{"id":93683,"date":"2019-03-03T05:00:30","date_gmt":"2019-03-03T12:00:30","guid":{"rendered":"https:\/\/www.biggerpockets.com\/renewsblog\/?p=93683"},"modified":"2024-02-19T07:56:23","modified_gmt":"2024-02-19T14:56:23","slug":"visualizing-cash-flow","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/visualizing-cash-flow","title":{"rendered":"Visualizing Cash Flow: How to Accurately Budget Expenses"},"content":{"rendered":"

Normal is not the same as average.<\/p>\n

That\u2019s a theme we\u2019ll revisit time and again over the next five minutes. We\u2019ll start by breaking down two years in the life of a rental property and look at how a normal month looks very different from the monthly average.<\/p>\n

In rental management and in life, money doesn\u2019t flow regularly like a tranquil creek.<\/p>\n

Rather, it moves along steadily for a while, then a storm of expenses hits and it\u2019s thrown radically off course. Then the storm subsides, and the creek slips back to its normal flow.<\/p>\n

We\u2019ll use rental cash flow for visualization, but then we\u2019ll tie these lessons back to personal finance and household budgeting. Stick with us even if you\u2019re not a landlord, because we\u2019ll be illustrating a larger point about budgeting and how money flows.\u00a0After all, who can\u2019t use a little bump in their budget?<\/p>\n

Two Years in the Rental Lifecycle<\/h2>\n

Congratulations! You own a rental property.\u00a0Your property (let\u2019s call it Treehorn for fun) rents for $1,000\/month.<\/p>\n

Your mortgage on Treehorn costs $450\/month, including taxes and insurance. Treehorn\u2019s property management expenses include 8 percent of the collected rent, plus a one-month fee for placing new tenants. (Whether or not you have a property manager is irrelevant \u2013 you should be paying yourself for management if you manage the property yourself<\/a>.)<\/p>\n

That means in a quiet, \u201cnormal\u201d month, your expenses are $450 for the mortgage and $80 for management. For the \u201cI hate math\u201d crowd, that\u2019s $470 in cash flow on a normal month, which is all fine and dandy, until occasional-but-very-real expenses rear up and start breathing fire at you.<\/p>\n

Take a look at your rents and expenses over these two years:<\/p>\n

\"\"<\/p>\n

There are plenty of quiet months. But there are plenty of months with extra expenses, too.<\/p>\n

Here\u2019s another graph, showing your take-home cash flow each month over these two years:<\/p>\n

\"\"<\/p>\n

What\u2019s the difference between \u201cnormal\u201d and \u201caverage\u201d?<\/p>\n

In a \u201cnormal\u201d month, your cash flow is $470. But averaged over time, your cash flow comes to $179.46\/month\u2014and that\u2019s<\/em> the important number.<\/p>\n

Related:<\/strong> The Foolproof Monthly Budget: How to Save Up Money to Buy Investment Properties<\/a><\/em><\/p>\n

Expenses: Irregular but Real<\/h2>\n

In our example here (which is based on a real property of mine), Treehorn\u2019s roof needed a major repair in March of Year 1, which set you back $1,458.<\/p>\n

Later that year, you coughed up $200 for Treehorn\u2019s furnace to be serviced in September.<\/p>\n

Then, at the end of November, the tenants gave you notice that they were moving out. In December, you sent in a painting crew, who repainted the inside of the unit to the tune of $1,850.<\/p>\n

Making matters worse, Treehorn spent two lonely months vacant as you marketed it for rent. By mid-January, your property manager found a new renter, who moved in on February 1st.<\/p>\n

Kiss goodbye a one-month fee for placing the new tenant. When added to the regular 8 percent of February\u2019s rent, you were left with property management and labor expenses of $1,080 for February.<\/p>\n

Treehorn then performed for you for a little while, until a repair bill of $375 slapped you in July.<\/p>\n

October brought a maintenance bill of $250 to fix an ailing thingamajig.<\/p>\n

You closed out Year 2 quietly. And for that, we thank Treehorn.<\/p>\n

\"\"<\/p>\n

The Cost of Turnovers (Not Fun) & a Sankey Diagram (Fun)<\/h2>\n

Whether you think these repair and maintenance costs were high or not (I don\u2019t think they were), they pale in comparison to the turnover costs.<\/p>\n

I harp on this all the time to our online students: turnovers are a landlord\u2019s worst enemy.<\/p>\n

Consider the example above: the turnover cost $2,000 in lost rent, $1,850 in repainting (which only needs to be done during turnovers), and $1,000 in labor to place a new tenant. That\u2019s almost $5,000 in costs caused by one stupid little turnover!<\/p>\n

By contrast, the maintenance and repairs costs above totaled $2,283. And at the very least, the property was materially younger and in better shape for those costs.<\/p>\n

The same can\u2019t be said of the turnover expenses. Even the paintjob is effectively lost money \u2013 the new tenants will leave their marks on those walls, which will probably need to be repainted again come the next turnover.<\/p>\n

When most landlords want to improve their cash flow, the first thing they jump to is raising the rent. And sure, that improves cash flow in a \u201cnormal\u201d month.<\/p>\n

But I\u2019ve found that the best way to improve my real cash flow, my long-term average profit, is by doing everything possible to cut my turnover rate.<\/p>\n

Treehorn\u2019s average monthly cash flow was $179.46, and here\u2019s what that average monthly cash flow looks like:<\/p>\n

\"\"<\/p>\n

As a final thought for landlords, imagine you prioritized tenant retention and reducing turnovers<\/a>. Instead of Treehorn turning over every two years, it turns over every four. When you chop those turnover costs in half, the average monthly cashflow surges from $179.46 to $277.17.<\/p>\n

Not a bad bump in profits, right?<\/p>\n

What Rental Cash Flow Teaches Us About Personal Cash Flow<\/h2>\n

\u201cThis is all well and good,\u201d you say, \u201cbut I\u2019m not a landlord.\u201d<\/p>\n

And you\u2019re still reading? That\u2019s amazing.<\/p>\n

By now, it should be clear that cash flow is about averaging out the peaks and valleys of irregular expenses. Experienced landlords know this, and new landlords need to learn it fast to succeed.<\/p>\n

But how is this lesson relevant in our personal cash flow and budgeting?<\/p>\n

It\u2019s relevant because the same thing happens in our personal budgets, just not as obviously.<\/p>\n

You may not have to budget for turnovers, but you have other irregular costs. Homeowners have to budget for property repairs just like landlords do. Cars also need maintenance and repairs, just like houses. All of us have occasional medical bills, large and small (one might call these our own personal maintenance and repairs costs).<\/p>\n

I bet if you added up every penny that you spent on gifts over the past 12 months, you\u2019d be shocked at the total. (Seriously \u2013 between holiday shopping, birthdays, weddings, showers, and other arbitrary occasions when we\u2019re supposed to buy people presents, most of us spend an undocumented fortune.)\u00a0It\u2019s these irregular \u2013 but very real \u2013 expenses that throw the proverbial wrench in our budgets.<\/p>\n

\"\"<\/p>\n

Sure, everyone knows how to budget for their rent or mortgage, and their car payment. But how often have you said to yourself, \u201cWell, this month was different because I had to put Cindy\u2019s wedding present on my credit card. I\u2019ll make it up next month.\u201d Except next month it\u2019s, \u201cWell, it was Little Johnny\u2019s birthday this month, and we wanted to make it special. But next month will be different. We don\u2019t have to buy any presents next month!\u201d<\/p>\n

Then next month you get hit with an unexpected $500 medical bill. The month after that it\u2019s an $800 car repair.<\/p>\n

Seeing a pattern here?<\/p>\n

Related:<\/strong> How to\u00a0Calculate Cash Flow on Your Next Rental Property<\/a><\/em><\/p>\n

Budget for the Irregular<\/h2>\n

If you\u2019re a landlord, you (hopefully) have an expense checking account set up for each property. You put money into it every month, based on your average monthly cash flow calculations for expenses like repairs, maintenance, vacancies, etc.<\/p>\n

The lesson for all of us is to do the same with our irregular personal expenses. Set up a special account with the sole purpose of covering irregular personal expenses: gifts, unexpected medical bills, car repairs, and so on.<\/p>\n

How much you put toward it is a personal decision, but if the account ever gets below $200, you\u2019ll know you need to be putting more into it.<\/p>\n

At the end of the year, if you have extra money in the account, good for you! You can shift some of it to an investment account for real estate, stocks, notes, whatever.<\/p>\n

You know these expenses are coming. You\u2019re an intelligent adult. Now budget for them, so you\u2019ll never be surprised again when irregular expenses pop up and make a grab for your wallet!<\/p>\n

We’re republishing this article to help out our newer readers.<\/em><\/p>\n

\"\"<\/a><\/p>\n

How do you handle irregular expenses? <\/em><\/p>\n

Any tips or tricks you’d care to share? Don’t be shy! Post them below!<\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"

What does cash flow look like? Here’s what a rental property’s cash flow looks like\u2014plus what all of us can learn from it for our personal budgeting!<\/p>\n","protected":false},"author":158586,"featured_media":93811,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[4241],"tags":[],"class_list":["post-93683","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-real-estate-business-management"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/93683","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/158586"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=93683"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/93683\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/93811"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=93683"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=93683"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=93683"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}