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This week, I interviewed David Richter, the author of “Profit First for Real Estate Investing” and the CEO of Simple CFO Solutions.
Our company implemented his Profit First system a few years ago, and it has TRANSFORMED our business finances!
When I first started Duratus Properties, we were haphazardly managing our finances on various spreadsheets, we were not on the same page with our accountant, and we did not have a clear financial picture or financial management system.
Then, one day, I learned about the Profit First system on a podcast and it sounded like EXACTLY what we needed to get everyone on the same page and get our finances under control.
If you want to know what the system is and how to implement it, I certainly recommend reading Profit First for Real Estate Investing, but here’s how we implemented it step by step (feel free to use this in your business).
PFREI Implementation Steps:
- Owners write down their “Need” and “Want” numbers
- Need = Personal bank and credit card statements for the last six months and the average of what you spent.
- Want = Need number times (at least) two.
- Need & Want Calculator
- Fill out this Worksheet
- How many deals do you need to do and at what profit point do you need to do them to pay yourself what you Need?
- Formula 1: Find how much your business needs to make: your Need number divided by the percent you need to pay yourself equals your business goal.
- Formula 2: Find how many deals a year you need to do in order to hit your business goal: your business goal divided by your average profit per deal equals the number of deals you need to do in a year.
- EXAMPLE: If you are a fix-and-flipper who averages about $ 30,000 in profit per flip, how many flips would you need to do in a year to make sure you could pay yourself $ 84,000 and have that number be 35% of your business? Because we know we need $ 240,000 as a business goal to be able to pay ourselves 35% to give us $ 84,000, we can take $ 240,000 and divide that number by $ 30,000 in deal profitability to give us the number of deals in a year. In this case, it’s eight deals a year or two deals per quarter in the year.some text
- A healthy percentage to pay yourself at this level of revenue is about 35% to 50%.
- Run an INSTANT Assessment on Your Business
- Blank Templatesome text
- The instant assessment is a very simple way to gain this knowledge. You only need to know two numbers: your income and what you paid yourself in the last twelve months.
- Instant Assessment PDF
- Formula: Sale Price minus Pass-Through Revenue (purchase price plus rehab plus closing and holding costs) equals Real Revenue
- Blank Templatesome text
- Calculate Your CAPs & TAPs
- Current Allocation Percentages (CAPs): give you a clear picture of how you're allocating your finances amongst income, owner's compensation, operating expenses, profit and taxes. This is your Real Revenue now.some text
- Calculate what you made and kept for yourself in the last twelve months and figure out your CAPs
- Target Allocation Percentages (TAPs): These are the percentages of the Real Revenue you should aim for to have a healthy company and to unlock the true benefits of why you started investing.some text
- Project what your Real Revenue will be over a year and determine your TAPs.
- Allocation Calculator
- Example TAPS for a Flipping Company: some text
- Current Allocation Percentages (CAPs): give you a clear picture of how you're allocating your finances amongst income, owner's compensation, operating expenses, profit and taxes. This is your Real Revenue now.some text
- Example TAPS for a Rental Company:
- Set Up the Foundational Bank Accounts
- Profit: Set up one new account dedicated to your company's profitability and transfer 1% of all sales into that account. The Profit Account This account is to give you a return for running a successful company. Putting your first dollars here is how you stop losing out on the money you already made.
- Owner’s Compensation: This account ensures you pay yourself for the work you do in the business. This is an account that ensures you, the owner, get paid.
- Owner’s Tax: This account is for saving for the taxes you pay Uncle Sam throughout the year. As the owner, your business should pay your taxes for you.
- Income: This is a holding bucket for your money until you transfer the income to the other accounts. Profit: This is the foundational account that will help you become and stay profitable.
- OpEx (Operating Expense): You already have this account set up because you already pay bills and operational expenses.
- OPM (Other People’s Money): This account will save your bacon because it’s for the money received from private lenders for your rehabs. The money in this OPM account is to be spent ONLY on properties for which those funds have been designated for rehab.
- Reserves: I also propose that real estate investors set up another account right away called Reserves. If you do not want to worry about your finances or whether a property is closed, add a Reserves account right from the start to give yourself breathing room.some text
- The fact that they have reserves—not the number of deals they do—is a mark of a successful business.
- Set Up 5 Additional Recommended Accounts
- PITI: PITI stands for Principal, Interest, (Property) Taxes, and Insurance. One of your biggest expenses will more than likely be the mortgages you have on your rentals unless you own them free and clear. An account just for PITI has been game-changing for the buy-and-hold investors we work with because they now can see at a glance what they will pay monthly for their mortgages. This
- Rental Repairs/ Maintenance: Vacancy and Turnover The biggest expenses you’ll have as a buy-and-hold investor will be repairs, vacancy, and turnover.
- Security Deposits: You need to set up an account for the tenants’ security deposits. Please do not mix security deposits with any other money.
- Bad Debt: To get started, a lot of investors finance a lot of purchases with credit cards or with unsecured loans and may keep in that habit as the business grows. Having an account to pay down this debt brings peace of mind and helps you focus on eliminating the bad debt in your business.
- Charity / Giving: I encourage you to consider opening an account for the sole purpose of charitable contributions.
- 3 More Advanced Accounts to Consider
- Marketing Account: Any type of real estate company you own, whether it is a fix-and-flip or rental company, could potentially have a marketing account. some text
- I’ve seen real estate investors who specifically set up an account to funnel their marketing dollars into, so they can clearly see what they spend every month for marketing and what they can spend.
- This marketing account makes it very easy to track what works in your marketing and what doesn’t. Marketing dollars are the fuel that drives your business, so you need to make sure your engine is always able to run.
- Payroll Account If you have employees you pay on a regular basis, I’d consider opening an account specifically for payroll. This would serve several purposes: some text
- It helps you have peace that you have enough to pay your people every single time.
- If you need to hire someone, start adding the money you know you’ll need to pay them into that account before you hire them to make sure you will be able to pay that new hire without it hurting your business.
- Bonus Benefit: It lets your people know that you care about them and gives them peace of mind.
- Investors’ Principal Account: The investors’ principal account is specifically for any money you get from private lenders or hard money lenders that is not tied to a certain property.
- Marketing Account: Any type of real estate company you own, whether it is a fix-and-flip or rental company, could potentially have a marketing account. some text
- Prioritize & Cut Expenses
- Figure out your current expense percentage. Get your financial statements and find the average of what you currently spend on your expenses
- Here are the steps to gain clarity on the expenses and know which ones to cut: Print out your bank and credit card statements for the last month. some text
- Next to each expense item on the statements, categorize them by three letters: P, R, and U. some text
- P is for Profitable. This expense drives revenue, brings profit to your company, or saves you a ton of time and headache. Write the letter P next to these expenses.
- R is for Replaceable. This expense can be replaced by something cheaper or by an option that will have a greater return. Write the letter R next to these expenses.
- U is for Unnecessary. These expenses will be items such as the subscriptions that you have that you never use or expenses that don’t drive revenue, bring profit to your company, or save you a ton of time and headaches. Write the letter U next to these expenses and circle them with a red pen.
- Next to each expense item on the statements, categorize them by three letters: P, R, and U. some text
- Print out a list of all your team members and write down the same letters next to each name (P, R, or U). some text
- This will most likely be the most painful part of the whole exercise, but you need to make sure each and every team member pulls their weight and either brings in revenue (like great salespeople), protects the revenue (like great finance people), or saves you time (like operations and administrative people) to focus on higher level tasks.
- Run a PFREI Assessment of the Business
- Business Assessment Template
- This is more in-depth than the instant assessment we did at the beginning
- Get the Maximum Return on Your Marketing Dollars
- Fill out the Marketing Tracking Sheet
- Set up KPIs around your marketing dollar returns.
- Create a Deal Dashboard
- Set up a dashboard and track your deals’ total and average profit by acquisition and exit strategy method and location to get a handle on your business and operate like a true business owner.
Additional Recommendations:
- Join the PFREI Facebook Group
- Read Dawn Fotopulos’s book, Accounting for the Numberphobic
- Free Resources