Magazine article Journal of Property Management

Know the Numbers: Reviewing the Income Statement for Accuracy

Magazine article Journal of Property Management

Know the Numbers: Reviewing the Income Statement for Accuracy

Article excerpt

Most property managers realize that financial statements are not unlike a report card presented to their owners. Owners rely on these reports as a representation of the operating results of the property.

Managers are not only responsible for a property's performance, however, they are also ultimately responsible for the accuracy of its income statements. As accountants like myself make a living giving owners confidence in their financial statements' accuracy - managers should be doubly sure of their numbers. So how do property managers gain a similar level of confidence on their own?

In the last issue of the Journal of Property Management, we discussed how to test the reliability of the net income of a project. In that article, we said that the easiest way to determine if the net income was accurate was to confirm each balance sheet amount.

To illustrate: suppose all the income you received during a month is collected in cash and you put it into your wallet. In order to determine your net income for the month, all you have to do is count the cash in your wallet at the beginning and end of the month. The difference is your net income or loss. The balance sheet tells us how much cash we have in our wallets at the beginning and end of the month.

Because each amount on the balance sheet represents a balance at a given point in time, it is a relatively simple matter to verify the amount reflected. For instance, the amount of tenant security deposits held, tenant rent receivables, or vendor bills due on a given date can be easily verified. After confirming each asset and liability account balance, the capital account balance can be verified by taking the capital account balance at the beginning of the period, adding owner contributions, and subtracting owner withdrawals.

Once this has been accomplished, the balancing amount will be net income.

This only confirmed, however, that the bottom line net income amount was accurate. It did not tell us if the various components of net income (income and expenses) were accurate. This is a much more difficult task.

In order to examine the income statement for accuracy, you should start with a general review of the statement using the following analytical tools:

* comparative figures,

* potential gross income, and

* percentages.

Let's examine the use of each of these tools separately, using the sample income statement found in Figure 1, prepared on a cash basis.

Comparative figures

If I presented the income statement in Figure 1 without comparing the actual results to a budget or some other measure, this statement would be far less meaningful to a reader. This is always true of an income statement. The reader must have a point of reference. The net income amount of $29,276 is an absolute.

How do we put this amount in relative terms like "this is a good result" or "these results are disappointing"? Without a comparison, we are not sure if the property should have made more or less money.

Comparisons are also necessary to properly analyze the accuracy of reported amounts. Reviewing Figure 1, we can see that all amounts are fairly close to projections except repairs and utilities. This leads us to believe that there may be problems with these two amounts. (Something we would not have known if the comparison had not been made.)

The three amounts generally used for comparisons on income statements include: budget, prior-year amounts, and industry standard.

The budgeted amount is the best comparison because it lets us know how we are doing compared to how we expected to do. Prior-year amounts are the second best comparison because they reflect the operations of the same project and can let us know if there are improvements or not.

The least desirable comparison is industry standards because all projects and operations are different and the nuances of a particular project are not reflected in industry standards. …

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