It might surprise you to read this, but not all self-storage operators have a business background or the financial knowledge to go with it. I was once in that same boat, but I learned the hard way that fiscal savvy is critical to facility success.
Success in self-storage boils down to numbers, and if you want to know the health of your operation, you can read it clearly in your financial statements. Your ability to understand the story they tell you will determine the dials you turn and levers you pull to grow the operation. Similarly, if you’re looking at someone else’s business, such as a potential facility acquisition, you need to comprehend what the numbers are telling you and how you can improve asset performance.
As someone without a background in accounting or business management, I had to learn to “dumb down” the things my accountants told me to make meaning of the financial reports all self-storage owners should examine. Here’s an overview of the system I use, which focuses on three key reports: the profit-and-loss statement (P&L), the balance sheet and the cash-flow summary.
The P&L is a tally on profit. It essentially keeps score of your income and expenses.
Income is relatively easy to understand. Most people think of it as the money coming into a business. In self-storage, it’s the amount of money that makes it to the bank and is reported as rent, late fees, truck-rental income, etc. Expenses are the cost of running the business. Ultimately, if you do a good job bringing in income and managing expenses, there’ll be a positive number at the bottom of your P&L called profit. If you do a poor job, that number will be negative.
For most self-storage owners, if the number is positive, we tend to celebrate, and if it’s negative, we worry. I looked at this statement for years thinking I understood what was going on, but I didn’t, not really.
The key to understanding a P&L is recognizing that it’s a theory of your company’s profit, or net revenue. For example, let’s say you had $50,000 in income and $20,000 in expenses last month. In theory, you made $30,000, but do you really have 30,000 more dollars in the bank? Ninety-nine times out of 100, you don’t. You may show a great month on paper but still not have enough money to pay the bills. This is because the items on the P&L are fluid.
What I mean is some expenses will have been paid while others haven’t. Most of us use accrual accounting, which means bills are posted when they arrive. That’s when they become expenses. However, some expenses are paid in cash or with a credit card (IOU), and some are paid later. Property taxes, for instance, are paid once per year. Yet all these costs are wrapped up in the P&L, whether reflected monthly, quarterly or yearly.
Similarly, some income may arrive as cash while some is in the form of accounts receivable (also an IOU). For some self-storage owners, IOUs can actually be indicated as income in the time period covered by the P&L.
Are you beginning to see how that bottom-line number we all rush to look at is a theory about the profit your business makes? You can’t spend profit; you can only spend cash.
To be clear, it’s an important theory. If the profit number is consistently negative, the P&L is telling you that your business model isn’t working. The problem is it doesn’t tell you how much cash you’re making or losing. After all, the real health of your company is how well you turn profit into cash—and not just any kind of cash, as well we’ll discuss momentarily. First, let’s look at the second critical statement you need to understand your business health: the balance sheet.
The Balance Sheet
This is a weird one. It turns out that every business has “Things and Stuff,” which is broken out by items you either owe or own. Accountants refer to your Things and Stuff as “assets.” They call what you owe “liabilities,” and what you own “equity.” I think it makes better sense to think about these in more simplistic terms.
Most accountants say you own your self-storage investment (the money used to invest in, buy or start a facility) and profit (earnings). Items like buildings, fencing, computers, retail merchandise and cash in your bank account go onto this report. So, too, does the money customers owe you, which is initially filed under accounts receivable. Once paid, it moves to cash in the bank—that is until you use it to pay bills. As you can see, these items are also fluid.
Basically, accountants include items from four major areas on the balance sheet:
- Accounts receivable
- Property, plant and equipment (PP&E)
I don’t really care which category an item falls under. To me, it’s all Things and Stuff. What’s important is what I owe and own. Items I owe include property taxes, utility bills, insurance premiums, employment taxes, salary, etc., which fall under “accounts payable.” There may also be long-term expenses such as a real estate loan. If an item has interest attached, it falls under “long-term liabilities.” But again, it’s all just stuff that I owe.
What’s cool about the balance sheet is the figure under Things and Stuff equals what you owe and own. For example, let’s say your Things and Stuff equals 10, and what you owe is eight. The amount you own would be two.
If you think of your P&L as a movie about the theory of profit over a particular time period, then the balance sheet is like a snapshot. It gives you a summary for Things and Stuff at a moment in time. It could be different one minute later.
To gain a better understanding of what’s reflected on the balance sheet, let’s consider one of the big items you own: profit. There are really two types. The first is the profit figure on your P&L. For the sake of this exercise, it’s the theoretical profit from a time period that ends on the day the balance-sheet snapshot was taken.
The second is the earnings reflected on the balance sheet. This includes everything you’ve made since you started the self-storage business that you haven’t paid to yourself or your investors. If you pay yourself or your investors some of the profit, the accountants label it “dividends.” I prefer to think of it as profit I paid out. Incidentally, if you decide not to pay it out and keep it in the company, it’s called “retained earnings.”
Let’s look at a couple of earnings examples that should help drive this home. Company 1 has 10 items under Things and Stuff. Six fall under the owe category and four are under own (profit/earnings). Company 2 has 1,000 items under Things and Stuff, with 996 under the owe category and four under own. Both companies have earnings of four, but they aren’t alike. There are big differences between their assets and liabilities. Which would you rather invest in or buy?
Based on these basic numbers, Company 1 can turn a 40% profit on its assets, while Company 2 can turn less than .05%. This is true even though it’s easy to bet that Company 2’s assets are worth more than those under Company 1. When you simplify the balance sheet, you can more readily see which company is worth more and which is better run.
When you begin to apply this in real life, you’ll be able to see things about a company from its balance sheet that may not have jumped out at you previously. For me, translating an accountant’s language into understandable terms helps turn the numbers into a story.
The Cash Flow Statement
Like the P&L, the balance sheet doesn’t show you how much cash you have, even though it’s the lifeblood of your company. Without cash, you’re dead. The problem is accountants aren’t particularly interested in keeping a record of your cash. Those who oversee finances are more interested in the P&L and balance sheet because those deal with profit; and taxes are calculated off profit, not cash.
This is why I love the cash-flow statement. While the first two reports we discussed are really just theories, this one is factual. It measures three types of cash in any given time period:
- Operating: This is cash made within the time period through rent or sales, or when someone pays what they owe from another time period that’s collected on an IOU (accounts receivable).
- Investment: This is cash made by selling some of the Things and Stuff on the balance sheet. Specifically, it’s really what falls under PP&E. It can also be identified as investment cash spent by buying PP&E during the time period.
- Financing: This is cash that can be made by borrowing from a bank or raising it from investors. It can also be spent by paying down a loan or repaying investors (dividends).
The cash-flow statement tells you what happened to your self-storage operation’s cash during a period in time. It opens with a figure for the outset of the period and then adds and subtracts operating, investment and financing cash to arrive at an ending balance.
All three types are useful, but as a general rule, if your operating cash isn’t growing, your business won’t survive. While there may be growth spurts in which profit rises faster than cash, your cash should typically be growing faster than profit. This is partially because accountants have this thing called depreciation that, again, is a theory that helps keep profit down for taxes.
Know Your Story
I hope this helps you form a basic understanding of how to read your self-storage financial statements, whether it’s for your own business or someone else’s. The goal is to turn the numbers on these reports into a story that helps you adjust your operation or gauge how to improve a potential investment.
These three statements—the P&L, balance sheet and cash-flow summary—along with other reports that can be sourced from your management-software system, should give you all you need to make assessments and earn more money. At its essence, a self-storage asset is a way to buy capital improvements and generate operating cash. Continuing to improve your financial literacy will help ensure your investment is successful.
Mark Helm is a commercial real estate agent and self-storage investor. He began working with real estate investment trusts in the mid-1990s to locate and purchase self-storage properties before striking out on his own. He’s the author of “Creating Wealth Through Self-Storage” and the creator of “Storage World Analyzer,” a cloud-based, financial-analysis software tool designed to help self-storage operators and investors evaluate potential real estate acquisitions or development projects. To reach him, email [email protected].