Cash Flow vs. Net Income

If you have more than one single rental property, I would recommend starting to treat your rentals as a business.  Get a separate checking account, register an LLC, and learn double-entry bookkeeping.  I use Quickbooks Online for my accounting and Quickbooks actually makes it easy to do double-entry bookkeeping without you even realizing it (except for the rare occasion that you need to do a journal entry).

One thing that Quickbooks does not handle too well however is cash flow.  “They” say that cash flow is king and I tend to agree with “them” … (whoever “them” refers to).  Cash flow is the most important metric in terms of the “survivability” of your business, whether it be rentals or something else.

So why doesn’t Quickbooks tell you your cash flow?  The answer is because although cash flow is a relatively simple calculation (generally just cash in minus cash out), it actually spans two different reports in Quickbooks, Profit & Loss and Balance Sheet and to get a good picture of your cash flow you actually need to pull BOTH of those reports and do some “hand-jamming” of numbers.

The “income” side of the cash flow equation is always contained in the Profit & Loss statement.  However, when you pay out cash for your rental, it could be in the form of an expense (eg. utilities, maintenance, mortgage interest, etc.) … OR it could be in the form of paying down debt (eg. principle payments on a mortgage).  Expenses are ALWAYS shown in the Profit & Loss report, whereas pay-down of debt is ALWAYS shown on the Balance Sheet.  Think of Profit & Loss as “Income – Expenses = Net Income”, and think of the Balance Sheet as “Assets – Liabilities = Equity”.

A maintenance expense therefore will not show up on the Balance Sheet except that it will draw down a cash account so you will end up having a smaller asset (eg. less cash).  A principle payment on a mortgage will not show up on the Profit & Loss statement at all, only on the Balance Sheet.  That is why the Profit & Loss statement is not sufficient for calculating cash flow, because you need to include your principle payments on mortgages in your cash flow statement.

Strangely enough, the tools that are better for calculating cash flow are also the most simple.  I use mint.com and categorize all outgoing and incoming cash to get an up-to-date cash flow picture.  I know landlords that have a separate checking account for each property.  If there is money left in the account, the the house is cash flow positive, if not, it’s negative.  Easy enough.  (Personally I find that many checking account to be way too much work but to each his own I guess).

The bottom line (literally not figuratively) on the Profit & Loss statement is “Net Income”.  That is the truest calculation for income minus expenses.  Since net income doesn’t include principle payments, it is by no means a substitute or necessarily even close to actual cash flow.  Just because those principle payments go to pay down a liability rather than pay an expense, they still leave your checking account each month.

Lastly is depreciation.  Depreciation is an expense that shows up on the Profit & Loss report but does not come out of your pocket (or checking account for that matter).  Therefore, depreciation will decrease your net income but will not decrease your cash flow.  When you look at your net income and want to convert that to cash flow, you will have to disregard your depreciation expense since it’s really only for tax purposes and is not something that you actually pay.

If you have any questions on this, please either comment below or drop me a note.

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