Why Cash Flow Is King
Cash flow is a crucial element of success for real estate investments. But what is "cash flow" and why is this measurement of money so important?
Simply stated, cash flow is the balance of money flowing into and out of a business, investment or account. For a real estate investor, cash inflows might include rents and sums received from the sale of property while cash outflows might include interest expense, property rehab, maintenance and repair costs, and sums spent to acquire property.
Cash inflows aren't identical to profits, which are the sums that remain after expenses are deducted from revenues over certain periods of time. That means a business that generates positive cash flow isn't necessarily profitable. For instance, a start-up might be able to operate as a going concern for some time if capital is readily available from investors. That investment of capital doesn't guarantee a return, however.
Mismanagement of cash flow can cause severe problems for real estate investors. One common woe is that an investor who don't doesn't have enough cash on hand to pay bills may be forced to borrow money on disadvantageous terms, perhaps through the use of credit cards. Higher interest expenses then impair profits and hinder the investor's ability to manage the property and acquire more properties. Emergency borrowing rarely happens on good terms for either businesses or individuals.
Other common types of cash-flow problems can occur if the local housing market experiences a downturn in property values or a spike in rental vacancies. When house values decline, an investor who has tied up too much cash in inventory may be forced to sell properties at an inopportune time and on disadvantageous terms in order to raise cash to meet expenses. Likewise, when the rental market softens and tenants move out, an investor who lacks cash reserves may be unable to refurbish those vacant residences and advertise to find replacement tenants in a timely fashion.
Perhaps the ugliest and most unfortunate cause of a cash flow shortage is embezzlement. An investor who doesn't keep a close watch on cash, checkbooks, bank accounts and the like may find those liquid assets have walked away in the company of unethical managers, employees or even family members.
Smart investors implement appropriate accounting controls to make sure assets are secured from misappropriation and theft. Investors also should utilize cash flow statements, budgets and reserve accounts to manage cash flow.
