What is Financial Analysis? How Does It Relate to Real Estate Investing?
What is financial analysis?
A financial analysis, according to Investopedia, is “the process of evaluating businesses, projects, budgets, and other finance-related transactions to determine their performance and suitability. Typically, financial analysis is used to analyze whether an entity is stable, solvent, liquid, or profitable enough to warrant a monetary investment.”
A financial analysis is used to set financial policies, build long-term plans for your business by evaluating economic trends, and identify your next investment. Financial Analysts generally look at a company’s financial statements (balance sheets, income statements, and cash flow statements) in order to calculate ratios of data that they can compare to other companies, or your own financial history.
Return on Assets (ROA) is the most common ratio that financial analysts will use to see how efficient the company is at managing their assets and measure that against its profitability.
How does it relate to real estate investing?
When you want to invest in real estate, especially for rental properties (fix and flip, multi family homes, new construction, etc.), those requesting funding from investors will generally need a financial analysis completed to obtain that funding.
In analyzing the real estate property investment, the timeline, lack of liquidity, and effects of the real estate environment should be taken into consideration. Investors will typically temper a financial analysis with an understanding of the risks involved before investing. Analyzing a real estate investment can include looking at:
- Cash flow - This is the amount of cash received annually by the investor. It includes any revenues generated and financing proceeds realized - minus any expenses incurred, except income taxes.
- Tax effect - This is the amount of taxes payable the investor is responsible for paying in the current tax year, affected by the investment.
- Future benefits - This is the amount the investor’s capital position is affected by the refinancing or sale of the property on an after-tax basis. Future benefits also take into account changes in values of the asset and prior mortgage amortization. The impact of the transaction on the future realty taxes are also taken into consideration for future benefits.
By looking at a combination of the cash flow statement and income statement, you’re able to better measure the value than the individual statements could provide. Having a financial analysis is not only beneficial to the investor, but the owner of the property, too, because it can show a measure of opportunity cost over time.
Whether you’re using estimated or actual figures, analyzing an income property’s rental income and expenses is key to knowing your operating cash flow.
When you’re looking to create a financial analysis for a rental property, or you’ve created one and want to connect with real estate investors, Renovo’s Circle of SuccessTM can help. Contact us today to see how Renovo can help you realize the potential of a rental property you’re looking to purchase.