INCOME, BUDGET AND BALANCE SHEET

Assignment Questions

Certified Financial Specialist

• Teach federal regulations and guidance for housing programs providing NCHM’s interpretation of both

• Provide examples of policies and procedures used in the industry

• Provide the instructor’s opinion on how to handle specific situations

• Do not give legal advice or set policy for your owner or management company

NCHM Courses and Instructors

Disclaimer

Instructor Introduction •

•

Instructor

Course Materials

CFS Course Book

Presentation Slides

Ta b

Exercises

Ta b

Reference Material and SpreadsheetsTa

b 3

HUD Documents

Ta b

•

Certification Exam Don’t panic…

*CFS is relevant to any type of multi-family rental property, be it affordable or market-rate

(although we will discuss some of the differences).

About the Program

Part 1 Part 2

Course Organization

By the end of Part 1 we hope you will learn:

• What truly are the financial goals of

apartment ownership

• The basics of property-level accounting

and financial management

• The structure and purpose of different

financial statements

Objectives

• How to analyze financial statements;

quickly zeroing in on the numbers that

matter

• How to better understand your own

financial statements and make better

decisions

• Why good budgeting is so important!

The Financial Goals of Ownership

Financial Goals of Ownership

• Important to understand

goals of ownership

• Goals are financial and

non-financial

• Different owners have

different goals

To get us started, please do Exercise #1, Part A only, Tab 2, Page #1

All owners essentially chooses from the same menu:

• Cash flow

• Appreciation of Value

• Preservation/Growth of

Equity

• Tax Benefits. … and a related goal: Preservation of the Asset

CASH FLOW/NET CASH

Monthly/Annual net income flowing to the bottom-line

APPRECIATION

Increase in the fair market value of the property over time

Financial Goals – Definitions

PRESERVATION/GROWTH OF EQUITY

Protection and growth of the net value of the asset (the owner’s equity portion)

TAX BENEFITS

Improved financial return by taking advantage of certain income tax breaks

The above combine to result in “Return on Investment”

What if the owner is a non-profit or housing authority? Does it still have these goals?

Is it still concerned with Return on Investment?

Preservation of the Asset

• Goal – Ensure that the property continues to be a viable

asset in the future so that it will continue to meet the

owner’s financial and non-financial objectives

• Isn’t a direct financial goal; can’t be measured by one

factor as the others can

• Recognizes that the physical condition of the property

also matters

• Management “preserves” the asset by making wise

decisions in the core areas of operation

Generally, slum landlords aren’t interested in preservation of assets!

• Initially, when the project is “underwritten”

(that is, when it is first financed or last re-financed)

• Assumptions are made and goals established, such as:

• Income and expense assumptions (A “pro forma”

budget)

• Expectations with respect to the amount of cash flow

and the expected “Return on investment (ROI)”

Return on Investment = The total financial return to the owners taking into consideration, annual cash flow, the projected gain on sale, and any applicable tax benefits. Usually expressed as a % of the owners’ equity.

How and when are financial goals established?

• Most projects are financed with a combination of debt and

equity

• The details of the project financing are driven by the

requirements of the particular loan program (e.g. HUD, FHA,

private lender, etc.)

• Replacement reserve requirements

• Interest rates and terms of debt

• Debt service coverage

• Cap rate assumptions

• Etc.

Loan Programs Dictate Most Parameters of the Financing

Financial Goals

• Identifies the value of the business

• It tells me what the NOI is worth

Therefore…

• It is important to have an accurate NOI

• Classifying expenses correctly

CAPITALIZATION RATE = NET OPERATING INCOME

PURCHASE PRICE

Why is the Cap rate so important?

• How the property was structured financially

when it was built or at its last re-finance/purchase

• How it has been operated since, and,

• The current goals of the owner.

Management Has to Play the Cards That Were Dealt to It

Understanding these, helps you form operating expectations that are reasonable and achievable.

Owner Goals

Based on what you have learned, what, if any, questions do you have regarding your owner’s financial goals?

• Are there specific cash flow expectations for the property?

• Are there any special loan requirements, such as Debt Service

Coverage requirements, that management should know about?

• Any there targets for replacement reserve balances, capital

expenditures, etc.?

Turn to Tab 2, Page 1 and complete Exercise #1, Part B

Basic Financial Statements

Before we dive in… What’s a Fiscal Year?

FISCAL YEAR

12-month period for financial purposes; it may or may not be the same as a calendar year (January to December)

In this program and on Exam everything is calendar year

APRIL 1ST MARCH 31STTO

OCTOBER 1ST SEPTEMBER 30THTO

They are (or should be):

1) The way we track how the property is performing

with respect to its financial goals, and

2) Tools that help us make better operational decisions.

Financial statements are more than just reports on bookkeeping

To have them become this, we need to unlock their power! And we do that through knowledge and understanding.

The Two Basic Statements

Income & Expense Statement

• Income the property

receives

• Operating expenses of

the property

• Difference between

income and expenses

• Referred to as Net

Operating Income

Balance Sheet

• Assets

• liabilities of the property

• Difference between

assets and liabilities –

often referred to as

Equity.

Basic Statements in Plain English

Income

Subtotal $4,100

Pay from F/T job $3,400

Pay from P/T job $700

Expenses

Rent $1,050

Student loan $350

Car payment $400

All other day to day

expenses

$1,900

Subtotal $3,700

“Net Income” $400

Cindy’s Income & Expense Statement

INCOME SUBTOTAL

– EXPENSES SUBTOTAL

“NET INCOME”

How is Cindy doing?

She’s doing okay financially

She’s not doing so good financially

I don’t have enough information to decide.

Basic Statements in Plain English

Assets

Subtotal $22,500

Checking and savings $1,000

401k $4,000

Liabilities

Student loan $25,000

Car loan $18,000

Credit card debt $6,500

Subtotal $49,500

Net Worth (“Equity”) -$27,000

Cindy’s Balance Sheet

TOTAL ASSETS

– TOTAL LIABILITIES

NET WORTH

Car $17,000

Now, how is Cindy doing?

Like I said, she’s doing okay

Like I said, she’s not doing so good

I still don’t have enough information to decide.

I’ve changed my mind.d

• We need both statements to better

understand Cindy’s financial situation

• One gives us a picture of her day-to-

day situation; the other helps us see

the big picture

And, as we’ll see, we need to “combine” the two statements to understand the financial situation of an apartment community.

Key Takeaways

The Balance Sheet

Caution: Don’t mistake for market value!

Liabilities

Other Balance Sheet items we will only mention briefly; not topics on Exam

Accumulated Depreciation

Retained Earnings

Methods of Accounting

Is your property’s income and expense statement on a cash basis, an accrual basis or something else?

Cash

Accural

Something else

I don’t knowd

Cash vs. Accrual Methods

Cash Method

• Income and expenses

are posted (i.e., record on

the books) as of the date

they are received or paid,

respectively

Accrual Method

• Income and expenses are

poste to the period to which

they apply:

• For income, the period the

income was earned (whether

received or not)

• For expenses, the period for

which the expense applies

(whether paid or not)

In Plain English

Income Mar Apr May

Ms. Green $675

Mr. Calico $600

Ms. Blue $700

Total Income (Apr) $675

Accrual MethodCash Method

Income Mar Apr May

Ms. Green $675

Mr. Calico $600

Ms. Blue $700

Total Income (Apr) $675

Expense Mar Apr May

Education $195

Electric $950

Lawn Care $600

Total Expense

(Apr) $195

Expense Mar Apr May

Education $195

Electric $950

Lawn care $600

Total Expense

(Apr) $1,745

Mar Apr May

Net Income (Apr) $480

Mar Apr May

Net Income (Apr) $230

Cash vs. Accrual

Turn to Tab 2, Pages 2-3 and complete Exercise #2

Answers to Exercise #2

Income Oct Nov Dec

Ms. Gilder $950

Mr. Kim $975

Mr. Perez $975

Total Income (Nov) $975

Accrual MethodCash Method

Income Oct Nov Dec

Ms. Gilder $950

Mr. Kim $975

Mr. Perez $975

Total Income (Nov) $2,900

Expense Oct Nov Dec

Snow Removal $1,000

Plumbing $245

Supplies $445

Total Expense

(Nov) $690

Expense Oct Nov Dec

Snow Removal $1,000

Plumbing $245

Supplies $445

Total Expense

(Nov) $1,245

Oct Nov Dec

Net Income (Nov) $285

Oct Nov Dec

Net Income (Nov) $1,655

February snow removal service paid in August

Why Accrual?

FEB MAR MAY JUN JUL AUGAPR

EXPENSES More accurately reflects the situation

INCOME More accurately reflects income

earned for the period (but need to

know accounts receivables)

NET OPERATING INCOME More accurately reflects

operations that month

The Income and Expense Statement

Income & Expense Statement

• Income the property receives

• Operating Expenses of the

property

• Difference between income and

expenses

• Referred to as Net

Operating Income (NOI)

Let’s look at an example: Tab 3, pages 3-4 (Northfield)

Not all statements are alike!

THEY CAN GO BY DIFFERENT NAMES:

• Income statement

• Operating statement

• Profit and loss statement

• Monthly variance report

CAN BE FORMATTED DIFFERENTLY, BUT USUALLY CONTAIN:

• Name of Property

• Name of Report

• Period of Time Covered

• “Book” Type (sometimes)

• Time Stamp

CAN PRESENT DIFFERENT TYPES OF INFORMATION SUCH AS:

• Actuals only

• Actual vs. Budget

• Actual vs. Budget plus Variance

Most common and preferred

• Used to make bookkeeping and accounting easier

• Most affordable properties follow HUD Chart of Accounts

• HUD Chart of Accounts is more than 100 accounts!

• Only use those accounts that are relevant

• Can customize charts of accounts as long as formal reports

conform to requirements

• Market-rate properties can adopt any chart of accounts,

though most use something similar to HUD

What are those numbers?

CHART OF ACCOUNTS

A list of numbers and descriptions for each line item

The Income & Expense Statement

What are not “operating” expenses?

• Outlays of money reported on the balance sheet

• For example:

• Capital Expenditures

• Reserve for Replacement deposits

NET OPERATING INCOME:

INCOME – OPERATING EXPENSES

We’ll discuss these “outlays” later

Net Operating Income

We’ll see how an income and expense statement is “modified” to give us the information we need to get to the bottom-line but for now let’s drill down on NOI.

River Bend Apartments had NOI of $400,000 last year. How is the property doing?

It’s doing okay financially

It’s not doing so good financially

I don’t have enough information to decide

Let’s Drill Down on the Income and Expense Statement starting with income…

Full Income & Expense Statement for Northfield is in Tab 3, Pages 3-4

Rental Income

Gross Potential Rent

Rent

Subsidy (if any)

Adjustments to GPR (+⁄−)

Loss to Lease

Incentives

Vacancy

Bad Debt/Recovery

+ Non Rental (or “Other”) Income

Total Income

Total Rental Income

Income (also known as “Revenues”)

20 unit property

All 1 bedrooms

Budgeted rents:

$800/month

Monthly GPR

$16,000

12 months Monthly GPR

$16,000

Annual GPR

$192,000

MONTHLY GROSS POTENTIAL RENT

ANNUAL GROSS POTENTIAL RENT (for same property)

Gross Potential Rent The budgeted rent for a given period of time

Gross Potential Rent

In market rate properties = The rent we planned to get for

a given unit (or unit type) when the budget was prepared

(sometimes referred to as the “asking” rent, although that

can be misleading)

In HUD Section 8 project-based properties = Contract Rents

In Tax Credit properties = Maximum (or Max) Tax Credit

Rent (or lower if market dictates).

Rental Income: Subsidy

If a property receives

direct rent subsidies from

any governmental rental

housing program it is a

part of Gross Potential

Rent.

Rental Income Adjustments

Rent concessions

• One month free rent

• $25 off first three months’ rent

Non-rent incentives

• Free parking for 6 months

• Reduced security deposit

• Improvement to apartment

(e.g. ceiling fans, new carpet, etc.).

Incentives (or Concessions) A discount or other item of value given to entice someone to sign or renew a lease

Usually only these tracked on incentives line

Rental Income Adjustments

Concept not used by all properties; more common in market-rate

Unit No. 501 Jan Feb Mar Apr May

Budgeted $1,000 $1,000 $1,000 $1,050 $1,050

Actual $950 $950 $950 $950 Vacant

Loss to Lease (LTL) -$50 -$50 -$50 -$100 $0

Complete Exercise #3 at top of Page 4 of Tab 2

Loss to Lease Difference between budgeted rent and actual rent achieved

Unit No. 45 Jan Feb Mar Apr May

Budgeted $950 $950 $975 $975 $1,000

Actual $925 $925 $925 Vacant $1,050

Loss to Lease (LTL) -$25 -$25 -$50 $0 +$50

Answers to Exercise #3

Rental Income Adjustments: Vacancy

VACANCY LOSS Rental income (in dollars) lost due to vacant units

PHYSICAL VACANCY RATE Number of vacant units divided by number of total units

ECONOMIC VACANCY RATE Rental income (in dollars) lost divided by GPR.

Turn to Tab #2, Page #4 and do Exercise #4 (a) and (b)

Exercise #4: Vacancy Loss

Unit No. Days Vacant Rent per Day Rent Loss

102 23 $30

219 5 $35

220 12 $35

341 17 $32

412 13 $31

501 21 $30

623 30 $36

TOTAL

(a) Physical Vacancy Rate: 10 units 120 units = 8.3%

(b) Economic Vacancy Rate: $3,942 $108,000 GPR = 3.7%

$690

$175

$420

$544

$403

$630

$1,080

$3,942

Answers to Exercise #4

Which is more accurate: physical or economic?

• Typically rent owed by residents that have

vacated

• Usually shown under income as a negative

number (deduction from income)

• Any funds actually collected shown as bad

debt recovery (added to income)

• Typically accounting department or senior

management determines when an account

is to be declared bad debt, per policy.

Rental Income Adjustments

Bad Debt Money owed to the property that you have no reasonable expectation to collect

Other Income

• Parking

• Laundry/vending

• Pet Rent/pet charges

• Interest income

• Maintenance charges

Non-Rental Income All other income of the property; income other than rent

• Security deposit

recoveries

• Late fees*

• NSF fees*

• And others

* Not permitted in HUD 202

Let’s take a look…

Now let’s move on to Expenses and the Bottom Line…

There are two kinds of expenses:

OPERATING

and

“NON-OPERATING”

• We will get into details of line items in

budgeting

• For now, we need to understand how they

are organized: different from company to

company.

Operating Expenses All cash outlays except balance sheet items such as capital expenditures and reserve for replacement deposits

Let’s look at an example: Northfield Apartments – Tab 3, pages 3 and 4

O P

ER A

TI N

G E

XP EN

S ES

• A simple income and expense statement ends at NOI

• However, many statements are “modified” to add balance sheet

items and report “net cash” (the bottom-line)

• Financial activities that takes place after NOI are referred to as

“other cash transactions”.

Net Operating Income and Net Cash

Income

Operating Expenses

Net Operating Income

Other Cash Transactions (OCT)

Net Cash

NOI and Net Cash

Simple Income & Expense statement ends here

Other Cash Transactions

Lower cash in operating account

• Reserve for Replacement Funding

(or Deposits)

• RE Tax Escrow Funding (or Deposits)

• Property Insurance Escrow Funding

(or Deposits)

• Principal portion of Mortgage Payments

• Fixed Asset/Capital Improvements.

Increase cash in operating account

• Reserve for Replacement Releases

(or Recovery)

• Tax & Insurance Escrow Releases

(or Recovery)

OPERATING ACCOUNT

• Standard in HUD and FHA properties

• Required by most private lenders

• Usually determined by formula when

property is financed (or re-financed)

• While money is asset of owner, requires

the lender or loan servicer’s consent to

spend it

• Can’t spend it on non-capital items.

Replacement Reserves Money set aside, usually in a “restricted” account, for major capital improvements

EXTENDED LIFE

COSTS OVER

$5,000

CAPITAL ITEM

• A major replacement or “betterment” to the property; an item

having an extended life (more than a year) and costing over a

fixed amount

• Exact “fixed amount” varies from organization to organization

• May be paid for out of the Replacement Reserve, operating

cash, owner equity or borrowing.

Capital Improvements

Also known as “Fixed Asset Improvement”

Let’s practice with Other Cash Transactions

Turn to Tab #2, Page #5 and do Exercise #5

Answers to Exercise #5

NOI (Net Operating Income) $45,045

Other Cash Transactions

Replacement Reserve Funding

Fixed Asset (Capital) Improvements

Tax & Insurance Funding

Replacement Reserve Releases

Cash Position

– $12,000

– $3,450

– $5,000

+ $8,820

$33,415

• Sometimes referred to as “cash flow” although that

has another meaning to accountants

• Often called “cash position” in non-profits

• A related concept is “surplus cash”:

• Used in many HUD-financed properties

• Dollar amount determined to be excess income

for any given fiscal year over and above the

property’s financial obligations (aka “net cash” or

“cash position”)

• Amount must be verified by a qualified auditor.

Net Cash

Bottom line is – it’s the bottom line! 74

• Net cash is distributed to

owners or retained for the

future (although sometimes

distributions are limited)

• Net cash is retained within the

property for future use

• Non-HUD properties usually

are permitted to distribute net

cash to the non-profit sponsor

for other charitable uses

Non-ProfitsFor-Profits

Net Cash: What happens to the money?

Reading the Income and Expense Statement

Southtown Apartments

Instructions: Review the Southtown Apartments Income and Expense

statement (found behind the 3rd Tab, Pages 5-7); identify the important

information; record your answers and be ready to report your findings

in 10 minutes.

Turn to Tab #2, Page #6 and do Exercise #6

What did you learn about Southtown Apartments?

Reading an Income & Expense Statement

How the Pros Read Statements

• They don’t start at the top; it takes too long and doesn’t

provide a context

• They read a statement from the bottom up; starting with

the bottom-line, usually cash flow

• They typically ignore monthly data at first, focusing on

Year-to-Date numbers

• They start with the variance information.

Let’s pause here to define “variance”

Perhaps the single most useful tool on an

income and expense statement!

Actual Budget Variance

Rental Income $14,000 $12,000 $2,000

Payroll $14,000 $12,000 ($2,000)

Variance The dollar difference between what was budgeted and the actual result

Variances (and therefore the income statement) are only as good as the budget they are based on.

Note: Numbers in brackets “( )”, red numbers and/or with a minus sign mean “Unfavorable to budget”

Let’s look at Southtown again…

• Start with the bottom-line — the one that

matters to you (whether NOI or net cash)

• Look at the variance FIRST

• Assess if the property is on track or not

• If it is not, look at the totals for income and

expenses versus budget

• Zero in on the biggest contributors to the

problem and work back from there.

To summarize:

• Don’t be fooled by what appear to be good variances

• Example: Being “under budget” on maintenance may

not be a good thing

• Look at relationships between variances

• Example: Under budget on marketing while

vacancy loss is higher than budgeted

Remember, when it comes to variances…

Stay away form “good/bad” and “over/under”; use “favorable to the budget” and “unfavorable to the budget”

• Two basic reports:

• Balance sheet

• Reports on property’s assets and liabilities

• Income and expense statement

• Site staff primarily use the income and expense

statement

• Reports revenues and routine operating expenses

• Need to know if statements are cash or accrual

• There are at least two “bottom-lines”: NOI and net cash

• Other cash transactions are typically balance sheet items

that impact net cash.

Summary of Part 1 of Program

• Income and expense statements are often modified to

report other cash transactions

• “Variances” from the budget help identify problems or

issue areas

• Be careful with so-called “good” variances

• “Read” an income and expense statement from “the

bottom up” to quickly zero in on potential problems

• An income and expense statement is only as good as

the budget it’s based on.

Summary of Part 1 of Program

• If the property is a “HUD” they need to be followed

• If your property is not “HUD” they’re great supporting documents

Guidance for Replacement Reserve 4350.1 Financial handbook and HUD Chart of accounts 4370.2 Management Handbook 4381.5

HUD Handbooks

Discover…

Part 2 Developing a

Site-Level Budget

By the end of Part 1 we hope you will learn:

• A deeper understanding of the

purpose of a budget.

• Key steps in the budgeting process

• Why and how to “forecast” a budget

Objectives

• How to develop accurate line item

estimates

• How capital planning fits in

• How to properly spread the budget

over the year

• How to present a budget and get the

best reaction. 90

• A financial prediction about what will happen in some

future pre-established time period

• A plan for the future expressed in dollar terms

• It is based on our assumptions about future conditions

• It gives us an objective tool to measure financial

performance (including how we are doing in meeting

the owner’s goals).

Budget

Budget Workshop

Task: Each company put together its budget for the trip by line item

Assume Leaving on the 1st and returning on the 8th.

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