The Proforma Income Statement: How to Project Rental Property Cash Flows And Performance!
Real estate investors commonly depend on a proforma income statement whenever performing a real estate analysis so that you can evaluate the long term cash flow performance of rental properties out over a number of years.
The concept of the proforma income statement is straightforward.
As a result of examining the financial performance of the rental property the year before and then making use of a variable to generate projections into the future, the real estate investor has the ability to project the cash flows he or she might expect to receive on a year-to-year basis over time based on those projections in the proforma.
Here's the way it works.
Assume that a property presently generates $30,000 gross operating income and has operating expenses of $12,000, consequently providing a net operating of $18,000 (i.e., income - expenses = net operating income).
In this case you could ascertain the subsequent year's net operating income based upon an educated guess for next year's income and expenses.
As an example, say that you project the gross operating income of $30,000 will increase yearly at 5% and the operating expenses of $12,000 at 4%. Then it follows that the net operating income at the conclusion of the coming year will increase to $19,020.
Revenue (next year) = $30,000 + (30,000 x .05) = $31,500
Expense (next year) = $12,000 + (12,000 x .04) = $12,480
Net Operating Income (next year) = $31,500 - 12,480 = $19,020
This is basically the procedure used for every subsequent year extending out for any specified amount of years until the rental income proforma is populated for that number of years.
Why are these property performance forecasts important?
Because, as anyone engaged in real estate investing understands, real estate is not regarded as liquid.
So it is prudent that a property's performance must be considered over the long term.
The proforma accomplishes this for real estate investors during their real estate analysis and for that reason explains why real estate investors regularly depend on it when making an investment opportunity decision.
How do I create a pro forma income statement?
If you have the free time and some working knowledge about the MS Excel spreadsheet program, you certainly can create one on your own.
Otherwise, you might want to consider making an investment in a good real estate investment software solution.
You will discover that many investment software solutions include a proforma (though with slight variances). Not all software solutions, for instance, might include computations for tax shelter or the time value of money in their proforma income statement.
Whichever method you choose, whether real estate investment software or a spreadsheet, here are a few important considerations to keep in mind when you are prepared to actually generate a proforma income statement.
1. Understand your objective. You want to use a proforma income statement to analyze the cash flow and other performance data that result from changes to income, vacancy allowance, operating expenses, and property value over future years.
2. The pro forma is 100% assumptive (a guess). Do not rely solely upon a proforma income statement to make your investment decision.
3. Don't project out too many years. Though a proforma can be constructed to project any number of future years, it is speculative, therefore you might not want to go out further then ten years. I personally would not feel comfortable going out any further.
4. Use realistic numbers to make your projections. Don't, for instance, increase the income 10% annually when 2-3% has been normal, or operating expenses 1% annually if a 2-3% annual inflation is more probable.
Sample (page 1)
Sample (page 2)
Okay, it's not a step-by-step tutorial but hopefully you get the idea.
If you would care to see a better screenshot of a proforma income statement simply follow the link provided below in my author resource box..
Here's to your success.
About the Author
James Kobzeff is a real estate professional and the owner/developer of ProAPOD - leading real estate investment software solutions since 2000. Create cash flow, rates of return, and profitability analysis on rental property at your fingertips in minutes! Includes a Proforma Income Statement. Learn more at www.proapod.com
ProAPOD also provides iCalculator - an online real estate calculator that enables you to learn dozens of real estate definitions and formulas as you calculate. You save 64%. Learn more at real estate calculator
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