Things to Look For When Analyzing an Operating Statement

I've made the case that a seller provided pro forma is pretty much useless, but one shouldn't just take an operating statement at face value either. They most certainly aren't useless, in fact, they are the most important thing when it comes to valuing a prospective acquisition. That being said, seller's can still hide and obfuscate the real numbers.

Bad Debts

If the seller is using accrual accounting, it's important to make sure that the seller has charged off the bad debts. With cash accounting, you will see how much money comes in, so there's no hiding it (although cash accounting can make things messy in other areas). But with accrual, all the potential rent is counted as collected and then what doesn't come in because of non-payment is charged off as a "bad debt." That's all fine and good, but it's important to make sure those debts have been charged off on the P&L.

Seasonal Changes

If you have a full year (or T-12) statement, you can see all the seasonal adjustments. But if only have a six months, be wary. First, you should ask why the trailing history is so short? Maybe it was a reposition, or maybe the property simply struggled for a long time and the owner doesn't want to highlight that. Regardless, expenses aren't uniform throughout the year. Landscaping is highest in the Summer, snow removal in the Winter and heating (if the owner pays the utilities) is highest in the Summer and Winter. In Jackson County, where I'm from, taxes are paid in December. If its cash accounting, often they won't account for the taxes each month, so if you don't look carefully, you may miss one of your biggest expenses

CAPEX

This is the big one. A lot of owners will try to shove things into the capital expenses (i.e. below the line so it doesn't effect the net operating income) that don't belong there. Things like major upgrades belong there. Roof replacements do to, although I would argue that unless it was done when the property was bought to upgrade it, it is a recurring capital expense. HVAC replacement is definitely recurring CAPEX in my opinion. And often, things like turnover or carpet is even put in CAPEX when that is undoubtedly an operating expense.

Make sure to look carefully at what the CAPEX expenditures are and add the one's that should be in the operating expenses back to get a more accurate picture of what has been going on.