7 Financial Housekeeping Tips for Vacation Rental Managers
Founder & CEO
In our webinar with C2G Advisors, we discussed some of the biggest challenges that vacation rental management companies face when preparing for a sale. One of the key points from that discussion was around the importance of good financial housekeeping. In this blog post, we break down the seven key characteristics of clean financials to help property managers gain a better understanding of their performance and position them for long-term success.
Imagine your business is one of your rental properties. No matter how much curb appeal it has, if the interior is a mess, it’s not going to live up to its potential. The same logic applies when it comes to your property management company. Even before going public, many successful companies depend on clean financials to guide their decision-making and keep tabs on key performance metrics like gross profits and net income. However, financial reporting across the vacation rental industry is anything but standardized, nor is it straightforward, even for experienced managers. Here, we provide seven financial housekeeping tips for vacation rental management companies.
1. Distinguish rents from revenues:
Only a portion of funds received by the property management company are actually owed to the property management company, so payments received from guests are revenues to the owner first and foremost. This is why rent revenue might show up as an item on the income statement, but it should not account for actual company revenues as they appear on the financial report. This section should only include the company’s direct income, which may also include guest charges that flow to the management company. Additionally, advanced deposits should be treated as a liability on the balance sheet, not included in total revenues. These reporting rules come from the accrual accounting method, which is the gold standard for companies under the generally Acceptable Accounting Principles (GAAP).
2. Follow accrual accounting methods:
Unlike the cash method, which records revenues and expenses based on when payments are made, accrual accounting means that revenues and expenses are recognized based on when the transactions occurred. Using this method for financial reporting is especially important for vacation rental management company financials because it demonstrates business professionalism and allows you to account for revenues associated with credit transactions more easily. More importantly, it yields a clearer picture of the business operations by associating income and expenses in the period closest to when the transaction actually occurred.
Revenue recognition, a key component of accrual accounting, describes the different ways that a company should record revenues depending on the time that services were delivered and payment was received. For business like vacation rentals, where payment may be received up front, revenue (being received on behalf of the owner) should not be recognized until the stay has actually completed, which financial professionals call deferred revenue.
Additionally, any subscriptions that clients pay for upfront require a special treatment called amortization, which means recognizing revenue incrementally throughout the period that services are delivered. From an administrative standpoint, taking these steps to record revenues using the accrual method allows the company to avoid spending money it hasn’t earned, which can quickly put a company in financial peril.
3. Break down each component of revenue:
As mentioned above, the revenue items that appear on your income statement should only include the portion of rents that is owed to the management company. This includes management commissions earned on the reservations, but may also consist of cleaning fees, maintenance dues or fees, damage waivers, and so on. In many cases, these may reflect the line items on each guest invoice. Separating these items and comparing results on a quarterly or monthly basis allows you to identify the specific areas of your business where sales are increasing or decreasing.
4. Break down variable & fixed costs:
Variable costs, or your cost of goods sold (COGS), are those costs incurred as a direct result of the revenues you’ve earned through your vacation rental business. An easy-to-read income statement will have a matching cost for each revenue component. Fixed costs, on the other hand, are the expenses you incur as a result of operating the business, including items like payroll, marketing, and general & administrative expenses. Payroll may be your company’s biggest expense, so listing out these expenses by department can add a surprising amount of insight into a company’s efficiency and areas for optimization.
For a quick analysis, divide each line item on the income statement by the total rent revenues to get a percentage of rent revenues associated with each one. This makes it easier for managers to identify where the percentage of rent revenues occupied by COGS and operating expenses can be minimized.
In many cases, investors, banks, or buyers may want to see all of your revenues and expenses down to the unit level. Rather than being caught off-guard and scrambling to re-categorize all these items, managers who start using this information in their daily operations will save themselves serious time and pain down the road.
5. Understand profitability metrics:
When you break out financials based on what you have earned and spent into their relevant categories, it becomes clear which areas of the business are generating profits and which areas may actually be losing you money. To understand profitability, first you need to know your gross profit, or the difference between your revenues and COGS. This tells you how much you’re putting in the bank before adding in operating expenses, and dividing it by total rent revenues will give you a sense of your top-line margin. It is typical for healthy property management companies to achieve 25% or higher profit margins.
Once operating costs are factored in, the result is your net income. This is perhaps the most important metric, especially for companies who are interested in making money. Typical companies in this industry strive to streamline their operations so that net income is at least 8% of rent revenue, while the best performers see 12% or higher.
6. Know your assets and liabilities:
So far, we’ve focused on the income statement part of your financials, but getting things right on the balance sheet is equally important for vacation rental managers. This is where a company reports its total assets, liabilities, and equity, where assets are equal to the sum of liabilities and equity. To make it easy, you can think of assets as what the company owns and liabilities as what the company owes, including deferred revenues. For vacation rental management firms, the biggest assets and liabilities on the balance sheet are associated with trust assets and trust liabilities.
As discussed, the cash that property management companies receive isn’t income yet. First, it goes to the trust, or a separate bank account where rent revenues cannot be commingled with any personal or other business assets. This trust asset has a counterpart on the balance sheet: trust liabilities. These are the accounts to be paid out from the trust, including advance deposits (deferred revenue) received from guests, the payables due to owners, sales tax, payables due to other vendors, and the amount owed to you as the management company.
One of the biggest errors that occurs on the balance sheet is misattributing liabilities as assets or equity, so it’s important to consult a financial advisor with any questions you may have about the methods you are using in your company’s financial reporting.
7. Talk to advisors with experience in vacation rentals:
As a CPA firm with in-depth industry experience, Ximplifi can help you prepare financial statements that accurately reflect your vacation rental business and align with industry standards. Our automation plugin, VRPlatform, allows you to seamlessly capture the level of detail you need to see your income and expenses by category without manual data entry, or you can enlist ongoing support from our team with VRAccounting services.
Because each company in this industry is so unique, we take a client-based approach that involves working closely with your team to understand your capabilities and objectives in order to deliver the best level of service for your needs. Whether you need help updating your accounting system, automating your processes, or a team to take it off your plate completely, Ximplifi is the only accounting firm that specializes in property management and offers a one-stop-shop for technology, service, and advisory.
Are you preparing your vacation rental management company for a sale?
Don’t forget to watch our on-demand webinar with C2G Advisors here.
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