“Sometimes it’s the journey that teaches you a lot about your destination.”

Navigating the Process of Compiling Fair Value Personal Financial Statements

By Paul L. Jones, CPA & Licensed Real Estate Broker, 10/3/2023

Third in a Series

As noted in my previous two articles on fair value personal financial statements (“PFS”) for real estate entrepreneurs, developers and investors, the PFS provides a snapshot of the financial health, the fair value and liquidity of the individual or organization, and provides the information that allows the principal(s) to make decisions and enables the stakeholders to understand financial condition of individual.

Real estate entrepreneurs, developers and investors are entrepreneurs that rely on their strong organizational skills to effect their business plans – it is key to their success.  Likewise, compiling fair value Personal Financial Statements (“PFS”) involves a structured process that ensures a complete, transparent and accurate reflection of the current market value of assets, stated balance of liabilities and net worth of the client, and if appropriate, the client’s income and expenses and changes in net worth.

The title for this article, the third in my series on PFS, is a quote from singer-songwriter, actor and businessman, Drake.  In this truism, Drake highlights the first benefit to be realized by the principal(s) – gaining an understanding of the assets owned and liabilities outstanding by.  The process itself causes the principal(s), their management team, their accountants and financial advisors to focus not only on the individual assets and liabilities but also on the portfolio, its composition and the team’s strengths, weaknesses, opportunities and threats (SWOT).

The Jigsaw Puzzle

As I was thinking about the process of compiling fair value PFS, I realized that it starts like the way I was taught to do a jigsaw puzzle: you dump all the pieces on the table and then begin to sort them out – to identify the borders and to start seeing the picture and how the pieces are to be put together. 

Similarly, the first step in compiling the PFS is to lay out, if you will, the different assets, liabilities, sources of income and the nature of the expenses incurred.  While we don’t dump them on a table, we list them in a spreadsheet. 

Through the process, the pieces form a picture of the principal’s personal and business operations.  The quality, organization and completeness of the principal’s accounting records and related files affects how much time and effort is required to develop this inventory.

Like the laying out of the puzzle pieces, the key to timely and cost-effectively completing an assignment is in planning the execution of the assignment and in staying with the gameplan.  Or, as Dr. Orison Swett Marden, inspirational author and founder of SUCCESS magazine in 1897, said, “A good system shortens the road to the goal.”

The Puzzle is a Monopoly Board

When compiling personal financial statements for real estate entrepreneurs and fair value statements for real estate investment funds and others, the jigsaw puzzle comes together and begins to look like a Monopoly board.  

Just as I was taught to do with the jigsaw puzzle pieces, as you identify the financial assets, liabilities, and operating companies as well as personal assets, we begin to identify which items belong together – and, soon, the spreadsheet looks like the way I would put the different deeds accumulated in Monopoly together by color set.  For instance, properties being developed may be one class, operating properties another, operating companies – like a brokerage business and management company are yet another, liquid assets like marketable securities and cash yet another.  Other factors that form the picture may include the different property types (i.e., office, industrial, retail, multifamily, for-sale residential, etc.), the principal’s level of operating control and the marketability of the asset or entity.

As the pieces are identified and categorized, all relevant information regarding the assets, liabilities and assets is gathered into digital files.  For real estate investments, this includes property deeds, mortgage documents, property tax assessments, appraisals, historical operating statements, rent rolls, budgets, projections and any recent market analyses.

Putting the Pieces Together

The assets on a personal or other fair value Statement of Financial Condition (i.e., balance sheet) are to be valued.  Accordingly, the valuation of the assets needs to be consistent with how investors and buyers value similar assets. 

Certain assets – like cash - are valued at face value.  Life insurance is based on their cash value at the valuation date.  Others, like marketable securities are based on their value as of the valuation date – and usually provided by the investment banking firm or can be obtained from the listing on the appropriate stock exchange.  However, privately-held companies, real estate assets and certain other assets, like jewelry are appraised. 

Accordingly, the next step is to identify the assets in your portfolio that require fair value assessment.  In the context of real estate, this would encompass properties such as residential or commercial buildings, undeveloped land, buildings under construction and minority interests in real estate partnerships or real estate investment trusts.

Then the process of establishing fair (market) value begins.  Work with an appraiser or other qualified professional to conduct a comprehensive valuation of your real estate assets.  The appraiser will consider factors such as the property's location, size, condition, comparable sales, rental income, and other relevant market data. They may use various methodologies such as the market approach, income approach, discounted cash flow or cost approach to determine fair value.  Through this assessment, the fair market value of each property is determined.

Ensure the valuation process is thoroughly documented. This documentation should include details on the methods used, the data analyzed, any adjustments made for unique property features, and other relevant factors that influenced the valuation. Transparency in the valuation process is crucial for credibility and accuracy.

While the primary focus is on asset valuation, it's important to ensure that liabilities and equity are updated accurately to reflect the current financial position.  Liabilities may include mortgages, loans, or other financial obligations related to the real estate assets.

Thoroughly review the compiled fair value personal financial statements to verify accuracy and completeness. Cross-check all calculations, ensure that all assets and liabilities are appropriately accounted for, and confirm that the fair value assessments align with the documentation.

Integrate the fair value assessments of assets, updated liabilities, and equity as well as the realized and unrealized income and expenses into the personal financial statements.  Finally, document the key factual information, the basis of presentation, major assumptions, and other pertinent disclosures in the footnotes to the statements and supporting schedules.

Consider involving a certified public accountant (CPA) – especially one with experience and knowledge of real estate - to compile or review and validate the fair value personal financial statements. A CPA can provide assurance on the accuracy and compliance of the statements with relevant accounting principles. 

Conclusion

Compiling fair value personal financial statements involves a meticulous and structured approach to ensure a precise representation of an individual's financial position, particularly in the realm of real estate investments. By engaging qualified professionals, conducting thorough valuations, documenting the process transparently, and reviewing the statements rigorously, individuals can trust that their fair value personal financial statements provide a credible and up-to-date reflection of their financial standing – and empowers them to make optimal choices for their investment and business activities.

About the Author

Paul Jones (linkedin.com/in/paul-jones-42b8147) is a Certified Public Accountant and a Licensed Real Estate Broker in the State of Florida.  He is a senior commercial real estate financial advisor with 45 years of experience providing underwriting, due diligence and valuation services for investors and lenders.   In preparing personal financial statements, he combines his knowledge of commercial real estate, structured finance, property and portfolio management with his accounting discipline to provide his clients with accurate, reliable, professional and informative personal financial statements.