Here's a relatable story for you: Jerry’s contracting business was going well, or so he thought. Though he had a bookkeeper on staff, Jerry tended to rely more on the advice of his local banker and accountant. While these two individuals meant well, they really didn’t understand the ups and downs of "construction finances". When the end of the year arrived, Jerry was shocked when his own bookkeeper alerted him that they were out of money to meet payroll and accounts payables.
This situation is unfortunately all too common for many contractors. What information the CPA develops and what most bankers understand may not necessarily be the most helpful information to run your business. If you wish to get to the next level, you will need to become familiar with the basics of finance management.
This article introduces you to six financial reports, grouped into three main areas, that help you keep your business on sound financial ground. These reports are simple to understand and should be easy for your accountant or bookkeeper to create and maintain. They are:
- Accrual-based Income Statement
- Accumulated Gross Profits
- Cash Flow Statement
- Aged Accounts Receivables
- Budget Variances
- Labor Productivity
First off, the accrual-based income statement is nothing more than a snapshot of your revenues and expenses earned during the current month and year-to-date. This report shows you how much money you are making from operations. The two most important line items are operating income and net income. The key question to answer is, “Are we receiving high enough prices to offset our costs?”
The second profit report will be unfamiliar to most of you, but it is the single most important report for you to keep an eye on: accumulated gross profits. This report tracks the difference between your direct job costs and your project revenue. The report should show the accumulation to date. At year-end your total accumulated gross profit is what covers overhead expenses and produces your bottom line profit.
Remember that cash is the lifeblood of your company. Without it you will go bankrupt. Monitoring and managing your cash flow is the single most important management task of any business owner. You should be reviewing a Cash Flow Statement at least once a month (personally, I think it should be a weekly effort).
The report should show the sources and uses of cash. You should also be adjusting your monthly budgeted cash flow based on changing sales and expense projections.
Your cash flow is directly linked to the size and age of your accounts receivable. Unfortunately, some of your customers will delay payment as long as they can. Many bookkeepers prefer to avoid confrontation and therefore will not pick up the telephone to call your client and demand payment. However, a growing receivables account can cause a cash shortage. You should be reviewing an Aged Accounts Receivables report once to twice a month. Then, call those late payers to get your money and, if possible, stop working for them in the future. You are not their bank!
Overhead expenses are a necessary part of your business, but you need to keep a close eye on them. The safest way to ensure that your overhead stays in balance with the field’s needs is to create an annual budget, by month, for all expenses the firm is planning on experiencing. You should monitor deviations from the Budget Variances report each month. How to budget wisely is a topic for an entire in-depth article, but follow this basic advice: create an annual budget and manage to the budget.
An important key to contracting success is having the lowest labor costs of you and your competitors. Before you run off and try to cut your employees' wages, understand that labor costs are a combination of labor productivity and effective wage rates. The most useful way to track your labor competitiveness is to monitor with a Labor Productivity Report. This allows you to monitor the speed at which your crews complete their work. As a company, your labor productivity will need to come in at or above budgeted labor productivity if your field performance is to meet its financial goal. You should be monitoring company-wide labor productivity trends twice a month, and investigating poor biweekly performance outcomes.
What ever happened to Jerry?
In our opening story about Jerry, the news got worse. Jerry went to bring his latest financial situation to his banker. When Jerry asked about increasing the amount of his line of credit to help him through a few lean months, his banker became very negative. In fact, at one point this same banker was threatening to “call” all of his current notes … when just a month earlier he thought Jerry was doing fine.
Taking your own contracting business to the “next level” requires greater financial discernment and evaluation. The most successful contractors are fully aware of their bottom line—along with the numbers that lead to the bottom line. They don’t depend on just one or two financial statements or their annual visit with their CPA or banker. They very much embrace a weekly and monthly review of their financial situation in order to make better decisions.
Hopefully you don’t find yourself as desperate as Jerry became. With a lot of belt tightening, Jerry pulled out of his situation—but not without a lot of close monitoring and a new perspective on what to watch out for on the financial side.
Getting to the “next level” requires contractors to take a more detailed look at how work is obtained, produced and accounted for. The numbers on any job can provide a picture of efficiencies, “profit knowns," opportunities and areas to adjust.
As a contractor you don’t need to have a degree in accounting or financial management, but you do need to be more thorough in your financial decisions. I have found many contractors who are intimidated by their “numbers,” not fully understanding their meanings and how to respond to their results. As an owner or senior leader with budgetary responsibilities, don’t back off from being more of a “numbers guy” and learn more about the numbers reflecting your company’s status.
You can become more financially astute with just a little bit of help and support. Consider the six financial reports presented here to get you moving in the right direction. Ask a trusted CPA or friend who does understand the reports addressed here to coach you on becoming more astute about the finances of your business.