Expense Recovery: Everything You Need to Know
Expense recovery is an action taken by a business to recover money it has overpaid to other businesses.3 min read
Expense recovery is an action taken by a business to recover money it has overpaid to other businesses. An overpayment may have occurred as a result of an internal accounting or clerical mistake, or because the business was overbilled for services received.
What Is the Expense Recovery Ratio?
The expense recovery ratio is used to calculate expenses and requires just two numbers. The first is the total cost of the investment. Often, these costs include any expenses that were necessary to start and maintain an investment. However, every business handles their cost and revenue comparison differently. Some businesses will exclude the cost of starting a project and will only consider the current and ongoing costs required to maintain and run a project.
The other number needed for the equation is the revenue the project has generated. To find the expense recovery ratio, divide the total revenue by the total expenses. Once you generate this number, record it using a decimal point to the hundredth place. To transform it into a percentage, multiply the number by 100. This final percentage number is the recovery expense ratio. Such ratios are always expressed in percentages.
Percentages make it easy to look at the numbers and consider whether a project has been successful. An investment has paid for itself to the exact amount if the expense recovery ratio is 100 percent. If the number is higher than 100 percent, the project has done more than "break even," it has produced revenues that surpass expenses. If the number is less than 100 percent, the project has not yet paid for itself, meaning that revenues have not covered expenses and have left a deficit on the project.
The clarity and simplicity of the expense recovery ratio makes it a valuable tool to asses a project's viability. Using a percentage to calculate the ratio offers a uniform method of comparing projects that have different profiles, total expenses, and total revenues. In other words, you can compare the current or potential success of a business endeavor with a large budget to another endeavor with a smaller budget. In addition, you can use the ratio effectively to analyze investments over both long-term and short-term periods.
The expense recovery ratio may also be used to examine the life of a project and how successful its profits have been since its initial launch, or even for just a particular period of time, such as a fiscal year.
Real Estate Expense Recovery
Expense recovery is often used in commercial or housing leasing. Typically, a commercial lease specifies a base rent, which may be calculated as a dollar amount per month, six months, or year, but is more likely to be calculated as a yearly dollar amount per rentable square foot of space that the tenant occupies. Some commercial leases may require additional rent over the base amount in order to cover expense reimbursements.
It's possible that the space will actually be divided among several tenants. There could be many different ways to structure the lease for the benefit and agreement of all parties, but the most logical agreement would be to distribute the reimbursements in a way that corresponds to each tenant's individual share of the total square footage of the space.
If you, as a property owner, pass insurance costs or property taxes onto your tenant, you'll need to pay those bills and expenses yourself and then issue a bill to your tenant for the reimbursable amount.
A few other methods of arranging tenant reimbursements are:
- Simple pass-throughs — In single-tenant properties or properties without common areas, reimbursement expenses may be billed (passed through) to the sole tenant. Or, if there is more than one tenant, expenses may be divided according to the amount of space each tenant takes up of the total space.
- Expense-stop pass-throughs — In certain pass-through arrangements, the tenant is required to pay only a portion of the expenses that may be recovered. In these cases, the landlord will pay up to a specific amount, referred to as an "expense stop," and the remainder of the bill will be passed on to the tenant.
- Common Area Maintenance (CAM) — CAM charges may be collected in larger properties where there are common areas designed for the benefit of all tenants (and often for the public, as well).
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