The Role of Bookkeeping in Investment Success: Building a Solid Financial Foundation

The strength of any portfolio is mainly based on its performance. With securities like stocks or options, it’s easy to tell the difference between the purchase price and the current price and therefore the exact amount of profit or loss. However, other forms of investment like real estate aren’t always so clear-cut.

Properly maintained ledgers will determine the net operating income of a property, which in many circumstances is more valuable information than the gross. A property with a high gross that requires a high amount of maintenance could end up being less profitable than a smaller gross that requires significantly less maintenance. If the ledger isn’t accurate enough, that information will become more difficult to ascertain.

Taking a class on how to start a bookkeeping business can be a great help. Even better, the business could be spun off into its own company, which reduces the amount of overhead on the investments side of things and, with the potential for additional people or businesses to become clients, can prove quite profitable in its own right.

Additionally, it can help determine those costs and whether they provide sufficient value. Imagine a building that was originally purchased for $50,000 by a private investor. The lease agreement with their corporate tenant states that the rent will be $1,000 per month and all maintenance costs are to be handled by the landlord (i.e., the investor).

Eight years later, he decides to sell the property. The prospective new owners ask him if the venture was profitable, as they’re only interested in investments that make money. He replies that the value of the building has not increased substantially but he’s received $96,000 in rent. However, he’s rather careless with the maintenance invoices once he’s paid them and has no idea how much he’s spent on the upkeep.

The prospective buyers, naturally, decide to pass because the books are in such disarray and it can’t be proven whether or not it has been profitable over the past eight years. The difference between being able to show only $40,000 in upkeep expenses instead of $50,000 has cost that investor a deal. Eventually, he’ll have to settle for a lower price and thereby lose money on the investment, which could have been avoided with good recordkeeping.

The capital gains tax is charged on all profits received on most types of investments and can reach as high as 28% in some circumstances. Without proper bookkeeping, the tax owed on these investments can be difficult to ascertain, especially in the final months of the tax year when additional income can change things.

If the investment books are accurate and up-to-date, an accountant can estimate the tax implications of a sale. Sales of a higher value can become the difference between receiving a tax refund and owing money to the IRS or turning a small tax bill into a much larger one. By selling at the beginning of the year instead, that tax debt can be lowered by other transactions over the next 10 or 11 months.

On a separate but related note, having impeccable books is very important for regulatory compliance. If state or federal officials start an audit or an investigation into the investment practices of a particular firm, it’ll be a lot easier to simply open the books and demonstrate their accuracy. They’ll almost certainly still investigate but the process will be much shorter, simpler, and more pleasant than having to locate relevant documents or receipts.

Another thing to keep in mind is the difference between taking the standard deduction when filing a tax return and itemizing deductions. For most smaller investors filing individually, the standard deduction of roughly $14,000 (which changes every year with inflation) is higher than what they could deduct if they choose to itemize.

However, those with medium-to-large portfolios may benefit by itemizing deductions, particularly if they’ve taken significant losses in one segment of their portfolio but received modest gains in other sections to balance it out.

A person with well-kept records will be able to check how they fared on individual investments and may be able to deduct some or all of that money from their tax returns, depending on the exact nature of the investments in question. A person without proper documentation may know the rough figures involved but could open themselves up to an audit if the IRS chooses to investigate further.

The possibility of audits in general is another important reason why accurate bookkeeping is essential for investors and non-investors alike, especially those with higher incomes. According to IRS statistics for the tax year 2019, 0.2% of tax returns were audited for filings between $25,000 to $500,000 by May 1, 2022.

However, those rates increase significantly with the amount of taxable income. Tax returns for those earning over $10 million were audited at a rate of 8.9%. Naturally, auditing a person’s tax return requires both time and money for the Internal Revenue Service.

They focus their efforts on the wealthy because a simple mistake, error, or purposeful omission could result in tens of thousands of dollars in recovered revenue, whereas auditing someone making $20,000 would cost more than it’d produce. If someone is audited and they don’t have paperwork proving their return was correct, they’d be in massive trouble.

Making informed decisions is the key to good investments and is the key delineation point between investing and gambling. By maintaining a clear and accurate ledger of all revenue, expenses, and investments, a higher level of profitability can be achieved. As the diversity of the portfolio increases, so does the need for additional data.

For example, if a person or company has investments in securities, real estate, and manufacturing, a quick look at their books should reveal which of these is the most profitable. A company that divides its resources equally between the three will likely have a lower profit than one that puts more money into its most successful enterprises.

Say there’s a sole investor who has holdings in real estate, crypto, foreign currency, and stocks. He doesn’t keep many records, as he’s only interested in how much money he makes every month. He knows roughly how much he’s invested and how much he’s currently worth but that’s about it. Everything is run by others and he provides the funding.

He’s pleased to find that his total portfolio increases by nearly 3% every month. Had he done his research, however, he would have found that the foreign currency markets he’s invested in have increased by 10% every month. As for the real estate, the apartment building he owns in a neighboring state has had three tenants move out and higher maintenance costs.

Three out of his four holdings are losing money every month but because he doesn’t keep paperwork or look at his expenses, his successful venture’s profit has been reduced. If he had sold the apartment building, his stocks, and his crypto to put that money into the foreign markets that proved successful, his profits would have been significantly higher. However, he’ll never make that decision because he doesn’t know all the facts.

A 2002 study revealed that roughly 50% of business decisions fail because of improper management, such as rushes to judgment, misuse of resources, and other forms of bad decision-making. As having the maximum amount of accurate information possible can better create well-informed decisions, the value of having a good ledger becomes clear.

Maintaining an accurate account of investments, revenues, and expenses is one of the most essential aspects of a company’s success or failure. If the correct information is not available or displayed in an easily understood way, investors can risk leaving money on the table or worse, actively making bad investment decisions that can lead to devastating losses.”