Have you noticed that good bookkeeping is very much like getting on a diet? See for yourself: we all need it, we all know it’s good for us, we all tried it at some point (at least the dieting part), and yet most of us are “off.” Why? I think it’s clear:
- too many diets/bookkeeping systems to choose from
- they are too complex
- there is no generic “one size fits all” solution
- and, most importantly, it’s a drag
No, I don’t know how to make bookkeeping (or dieting) fun, but at least I can try to simplify it. Yes, I do love advanced computer software such as QuickBooks. Yes, I do think that hiring an accounting pro is a good idea (shameless plug, I know). But no, I don’t think that every investor must go that far, especially early on. Here comes the good news: a perfect bookkeeping system can be created with nothing more than a $0.99 notepad and a $0.09 pencil.
Welcome to the Ten Commandments of Great Bookkeeping! And here comes more good news: unlike the original 10 Commandments, mine are not mandatory – except for the first three.
1. Record everything that you receive and spend.
As trivial as it is, this rule is most commonly neglected. How much did you pay to rehab this house? Oh, gosh, at least 5 grand. Maybe even 6! You know, maybe it was $7,000. Yeah, put down $7,000.
Sounds familiar? Fine, I can put down $7,000 like you said, but what if it was, in fact, $8,000? This mistake could cost you $400 in extra taxes. $400 hard cash out of your pocket and down the drain! No big deal? Then what if your estimate was $10,000 off the mark – a potential $4,000 mistake? And I have seen way too many of those. Don’t estimate – record everything!
2. Record regularly.
Let’s try a little exercise. Take a piece of paper – like a napkin or one of those “for sale” flyers placed on your windshield at the RICH parking lot. Write down everything you did and spent yesterday, by hour: Got up at 8; went to check on the Alvin plumbing job at 9:30; filled the truck at Chevron for $42.30; picked $22.67 worth of small hardware at Lowe’s at 10:45; and so on. If you can recall the entire yesterday, then grab another napkin and replay the day before yesterday. See how far back you can go. If you can remember one month back – then you can afford to do your bookkeeping once a month. But if you’re born on planet Earth, you probably struggle to remember yesterday. I know I do. Moral: if you record your spending once a week, you’re wasting your hard-earned money! Like flossing your remaining teeth, bookkeeping should be a daily routine.
3. Keep all your records in one place.
I believe you that you do have that HUD-1 statement… somewhere. And I know that you kept all the other papers too, except those destroyed by your dogs, cats, and tenants. But I still need to see them, and so do the lenders, the IRS, and the buyers. Makes common sense to keep them all together, agree?
If you noticed, I never said WHERE you should keep all these papers and records. Why? Because it really is not that important! You can use fancy software and expensive file cabinets – or you can use yellow pads and, yes, the infamous shoeboxes. You are fine, as long as your records are
- complete
- regular
- in one place.
Complete financial records, at a minimum, should include just four elements:
- when? (i.e. Oct 24, 2005)
- how much? (i.e. $45.00 cash)
- to/from whom? (i.e. Oscar G.)
- for what? (i.e. AC service)
As you can see, a simple paper table with 4 columns will do the job. Specialized accounting software will do a better job of course, but notepad is still ok. Like with a diet, simplicity in bookkeeping is often the difference between staying on and giving up. You can always upgrade later. Check my website – www.MichaelPlaks.com – for the custom bookkeeping tools that I created for real estate investors like you.
The remaining seven commandments are somewhat “optional”. If you ignore them and adopt only the first three – you are still in the game. But if you follow all ten, you will be ahead of the game.
4. Separate your records by property.
This tip applies to all breeds of investors: landlords, flippers, rehabbers, developers, and everybody else. If you use a notepad, all it takes is assigning one page per property, plus an additional page for general “overhead” expenses that are not tied to any specific property. Each page will look the same.
Separating records by property means keeping more than one shoebox. This creates a special challenge for us men who own only one pair of shoes. As a substitute for shoeboxes, I suggest boxes from 12-packs. Those are easier to come by.
5. Assign categories to all expenses.
This can be done later on, but it is usually easier to do right away. By categories I mean “repairs”, “utilities”, “insurance”, and so on. Here comes an important warning though: do not invent your own categories, ask your accountant. I have seen a lot of useless categories that mess things up, such as “parking and meals” or “interest and closing fees.” Homemade ice-cream is good; homemade accounting is far less digestible. Please ask if not sure.
6. Avoid paying cash.
I hope this makes sense. Cash is easy to use (when you have it), but is very difficult to keep track of. Forgetting about a $100 cash payment will easily cost you $40 in unnecessary taxes! Throwing away money seldom leads to success in business.
7. Carry a portable organizer with you.
By “organizer” I mean whatever tool you use for recordkeeping. It can be a laptop computer or a small notepad – as long as it is handy throughout the day. The best time to record an expense is right after you paid it. Fortunately, Houston has enough stop signs and traffic jams to allow “instant” recordkeeping.
8. Use computer software only if you will use it regularly.
Here is a lesson from personal experience. Having an exercise bike at home does not make you exercise. Similarly, buying software does not eliminate the chore of daily recordkeeping. Besides, most of us do not carry our computers around, except for the PalmPilots. Complete recordkeeping with a notepad always beats messy recordkeeping with a computer.
If you do have the discipline and skills to use computers, I suggest you consider two programs. First one is Microsoft Excel which is basically a computer-based table with lots of bells and whistles such as sorting, calculators, and reports. It is extremely flexible but requires substantial customization, so it may not suit computer beginners.
The second program is Quicken made by Intuit. It is a fairly simple and user-friendly software designed for keeping track of money. If you know how to balance paper checkbooks, you can do Quicken.
9. Beware of “true” accounting software.
True accounting is far more complex than my “4-column bookkeeping.” Without understanding of such weird things as debits and credits, it may not be a good idea to use professional accounting software, such as QuickBooks (also made by Intuit.) However, if balance sheets do not scare you, then QuickBooks is the king.
10. Hold on to your records.
For how long? Long enough. Keep all records related to acquiring and improving property all the way until you sell the property, and then for 3 more years. Most other records need to be kept for 3 years after filing the tax return. Ask your accountant for more details.
Does bookkeeping still look overwhelming? I hope not. But it’s hardly fun either. At the end of the day, the big question is – is it all worth the trouble? I will go back to my dieting analogy. Should we torture ourselves with diets in order to stay healthy? Everyone decides for himself, just like with bookkeeping. But if the situation gets out of control, remember: Doctor Plaks had warned you. Make your move now.