It’s amazing how many of us in the self storage business don’t know much about financial statements and financial literacy.
I had a big learning curve and still am not as strong as I could be.
But then again, balance sheets and profit and loss statements are not very intuitive.
Early in my real estate career, I got a close and personal look at how one could have a great profit and loss statement (p & l) and go broke.
Office Management
Throughout the 1990’s I sold and managed office buildings for investors.
It was a good gig. We would find and help investor groups buy the buildings, manage, lease, and reposition the buildings, then sell them (hopefully) for a higher price.
We made fees along the way on the purchase, management, leasing, lease renewals, and the back end.
In essence, our job was to increase the value of the asset. How we did this was to design strategies that increase the NOI (net operating income).
Operating income (i.e., rent in most cases) minus operating expenses (cost the run the asset like utilities, property taxes, etc.) equals NOI.
The market value of the income-producing real estate, including self storage, is what a ready, willing, and able buyer will pay for the recurring NOI.
Fortunately, our performance was measured by how much value we created for the Owners (as it should be). The increased NOI measures that.
We were good at it.
However, I saw some of those same projects, with real value increases, sometimes doubling them, in just a few years, going broke.
Why?
The monthly P & L’s sure didn’t show it.
You have to know what to look for on a balance sheet as well to get the answer. It is not always apparent.
We will come back to this in a minute and go over the answer.
What Financial Statements Should Tell Us
For a good business owner, or perhaps better said, in a perfect world, a financial statement should give us useful information. Useful information that will help us decide what we should do next in our business to improve it.
For most of us, this is not the case.
Many of us relate to financial statements as what we have to do to prepare for our taxes, or at best, what happened last month or last year.
Yes, most of us look at the P & L’s and see how well our facilities are doing. But usually, we already know what the statement is going to say (if we are running our businesses) and certainly don’t get a lot of useful day-to-day information on our next steps.
What if your financial statements could give you dials and levers to pull to adjust your business?
What if you could get enough understanding to be able to look at your (or any facilities you may be considering to buy) financial statements and see exactly what the next steps could be to take this business to the next level?
In 99.7% (I just made up that stat to be dramatic) of the cases, your CPA isn’t able to tell you (or perhaps I should say, not trained to tell you) how to see dials and levers on your financial statements.
They are good and what they need to be good at, taking your financials and fixing them and preparing your taxes for them.
(No offense to CPA’s out there).
And most of us will not be able to hire a CFO to do that for us.
Yes, it usually falls on us, the self storage owners to figure this stuff out.
So, let’s start with what the P & Ls doesn’t tell us.
The Answer
The P & Ls don’t tell us a thing about the cash.
“Cash is King.”
Cash is the most important thing there is in a business.
And your P & L doesn’t tell you very much at all about the cash at all.
In fact, if you are on an “accrual basis” (we will discuss in other episodes), it is possible to have no cash and plenty of income because the income on your P & L is created when the invoices are created.
Now, most facilities are on a “cash” basis, but not all of them I have seen.
Your balance sheet tells you some, but you really have to dig (or at least I do).
Yes, there will be how much is in your account at the end of whatever period you are looking at, but that is not the most useful information.
It always seemed weird to me that business financial statements did not focus on cash because cash is certainly what I focus on when thinking about the financial health of our self storage business.
Without enough money, we are sunk.
Without enough cash, our business fails.
According to Bloomberg, 8 out of 10 entrepreneurs who start businesses fail within the first 18 months. A whopping 80% crash and burn… And yes, at the surface level, the primary reason businesses fail is they simply run out of cash.
In fact, not all cash is created equal. THAT IS NEXT WEEKS EPISODE.
How To Get Started Improving Your Relationship To Your Financials
Let’s go back to my office example.
We were able to improve rents.
How?
- Upgrade buildings
- (cash expenditures not shown on P & L’s).
- Not renew tenants at lower rents. Tenants would either:
- Vacate (that loss of income would be reflected on P & L).
- Then we would eventually rent a unit at the following cost:
-
- Upgrading the space for a new tenant- (cash expenditures not shown on P & L’s).
- Commissions – (cash expenditures not shown on P & L’s).
-
- For tenants who renewed, Owners spent:
-
- Upgrade space – (cash expenditures not shown on P & L’s).
- Renewal commissions – (cash expenditures not shown on P & L’s).
-
As leases roll in office buildings, retail, apartments, etc., there is a cost. Most of the costs involved in keeping an asset going are not reflected in the P & L’s.
Even for your self storage business, although thankfully, there are much fewer of those types of expenses.
It is critical as a business owner to know what the P & L does and does not tell you.
It does not tell you very much at all about cash!
So, where do we start?
Next week will dive into the three types of cash and which one is most important.
But I always recommend starting with a budget.
A cash budget.
If you are just getting started, don’t overthink this.
You can get to the point where you created five and ten-year budgets, but for now, don’t make this such a big deal.
If you are not as financially literate as you want to be (like most of us, myself included), start with a six-month budget. This rule is significant if you are doing your first self storage deal.
Look out into the future for six months and guess how much cash you are going to spend.
Look at:
- Operating expenses.
- Payroll
- Repairs & maintenance
- Insurance
- Utilities
- Property taxes
- Property management
- Credit card cost
- All the other normal monthly expenses down to the toilet paper in a bathroom and paper clips
- Capital Improvements.
- Building improvements or expansions.
- New HVAC or mechanicals
- Any expense your CPA will depreciate time and not expense out on your P & L
- Loan Payments
Put the expected expenses in the above order (you will see why next week), and then above it, place the expected income.
Now, you can see your cash needs and your expected cash inflow to pay them.
Be sure to get cash from all sources, not just income from the facility.
Most of the time, especially for year one in many self storage deals, this document looks different that a P & L.
Nest week will explore the fact not all cash is created equal. For self storage owners, some cash is way more valuable than others.
Have fun and I will see you then.
