I have just bought my home study course, I am going over the profit and loss section.
My questions are:
Why do we put the mortgage interest in there and not the whole mortgage? Don’t I want all of the money accounted for when trying to figure out if the deal is worth it?
Is the Net Income what I will be taking home? The P & L says 24k is the net income, is that what I will be making a year or is it the NOI? If it is the NOI, do I get that depreciation and interest back at tax time?
So confused! Thank you in advanced for anyone who can help me out on this.
Mortgage payments are compromised of two parts ( Principal and interest) . Interest is money that is an expense ( cost of borrowing money) . The principal pays down your loan. So its not an expense but you are building equity via a pay down of your loan balance. You just wont see that about until you sell or refinance.
I dont have it front of me but deprecation should not show up on a profit and loss statement . Its part of the accounting but you don’t actually pay out a check for it. You will get an accounting benefit from it. Example, you pay 50k for a new road in the park, it does not get expensed , it is a capital improvement ( and will be depreciated). Which interest would you get back at tax time ? Mortgage interest you do not receive back ever. if thats what the line item is.
FYI you can run it across a real accountant as I am not one
You can’t go into business confused on these issues. The confusion will not go away with answering the few questions you asked here because your condition is much more serious than you may think.
“…do I get that depreciation and interest back at tax time?” Yikes! You need an intervention but I do not recommend you turn to a CPA. Instead take a evening course on basic bookkeeping and accounting. There may be something online you could take, maybe Youtube has a course or two. Decades ago, when I was climbing out of the cave of my youthful ignorance, I went to some thrift stores and bought some accounting text books and read all the sexy parts (ha ha) which I offer as perhaps another good source for you.
At any rate, with a course you will learn much more then an hour with a CPA and it will likely cost less. From your questions it is obvious you really need to learn the basics from the ground up. For kids in high school the information is deadly dull. But if you are planning on being in business for yourself, I think you will find it very interesting, logical and a lot of lights will go off in your head. Don’t short change yourself and skip this; it is one of the main foundation stones on which your financial house will built. Don’t stop you education until you can read your post above and laugh at it.
Take heart – we’ve all been there. But forging ahead without understanding the fundamentals of business is the road to ruin.
Thank you all for your advise! I am going to look on utube for some basic accounting classes. I think what I was missing also is the depreciation. I didn’t realize it was on the P & L for accounting purposes and I should add that back on to my bottom line for net income. Thanks again!
Actually, deprecation does not add to your bottom line.
Let me explain:
You need a new roof on your building. It costs $25,000 for a roof with a 25 year life. So you reach into your pocket and shell out the $25k. This 25 grand is a capital investment. Capital is wealth that is put into the service of wealth creation; that is to say, invested. For that reason, capital expenditures are different than regular expenses like utilities, payroll and insurance, which are ongoing operational expenses. With regular expenditures, you pay the bill and the money is gone. But when you invest capital, the wealth remains. It just changed form. For example a million dollars in your checking account turning into to ownership of a million dollar mobile home park. You did not spend your million dollars, since you still have it, now in the form of real estate. Most people are confused about this distinction perhaps because politicians, shameless liars that they are, are always calling new spending they would like to do “investing.”
Back to your roof:
Every day the sun comes up and spends all day pounding your beautiful new roof with ultraviolet rays. After 25 years of this abuse, your roof is toast. One way of looking at it is, your $25,000 of invested capital was loosing about 1000 bucks a year. Or, stated more clearly, your investment of capital, which you used to purchase your roof was loosing $1,000 per year. It was not adding to your bottom line; it was being subtracted from your net worth (how much wealth you have.)
The tax code adds a level of complexity to how depreciation is figured, but I think this example will help you grasp the basic concept.
Typically a P&L is also called an “income statement.”
The “Net Operating Income” is just that – income from operations. It usually doesn’t include “1-time” or “special” or “non-operations” part of your business.
At the end of the day, interest expense is a tax-deductible expense that is the cost of your “capital” structure. You get to choose your capital structure, so usually we don’t include that as an “operating” expense and it is not included in NOI. So you “add that back in.”
Depreciation is as @Randy_CA said, a real cost but it’s not a cash expense. Since it’s not “cash out the door” you typically “add that back in” when trying to figure out what a property is going to actually cash-flow.
This is what people mean when they say, “add back” the depreciation (and amortization) and interest expense.
You would add back any “special one-time big expenses” too if you knew what they were, because that should not be included in your “Operating” income as “special big one-time expenses” are usually investments in your capital operation and not an operating expense.
As a quick-and-dirty, you can look at the P&L, add back depreciation and interest, and that’s about the amount the property will “cash-flow” before debt service. For your cash flow after debt service, you take the NOI and subtract the cost of your financing (usually debt service interest AND principal!) minus any of those one-time expenses that are not “ordinary.” But you still have to plan for those!
I wholeheartedly agree take a simple basic accounting course.
What you get back at tax time is a separate issue. Assuming you buy the park and you do well, you’ll have some cash flow, and some net income, which is a different number from NOI, and you’ll owe some tax on that net income.
Absolutely right! It is shameful how unprepared for life most kids are after 12 years of enduring public education. They should know the basics of business, money management, the power of goal setting and have some practical skills that have value in the market place.
