The 5 Simple-Numbers were born from Andy Mulholland's frustration with his real estate business financials.
When we complicate our financials, they add little to no value to us. We need to simplify them, and get clear on our economic model in our real estate business.
Let me introduce you to the 5 Simple-Numbers in your real estate Income Statement (aka Profit and Loss).
Simple Number #1: TOTAL REVENUE
Total revenue includes all income from your real estate business.
Things like commission income, vendor income, referral income, transaction fee income, and more.
This is the TOTAL income into the business before your broker or team members received their portion.
Total revenue in your real estate business should not include revenue from personal investments, or profit/revenue sharing. Those are separate businesses altogether. If you include those separate revenues in your real estate team or brokerage revenue, it could throw off your margins, tricking you into thinking you have a healthy business, when in fact you don’t.
Simple Number #2: Cost of Goods Sold (COGS)
Cost of Goods Sold is simply the direct costs associate with producing your goods or services.
In the real estate business, this usually consists of your broker split, Your agent splits, Your ISA and showing partner splits, Your outbound referral fees…generally, any cost that gets paid as a direct cost of a specific transaction. There are exceptions to this, but in most cases these make up your cost of good sold.
Have you ever looked at your companies financials at the end of the year Felt proud of your total top line revenue but made little to no money in profit? It could be because your Cost of Good Sold is too high
Some ways to fix this are:
1) re-negotiate your splits with your broker, or find a cheaper alternative
2) adjust the splits with your agents, which can be tough to do
3) hire newer agents at the right split
4) add or increase your transaction fee to the client
5) focus on shifting from a heavy buyer business, to a heavy listing business, as there is more margin to be made on the listing side of a real estate business.
Simple Number #3: Gross Profit
Gross Profit is the profit a business makes after subtracting all the cost that are related to making its product, or providing its service from it's total revenues.
Simply put, it’s the company’s Total Revenue (Simple-Number #1), minus it’s Cost of Goods Sold (Simple Number #2).
Simple Number #4: Operating Expenses
Operating expenses are different than your Cost of Good Sold, in that these expenses are not tied to individual sales, but instead an independent expense that is incurred through normal everyday business operations.
Here at Simple-Numbers, we have found it most effective to categories ALL operating expenses into one of three main categories.
- The first category is People expenses. Also referred to as Salaries. People expenses are made up of your staff or W2 pay. Any person that is paid in your business as a W2 Employee would be considered part of your People expenses.
- The second category of Operating expenses is Marketing and Lead Generation. This would usually consist of any dollars being spent in the business with the intended result being the generation of a new opportunity OR “LEAD”. Which is why we call it “Marketing & Lead Gen”.
The only exception to this general rule, would be a dollars spent with the intention of “general branding” which may not have a direct intention of generating individual leads, but would be considered a form of marketing and part of this category of operating expense.
- The 3rd and final category of operating expense in a real estate business is called OVERHEAD.
Overhead is simply any dollar spent that isn’t a People expense OR a Marketing & Lead Gen Expense. Typical examples of this include but are not limited to things like Office Rent, Office Supplies, Automobile costs, Travel, Meals, Education and Coaching, And others. In essence, if you didn’t pay it to an employee, and it wasn’t intended to market your business or generate a lead, it would be considered an “Overhead” expense.
You should have a target goal for each category of expenses so you don’t overspend in your business and eat away at your profit.
We suggest 30% of your top line revenue be spent in Operating Expenses, roughly 10% in each category.
So, if your real estate business generated One Million Dollars in Top Line Revenue (simple-Number #1) you should be spending no more than $300,000 per year on Operating expenses, or $100,000 in each of the three categories. Of course, each business is different and you should consult with us, or a CPA before setting your individual businesses economic model.
Simple Number #5: Net Profit/Owners Pay
Net Profit is very simply the amount of money you have left in final profit.
To calculate your Net profit, simply take your Gross Profit and subtract your Operating Expenses. Net Profit is in our opinion the most important of the 5 simple-numbers. After all, you must be able to make a dollar to make a difference. If you’re working hard in your business, selling a lot of real estate, often working 7 days a week, away from your family, working on vacation, working evenings, weekends, training agents, marketing your team, putting out fires and the list goes on….and you STILL aren’t taking home the money you thought you would when you started your real estate business...I’ve got some good news for you!
There are only 2 places you need to look in order to fix the problem.
The first is your cost of goods sold, and the second are your operating expenses.
That’s it!
If your off in one or worst case BOTH of those categories, you won’t be as profitable as you should be based on your revenue.
I hope you can now see how important it is to correctly classify each of your business transactions AND understand the 5 Simple-Numbers in your financial statements so that you can accurately interpret the financial performance of your business.
Use our FREE 5 Min Budgeting Tool here to set an annual budget based on the 5 Simple-Numbers. It's free to download and includes a 22min video explaining exactly how to complete it step-by-step.
If you'd like to learn more about how Simple-Numbers Bookkeeping for real estate can help you get a grip on your business, please REQUEST A QUOTE, or book a FREE CONSULT with Andy and we'd be happy to talk.