MATCHING PEOPLE WITH PROPERTIES

N#23

Nov 02, 2020 Newsletter | Uncategorized

The operating account (or profit & loss account): the statement that shows the investor whether he/she makes or loses money

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Every first Sunday of the month, my friend, colleague, successful real estate investor, and entrepreneur Jordi Aguilar guides us in the fascinating world of real estate investments.

This post is part of a series to understand the investor’s language.

If we want to understand the world of investments and business we must learn their vocabulary.

The financial statements are classified as follows:
– Balance sheet
– Profit and loss account
– Cash flow statements
– Statement of changes in equity
– Memory

Last month Jordi explained the Balance sheet, today he explains the profit and loss account, also called the Operating Account.

The Operating Account is the income statement that expresses the profits or losses obtained in a given period of time.

In other words, it reflects all income, minus all expenses, giving a positive (profit) or negative (loss) result.

If you don’t have a company to manage your properties, the concept is still very useful. The operating account is similar to a personal income tax declaration. You declare income and expenditures. The difference is that as a natural person, there are fewer expenses to bring in (those of repairing flats, taxes…). As a company, you can put pretty much all the expenses.

The financial structure is not taken into account here, whether or not there is financing (did you take a loan or not). Although interest is considered, which is deductible.

This income statement is divided into several parts:

– operating account
– extraordinary result
– financial result
– profit before (pre) tax (PPT)
– net profit or loss of the year

  1. Operating account: the result of the company’s activity.

Gross margin = Income – Costs

 + Sales
 – Cost of materials
 = Gross margin

Operating income = Gross margin – Expenses = EBITDA

 Gross margin
 – staff costs
 – operating costs
 = EBITDA

It indicates whether the economic activity itself performs well, its operational efficiency.
EBITDA: Earnings Before Interest, Taxes, Depreciation and Amortization

Operating profit = Profit from operations – depreciation = EBIT (BAIT in Spanish)

EBIT: Earnings before Interest and Taxes, and
EBITDA: Earnings before Interest and Taxes, Depreciation and Amortization
It is the result of the business in each production cycle (usually one year)

 EBITDA
 – Depreciation
 = Operating profit (EBIT)

For example, we bought a 30.000 Euro van which we estimate we will have for 10 years, and with a remaining value of 5.000 Euro.
Annual depreciation rate = Initial amount – Remaining value / Years of useful life.
Amortization = 30.000 – 5.000 / 10 = 2.500 euros which we would subtract each year, for 10 years.

The concept of amortization also applies to properties. The interesting thing is to know that there is this “invented” expense, although the value of the property increases, here the ‘invented expenses are subtracted, so we end up paying less.
It is like hidden tax relief, as if the tax authorities were giving us money for this property.

According to data from the Spanish Tax Agency’s website, a maximum of 2% per year can be applied to companies, and applicable for 100 years:

 

Table of linear depreciation rates

Type of element Max. Linear Coefficient Max. period of years
Buildings
Industrial buildings 3% 68
Land exclusively used to dumps 4% 50
Warehouses and tanks (gas, liquid and solid) 7% 30
Commercial, administrative, service and residential buildings 2% 100

In other words, for a property of 200.000 euros, the Treasury allows you to be deducted as a company, 4.000 euros (=2%) of which you will not pay taxes. As a company, not as an individual.

Up to this point, only the business result itself has been taken into account, without considering the effect of financing. In other words, if that activity, which produces that income and requires those costs, is profitable in itself.

 

  1. Extraordinary results = Extraordinary income – Extraordinary expenditure

It indicates if there is extraordinary income, such as a sale of an asset (a piece of land, a machine…), but not from the company’s own activity:

 + Extraordinary income
 – Extraordinary expenses
 = Extraordinary result

 

  1. Financial result = Income – Financial Expenses

This is where the effects of funding are considered:

 + Financial income
 – Financial expenses
 = Financial result
  1. Profit before tax (PPT) = EBIT – Extraordinary results – Financial result

It is on this result that we pay corporate tax.

 

  1. Net profit or loss for the year = EBIT – 25% corporate tax (or whatever applies)
 Profit before tax (EBIT)
 – taxes
 = Net result

This is the final result, the Bottom Line.
It can be left within the company or paid to the shareholder.

Here the entire structure:

 Profit and loss account
 + Sales
 – Cost of materials
 = Gross Margin
 – Staff costs
 – Operating costs
 = EBITDA
 – Amortization
 = Operating profit (BAIT or BAII)
 + Extraordinary income
 – Extraordinary expenses
 = Extraordinary result
 + Financial income
 – Financial expenses
 = Financial result
 Profit before taxes
 – taxes
 = Net result

Knowing and interpreting the two financial statements we have talked about, the balance sheet and profit and loss account, we can already read the situation of the companies, or even apply it to your personal management, as it will help you to have a clear picture of your income, expenses, interest you pay, how much you owe in the short and long term, and what your personal or family wealth is.

 Here the Income and Balance Sheet

Income
Expenditure
Assets Liabilities

 
In the next chapter of the series, we will see how money circulates on the balance sheet and income statement, and the difference in approach between a financially literate person and one who is not.

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