but just as important because this is how you run your rental property business. You’ve got to do the bookkeeping, you got to do the maintenance, you got to do the things that are ordinary day to day stuff. And it can be intimidating sometimes. But I’m going to share the details with you. I’m going to give you the best practices I know to make these things work as somebody who’s practicing, as a real estate investor, someone who lives off their rental income and uses this on a day to day basis and is also able to travel and have fun.

 

[25:13]

I’m in Spain as I deliver this to you right now. And so rental properties back in the US. Are helping me live with my family in Spain. So there’s a lot of awesome results that can come from being in the rental property business, but there’s also a lot of details you got to take care of as well. And I want to let you know more of that is coming in 2023.

 

[25:31]

So thank you for being a listener to the podcast. Thank you. If you’re watching on YouTube, I’m looking forward to bringing you more episodes next week and each week throughout 2023.

 

 

Links

► QuickBooks: https://www.coachcarson.com/quickbooks

► Evernote: https://www.coachcarson.com/evernote

► The E-myth: https://amzn.to/1hpzjBb

 

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