DECISION MAKING ABOUT PROFITABILITY Flashcards
(210 cards)
1
Q
What is the role of a real estate manager in relation to profitability?
A
The real estate manager is a decision maker.
2
Q
What is one of the main sources of information for making sound decisions about profitability?
A
Budgets.
3
Q
List the specific types of budgets mentioned.
A
- Operating budget
- Long-range budget
- Rent-up budget
- Capital budget
- Cash-flow budget
4
Q
What does net operating income (NOI) represent in real estate?
A
A particularly important concept.
5
Q
What can fiscal considerations and hypothetical projections be listed on?
A
A pro forma statement.
6
Q
Name three important techniques for preparing and assessing financial decisions.
A
- Forecasting
- Zero-based budgeting
- Long-range budgeting
- Variance analysis
7
Q
What should a real estate manager be aware of regarding reporting documents?
A
Different criteria that apply to internal and external reporting documents.
8
Q
How is profitability calculated in real estate?
A
By understanding budgeting contributions to profitability planning.
9
Q
What is the main focus when working with different kinds of budgets?
A
Understanding their purposes and the information they contain.
10
Q
True or False: The operating budget is one of the specific budgets used in real estate.
A
True.
11
Q
Fill in the blank: The _______ budget monitors specific target areas related to cash flow.
A
cash-flow
12
Q
What is the purpose of variance analysis in financial decision-making?
A
To assess financial decisions.
13
Q
What is a basic purpose of management in real estate?
A
To meet the owner’s goals
14
Q
What is the formula for calculating profit?
A
Revenues - Expenses
15
Q
Why is the basic profit formula too simple for real estate?
A
Operating expenses are not voluntary and there are high debt service and capital expenditures
16
Q
What is gross potential rental income?
A
The maximum rent a property will produce
17
Q
What does effective gross income (EGI) equal?
A
Gross potential rental income - Vacancy and rent loss + Miscellaneous income
18
Q
What is net operating income (NOI)?
A
Effective gross income - Operating expenses
19
Q
Is NOI the same as profit?
A
No, NOI is not the same as profit
20
Q
What are the two important measures of a property’s financial health?
A
Net operating income (NOI) and Cash flow
21
Q
What is cash flow calculated as?
A
Net operating income - Debt service - Capital expenditures
22
Q
What does NOI indicate about a property?
A
It indicates the income available to pay loans and owners
23
Q
Why is NOI important for real estate managers?
A
It is a gauge of how well a real estate manager is doing
24
Q
What can an effective property manager do to NOI?
A
Increase the NOI
25
Fill in the blank: Effective gross income is calculated by taking gross potential rental income, subtracting _______ and adding miscellaneous income.
Vacancy and rent loss
26
True or False: Debt service is included in the calculation of NOI.
False
27
What does the equation for NOI look like?
Effective gross income - Operating expenses = Net operating income
28
What is a basic purpose of management in real estate?
To meet the owner's goals
29
What is the formula for calculating profit?
Revenues - Expenses
30
Why is the basic profit formula too simple for real estate?
Operating expenses are not voluntary and there are high debt service and capital expenditures
31
What is gross potential rental income?
The maximum rent a property will produce
32
What does effective gross income (EGI) equal?
Gross potential rental income - Vacancy and rent loss + Miscellaneous income
33
What is net operating income (NOI)?
Effective gross income - Operating expenses
34
Is NOI the same as profit?
No, NOI is not the same as profit
35
What are the two important measures of a property's financial health?
Net operating income (NOI) and Cash flow
36
What is cash flow calculated as?
Net operating income - Debt service - Capital expenditures
37
What does NOI indicate about a property?
It indicates the income available to pay loans and owners
38
Why is NOI important for real estate managers?
It is a gauge of how well a real estate manager is doing
39
What can an effective property manager do to NOI?
Increase the NOI
40
Fill in the blank: Effective gross income is calculated by taking gross potential rental income, subtracting _______ and adding miscellaneous income.
Vacancy and rent loss
41
True or False: Debt service is included in the calculation of NOI.
False
42
What does the equation for NOI look like?
Effective gross income - Operating expenses = Net operating income
43
What is a basic purpose of management in real estate?
To meet the owner's goals
44
What is the formula for calculating profit?
Revenues - Expenses
45
Why is the basic profit formula too simple for real estate?
Operating expenses are not voluntary and there are high debt service and capital expenditures
46
What is gross potential rental income?
The maximum rent a property will produce
47
What does effective gross income (EGI) equal?
Gross potential rental income - Vacancy and rent loss + Miscellaneous income
48
What is net operating income (NOI)?
Effective gross income - Operating expenses
49
Is NOI the same as profit?
No, NOI is not the same as profit
50
What are the two important measures of a property's financial health?
Net operating income (NOI) and Cash flow
51
What is cash flow calculated as?
Net operating income - Debt service - Capital expenditures
52
What does NOI indicate about a property?
It indicates the income available to pay loans and owners
53
Why is NOI important for real estate managers?
It is a gauge of how well a real estate manager is doing
54
What can an effective property manager do to NOI?
Increase the NOI
55
Fill in the blank: Effective gross income is calculated by taking gross potential rental income, subtracting _______ and adding miscellaneous income.
Vacancy and rent loss
56
True or False: Debt service is included in the calculation of NOI.
False
57
What does the equation for NOI look like?
Effective gross income - Operating expenses = Net operating income
58
What is a basic purpose of management in real estate?
To meet the owner's goals
59
What is the formula for calculating profit?
Revenues - Expenses
60
Why is the basic profit formula too simple for real estate?
Operating expenses are not voluntary and there are high debt service and capital expenditures
61
What is gross potential rental income?
The maximum rent a property will produce
62
What does effective gross income (EGI) equal?
Gross potential rental income - Vacancy and rent loss + Miscellaneous income
63
What is net operating income (NOI)?
Effective gross income - Operating expenses
64
Is NOI the same as profit?
No, NOI is not the same as profit
65
What are the two important measures of a property's financial health?
Net operating income (NOI) and Cash flow
66
What is cash flow calculated as?
Net operating income - Debt service - Capital expenditures
67
What does NOI indicate about a property?
It indicates the income available to pay loans and owners
68
Why is NOI important for real estate managers?
It is a gauge of how well a real estate manager is doing
69
What can an effective property manager do to NOI?
Increase the NOI
70
Fill in the blank: Effective gross income is calculated by taking gross potential rental income, subtracting _______ and adding miscellaneous income.
Vacancy and rent loss
71
True or False: Debt service is included in the calculation of NOI.
False
72
What does the equation for NOI look like?
Effective gross income - Operating expenses = Net operating income
73
What is budgeting?
The process of planning for profitability.
74
How can a budget be defined?
A statement of the financial position of a property for a defined period based on estimates of income and expenses.
75
What is the primary use of a budget in management?
To plan and control a property's operations.
76
What is the role of a budget in setting goals?
It is the basis for setting measurable goals and assessing how well those goals have been achieved.
77
True or False: A budget is a static document.
False
78
What are some basic responsibilities of budgeting?
Achieving an organization's goals such as increasing profits, maintaining market share, raising the NOI, and enhancing value.
79
What is the misconception about budgeting?
That it is merely a clerical task.
80
How does budgeting assist managers?
By easing decision making, allowing closer management of daily operations, controlling costs, and planning for future goals.
81
Fill in the blank: Budgeting is an information-gathering and _______ process.
monitoring
82
What future goals can budgeting help plan for?
Amounts of cash flow and periodic income.
83
What is the first purpose of budgets?
Budgets form the foundation of the overall management plan
## Footnote
This plan may be referred to as an action plan, workout plan, or other names.
84
What is the second purpose of budgets?
Budgets serve as guidelines for operating a property.
85
How do budgets help in comparing operations?
Budgets indicate whether operations are efficient or can be streamlined by comparing actual amounts from previous years' experience or from a similar property.
86
What is the fourth purpose of budgets?
Budgets can be used to measure the performance of the real estate manager and the management company.
87
What is the purpose of budgets in cash flow management?
Budgets are used to measure owners' cash-flow requirements and project future income and expenses.
88
What is an operating budget?
A one-year detailed plan for managing property.
89
What factors do real estate managers consider when creating an operating budget?
Forecasts, previous year's historical figures, and planned operational changes.
90
Can an operating budget be created for different time frames?
Yes, it can be created for either a fiscal or calendar year.
91
What determines the form of the operating budget?
The owners' information requirements.
92
What is a chart of accounts?
A listing of the line items found in the operating budget.
93
How does breaking down categories in the chart of accounts help management?
It allows for better monitoring and control of costs.
94
What types of income are included in receipts?
Rent, fees, and other sources.
95
What are operating expenses?
Expenses including maintenance, utilities, payroll, advertising, and taxes.
96
What do financing expenses encompass?
All costs of loans and mortgages.
97
What are reserves for replacement?
Funds set aside for improvement or rehabilitation of a property.
98
What are ownership requirements in the context of budgeting?
Cash-flow requirements of the owner.
99
Fill in the blank: The operating budget lists planned income and expense amounts for each month by _______.
[account]
100
True or False: The operating budget does not provide annual totals after it is created.
False
101
What is a rent-up budget?
A rent-up budget is used for new buildings, rehab projects, and properties with abnormal vacancies. It estimates income and expenses for the first year of operation or until occupancy is stabilized.
102
How does income typically change during the first year in a rent-up budget?
Income is typically lower during the first year.
103
What is the purpose of a cash-flow budget?
The cash-flow budget shows inflows and outlays of cash.
104
What does a capital budget plan for?
A capital budget is for planning and controlling a property's capital expenditures.
105
Why must capital budgets be kept separately?
For tax reasons.
106
What is a pro forma statement?
A hypothetical projection showing forecasted financial statements in contrast to reporting actual results.
107
When is a pro forma statement used?
To analyze the effects of major changes on a property or to estimate the revenues and expenses of a future project.
108
What is the importance of forecasting in budgeting?
Forecasting income and expenses is essential for creating a budget.
109
What should be the basis for forecasting future expenses?
Past actual expenses rather than past budgeted expenses.
110
What is a recommended method for forecasting future expenses?
Working backward through three years of expense statements.
111
True or False: Budget items always change predictably from year to year.
False.
112
Fill in the blank: A rent-up budget should be set up _______ to reflect the changes that occur as a building comes on the market.
month by month.
113
What should a real estate manager consider if last winter was particularly severe?
Last year's heating bills may be unusually high and should be compared to the previous two years.
114
What should be analyzed to determine the realism of insurance coverage limits?
Insurance policies' coverage limits
## Footnote
This involves checking whether the coverage is adequate and the premiums are reasonable.
115
What is a recommended action for forecasting utility expenses?
Contact utilities to determine future rate trends
## Footnote
Additionally, use averages of past years' utility expenses for estimates.
116
What budgeting method is suggested for determining payroll expenses?
Zero-based budgeting
## Footnote
This method requires justifying each expense from scratch rather than using previous budgets.
117
Why is it important to keep current tax schedules and rates?
To stay informed about upcoming changes in taxes
## Footnote
This can be done by contacting taxing authorities.
118
What is the best method for forecasting future expenses based on past expenses?
Determine how the expense has changed in the past
## Footnote
This involves analyzing trends and fluctuations in expense data.
119
What should be examined to anticipate potential expenses?
All potential risk factors
## Footnote
Identifying risk factors helps in proactive financial planning.
120
What economic factor should always be factored into forecasts?
Inflation
## Footnote
This is important even during periods of low inflation.
121
What is the basic formula for calculating an average?
Add up the numbers, then divide by the number of values
## Footnote
Example: (66 + 70 + 64 + 60) ÷ 4 = 65.
122
What is a weighted average?
An average where certain figures are given more proportional importance
## Footnote
This is done by assigning different weights to various numbers based on their significance.
123
True or False: Averages are sensitive to unusual numbers.
True
## Footnote
Unusual figures can distort the average, leading to inaccurate forecasts.
124
What should real estate managers be cautious about when using averages for forecasting?
Do not follow figures blindly
## Footnote
Averages can be misleading if they are influenced by outlier numbers.
125
What could indicate an unusually cold January in the provided heating bill figures?
A significantly lower average compared to other months
## Footnote
This can be assessed by comparing the averages of different years.
126
Fill in the blank: The average increase in plumbing expenses for Year 4 can also be calculated using the formula _______.
Year 3 expense + (Year 3 expense × average percentage increase)
## Footnote
Year 4 expense = $2,346 + ($2,346 × 0.0351)
127
True or False: The average increase in plumbing expenses can be calculated using both dollar change and percentage change.
True
## Footnote
Both methods yield slightly different results for Year 4 expenses.
128
What is the expected increase in Year 4 based on previous years?
Weighted average
129
What is the formula used to calculate the weighted average for the expected increase?
Weighted average = ($5,600 × 0.3) + ($1,200 × 0.7)
130
True or False: The weights assigned in a multiyear calculation must always be the same.
False
131
Fill in the blank: The actual weights given in a weighted average calculation should be determined according to your _______.
[previous experience]
132
What are fixed costs in real estate?
Costs that do not change as occupancy rates change and remain stable during the budget.
## Footnote
Examples include insurance and real estate taxes, which are set by external entities.
133
What are variable costs in real estate?
Costs that change with usage, such as electricity and water.
## Footnote
These costs vary based on the amount used.
134
What are controllable revenues or costs?
Revenues or expenses that the real estate manager can affect through management actions.
## Footnote
Managers can increase or decrease these through their management plan.
135
What is the focus of management actions in real estate?
To manage controllable costs and revenues to meet budget targets.
136
What is long-range budgeting?
A technique used to estimate future expenditures and returns over a period longer than one year, typically three to five years.
## Footnote
It involves forecasting income and expenses for decision-making.
137
What decisions can a long-range budget help with?
* Whether and when to sell a property
* Whether renovation can be accomplished profitably
* Decisions on financing or refinancing
* Operating within the norms for the area
* Whether and when to increase rents.
138
True or False: Fixed costs can be significantly altered by real estate managers.
False.
139
Fill in the blank: Variable costs are costs that change with _______.
[usage].
140
What is the significance of a long-range budget for property managers?
It allows them to predict future income and expenses, aiding in strategic decision-making.
141
What is zero-based budgeting?
A method that avoids using past budget figures to determine current figures
142
What does zero-based budgeting prevent?
Automatic insertion of expenses into budgets year after year
143
What sources does a real estate manager use in zero-based budgeting?
Contractors, vendors, utility companies, and IREM Income/Expense Analysis Reports
144
List the four factors that should lead to the consideration of zero-based budgeting.
* When historical information is not available
* When projections from past expenses are likely to be unreliable
* When records are inaccurate or nonexistent
* As a check to ensure expenses forecasted by another method are not out of line
145
What is budget variance analysis?
The comparison of differences between budget figures and actual outlays for a particular budget period
146
Define budget variance.
The difference between the budget and the actual amount spent or earned for a given period
147
Fill in the blank: A budget variance is the difference between the budget and the _______.
actual amount spent or earned for a given period
148
What is a favorable variance?
When actual spending is less than the budgeted amount
149
What is an unfavorable variance?
When actual spending exceeds the budgeted amount
150
If the projected amount is $40,000 and the actual amount spent is $50,000, what is the variance?
-25%
151
What is the primary reason for examining budget variances?
To determine whether you need to change management actions to meet owner's goals.
152
What does a budget variance report include?
Budgeted amounts, actual amounts, and budget variances (in dollars and as percentages) for each line item.
153
How do you calculate the net total variance?
Find the difference between total unfavorable variances and total favorable variances.
154
What indicates an unfavorable net total variance?
Total unfavorable variances are greater than total favorable variances.
155
What should a narrative in a budget variance report explain?
The rationale for any variances that exceed standards set by the owner or manager.
156
True or False: The importance of a variance is determined solely by whether it is favorable or unfavorable.
False.
157
What corrective actions should be considered a normal part of budgeting and management?
Corrective actions based on variances.
158
Fill in the blank: A narrative should provide details about each variance larger than a predetermined _______.
standard.
159
What is a good practice regarding budget variances in reports?
Create a column for approved budget variances.
160
What type of adjustments do most budgets allow for?
Midyear adjustments to reflect changes in circumstances or new information.
161
What should a balance sheet provide regarding a property's financial condition?
A realistic picture of the property's financial condition.
162
Why is it important to evaluate and refine the information incorporated into budgets?
Especially for new buildings.
163
What is the significance of variances that are 10 percent greater than the budgeted amount?
Explanations may be required for these variances.
164
What is the foundation of managerial decision making in real estate management?
Accurate information.
165
What does a periodic management report typically include?
Narrative portion, summary, financial reports, rent roll.
166
What financial reports support the narrative portion of the periodic management report?
Summary of cash receipts and disbursements, budget variance report, capital improvements recap, income statement.
167
What is managerial accounting primarily concerned with?
Internal financial reports and analysis of new investment proposals.
168
Who are the primary users of managerial accounting?
Managers and owners.
169
What is the purpose of financial accounting?
Preparing financial reports for external use.
170
Who typically requires detailed financial information from real estate managers?
Banks, corporate shareholders, potential investors.
171
What does a balance sheet for external reporting show?
An organization's financial situation at a specific point in time.
172
What three items are listed on a balance sheet?
Assets, liabilities, owners' equity.
173
How can owners' equity be derived?
Using the equation: assets - liabilities = owners' equity.
174
Fill in the blank: Preparing financial reports for external use is called _______.
financial accounting.
175
True or False: Financial reports for external use are less standardized than those used in managing the property.
False.
176
What are considered corporate assets?
Cash, accounts receivable, the building.
177
What are liabilities in the context of real estate management?
Creditors' claims on a property, such as mortgage and accounts payable.
178
What is typically included in a rent roll?
Details of lease arrangements with tenants and vacancies.
179
What are considered assets in real estate?
Apartment buildings, office buildings, and shopping centers
## Footnote
These assets can provide income through rentals or by being sold.
180
How is owners' equity defined?
The difference between the value of assets and liabilities
## Footnote
Owners' equity represents the net worth of the owner in the property.
181
What distinguishes current assets from long-term assets?
Current assets are expected to be converted to cash or used up during the year; long-term assets are held for longer than one year
## Footnote
Real estate is a prime example of a long-term asset.
182
What are current liabilities?
Liabilities that fall due within the coming year
## Footnote
These are obligations that must be settled in the short term.
183
What is the income statement used for?
To give a summary of the economic activity of an organization over a period of time, typically a year
## Footnote
It is essential for external reporting.
184
What major expenses are deducted from revenues in an income statement?
Operating expenses, depreciation, interest, and income taxes
## Footnote
Principal payments are not deducted.
185
What do operating expenses include?
Salaries, repairs, and utilities
## Footnote
Property taxes are included with operating expenses, not with income tax.
186
Fill in the blank: Current liabilities are those that will be paid off over some _______.
extended time span
187
True or False: The income statement for internal use includes principal payments deducted from revenues.
False
## Footnote
Principal payments are not deducted in the income statement for external reporting.
188
What should you do after completing Activities 1 through 3 in your Workbook?
Review your answers and then return to the Study Guide for Lesson 1
## Footnote
This is part of the learning process to reinforce understanding.
189
What is net operating income (NOI) an indicator of?
Managerial efficiency
## Footnote
NOI reflects the ability of management to generate profit from operations.
190
What are the six basic purposes of a budget?
1. Planning
2. Coordination
3. Control
4. Communication
5. Motivation
6. Evaluation
## Footnote
These purposes help organizations manage resources effectively.
191
What is the difference between the categories in an operating budget and a chart of accounts?
Operating budget focuses on expected revenues and expenses, while a chart of accounts is a listing of all accounts used in the accounting system
## Footnote
The operating budget is more forward-looking, whereas the chart of accounts is more about categorization.
192
Why does forecasting rely on past actual expenses rather than past budgeted expenses?
To prepare a more accurate new budget
## Footnote
Actual expenses provide a realistic basis for future planning.
193
What is a variable cost?
A cost that changes in proportion to activity level
## Footnote
Examples include costs like materials and labor that increase with production.
194
What are the two types of variances?
1. Favorable variances
2. Unfavorable variances
## Footnote
Favorable variances occur when actual revenues exceed budgeted amounts, while unfavorable variances occur when actual expenses exceed budgeted amounts.
195
Why would a shortfall in budgeted rent receipts and an unusually large utility bill both be considered unfavorable variances?
Both indicate that actual performance did not meet budgeted expectations
## Footnote
Unfavorable variances negatively impact profitability.
196
Why are there differences between reports for internal use and reports for external use?
Internal reports are tailored for management decision-making, while external reports meet regulatory and stakeholder requirements
## Footnote
Internal reports can provide more detailed insights than external reports.
197
What is net operating income (NOI)?
Net operating income is found by subtracting operating expenses from effective gross income.
## Footnote
NOI is an important measure of managerial efficiency and shows the cash flow and value of a property.
198
What expenses are not considered in determining NOI?
Debt service and capital expenditures are not considered an expense in determining NOI.
## Footnote
This means that NOI is not 'pure profit.'
199
What are the six basic purposes of budgets?
* Serve as guidelines for operating a property
* Indicate operational efficiency through comparisons with previous years
* Form the foundation of the overall management plan
* Measure the performance of the real estate manager and management company
* Schedule cash flow to meet owners' requirements
* Project future income and expenses
## Footnote
These purposes help in effective property management.
200
What is an operating budget?
A one-year detailed plan for managing a property that lists planned income and expense amounts for each month and account.
## Footnote
The line items are determined by the type of property and the owners' reporting needs.
201
What is the chart of accounts?
The chart of accounts is the listing of the line items that make up the categories of an operating budget.
## Footnote
It serves as a framework for organizing financial data.
202
Why are actual expenses important?
Actual expenses are a better gauge of how much was spent in the previous budget period.
## Footnote
They provide insights into budget accuracy and spending patterns.
203
What is a variable cost?
A variable cost is one that changes with usage.
## Footnote
Utilities are typically classified as variable costs.
204
What is a fixed cost?
A fixed cost usually remains stable during the budget period.
## Footnote
This type of cost does not fluctuate with the level of property usage.
205
What effect do favorable variances have on NOI?
Favorable variances increase NOI.
## Footnote
These variances result from better-than-expected income or lower expenses.
206
What effect do unfavorable variances have on NOI?
Unfavorable variances decrease NOI.
## Footnote
A shortfall in income or unexpected high expenses can lead to unfavorable variances.
207
What are reports for internal use directed towards?
Reports for internal use are directed toward managerial decision making.
## Footnote
They do not always have to follow a strict format but should be complete.
208
What is the purpose of reports for external use?
Reports for external use serve the needs of specific audiences, including investors, auditors, taxing bodies, and regulatory agencies.
## Footnote
These reports must be tailored to the information needs of the specific group.
209
Fill in the blank: A _______ cost typically remains stable during the budget period.
fixed cost
210
True or False: Budgets can only be used to project future income.
False
## Footnote
Budgets also serve multiple purposes including measuring performance and scheduling cash flow.
