What can the financial statement tell you

Question

As a CPA and an investor, I'm well aware that reviewing financial statements is important.  I'm curious what many of you as investors look at when reviewing these statements.

Besides the fact that there may be issues with the statements, what do you look for?

The financial statements can tell something about the management or lack there of.  I look at repairs and maintenance for any indication of possible deferred maintenance.  Are their legal fees?  Some expenses are discretionary.

There can be a lot of useful information gathered from a financial review.  What do you look for?

Bill Gulley · Answer

Really, I almost ignore the statements haded out by ant seller or Realtor....mainly because they are usually eye wash.

If I see one that is in line with GAAP I ask for supporting documentation. It becomes a forensic audit. And questions may arise when they go from cash to accrual last year relating to overstated income.....most investors aren't that sophisticated in their accounting....not all, just most, IMO.

As Tod mentioned, the allocation of expenses will stand out and the recognition of income. Deffered maintenance may show up as an average expense, but the property inspection will take care of that too.

A quick check of tax accounts, accrued income tax or payables will be something that I would base the real income upon. Cheat on your taxes do you?

I always ask for at least the last 12 months bank statements on the business account. Sometimes hard to get, but if they want a better offer price...well! That will tell you about the cash flow (since most deposits are made timely) and any credit card statements with that property. You'll see that on the check statement.
And, the last two years tax schedules.

Financial statements alone will not paint an accurate picture without supporting documents, but they are representations made by a seller!

Account Closed · Answer

I put no faith in what a sellers agent puts together.  I do want to see what the seller has though.  With commercial properties it may not be complete but you usually have something more than when you are looking at residential properties.  The state of the financials tells me something as well.

Tod R. · Answer

Since I've started looking at smaller properties for my personal investments I have noticed that sometimes the information provided seems incomplete at best.  Income and expenses can be manipulated.  At one apartment complex we looked at, the owner was timing the deposit of rent checks to make income look consistent.  He used prepaid rents to offset past due rents.  On a cash basis, I suppose that makes sense.  But he did not show a receivable of past due rents.  Often I see expenses that appear to be below market, and these numbers are used in a pro forma schedule that reflects NOI above market.  When in fact, there is deferred maintenance that is causing the below market expenses.

Bill Gulley · Answer

Good point Charles. But starting at the very beginning of the purpose of accounting, like the introduction to Accounting 101, Accounting is the langiuage of business.

Speaking the language is important to communicate the condition of any company, the other side of this ledger is that the system used be managable and appropriate for the business yet sufficient to describe conditions.

While some of us can pick through any financial system and apply complex analysis, is it appropriate?

I have never purchased a portfolio of a 1,000+ units, but have been in the management side of that size portfolio, but unlike for profit organizations, government accounting works from a zero base budgetary system. As Charles mentioned, there are alot of tricks available, but the more units, the larger the numbers the more latitude the accounting system will have that becomes appropriate to improve performance.

Point being, GE makes electric motors and alternators. Joe, at Joe's Alternator Garage can do the same thing. IMO, most landlords are at Joe's level, that's why their financial statements may not be in a condition to properly evaluate the 12 units owned.  And, that's why I really ignore statements without supporting documents.

As mentioned above, with a listing agent supplied statements, like Charles, I put no stock in them at all. I know hundreds of agents and none of them are accountants.

Another point, when I buy a property, I don't buy the accounting system or methods of the past owner, what they did has no bearing on how I carry the property of it's operations. So, how meaningful is it?

Account Closed · Answer

Dale,  as you say cash flow is the life of the business.  Measuring the pulse is important.

There are many thing that can be done to help a business perform better and to increase cash flow.  There are many great tools that can help.

Dale Osborn · Answer

Money in versus money out - will it pay all the bills, debt service and have positive cash flow left over. Each property you get into should be self supporting. I have a MHP for sale in Colo Spgs, CO on mhps.com and have the financial statements as attachments. Perhaps you could take a look at them and let me know if I need to work on some areas. Property is a 134 space MHP (129 MH spaces and 5 apts). Many put a lot of weight on CAP rates, but the main item of importance to me in a property is positive cash flow on the bottom line.

Account Closed · Answer

Vikram, the financial statements can give you the big picture view as you said to determine if the fundamentals make sense.  Understanding managements style is very important.  As someone that spends time evaluating stocks, I'm sure that you have dug into many financial statements.

Vikram C. · Answer

I have not evaluated financial statements in a real estate context, but based on my experience with corporate financials, here are a few things I would always look for:

1.  Accounting policies.  e.g. revenue recognition, etc.  I like to see management use conservative policies and still show good numbers.  I am particularly alert to any recent changes in accounting policies.

2.  Notes.  The notes to the accounts sometimes contain very illuminating information that can help you form an opinion about management.

3.  Changes in ratios.  I am always interested when an important ratio changes signficantly and like to know why.  Financials are a numerical summary of the story of the business and it is good to understand the big picture story.

Account Closed · Answer

One thing you might see is high bank charges.  This is a strong indication that the business has cash flow issues.

I'll often look at things like other income to get a feel for how many tenants are paying late.  I then look for any legal expenses for possible evictions.

For commercial property you should be able to get better financial information than you might for residential property.

What can the financial statement tell you

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