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Running a business

Construction financial statements: three items you must review monthly

Financial statements not only show a business’s current financial health, they also provide important indicators of future trends.

Running a successful subcontractor business requires regular review of financial reports, such as the balance sheet and profit and loss (P&L), income, cash flow and work-in-progress statements. Doing so puts the contractor in a better position to identify potential red flags, accurately forecast budgets and maintain long-term financial health.

Deeper insight into the numbers provides subcontractors with clear, real-time snapshots of the business’s financial position. For example, reviewing receivables, payables and gross profits provides a solid foundation to predict profitability. This helps to better plan future projects, price appropriately and ensure overall business liquidity. Maintaining current, accurate financial reports also helps banks, creditors and other lenders assess a contractor’s creditworthiness when determining loan terms, interest rates and lines of credit.

Most subcontractors don’t launch their businesses because they are experts on generally accepted accounting principles (GAAP) or love handling complex accounting work, but it is a necessary part of the job. It’s imperative to consistently review financial reports in order to make informed, profit-driven business decisions. We’ve developed this guide to outline key financial statement items that every subcontractor should review.

Three things not to miss on a construction financial statement

Construction industry accounting expert Tonya Schulte, principal at The Profit Constructors, deeply understands the necessity of financial reporting for her clients. She highlights three key performance indicators that every subcontractor should pay close attention to.

1. Project profitability

When it comes to financial reporting, subcontractors operate like the majority of small businesses. They need to track the basics: overall profitability, cash flow and liquidity. Unlike some other businesses, however, subcontractors are subject to the “extreme seasonality effect” that creates major highs and lows for their quantity of work throughout the year. Every job also brings a unique set of factors that drive timeline, labour costs, administrative expenses and other direct and indirect costs.

Schulte explains that subcontractors have to dig deeper into the numbers to better plan and forecast profitability by regularly reviewing financial information for each individual project. According to Schulte, “This takes profitability to a different level and ensures that it’s being measured on a per-project basis.”

Making every job profitable is the end goal, but for many contractors, this can be an overwhelmingly complex task. Tracking every expense against cash inflow when you are managing multiple jobs simultaneously requires dedicated, organised focus.

Using the right technology makes project profitability tracking much easier. According to Schulte, “The ‘project’ module in QuickBooks shows you exactly what your revenue and project expenses are in graphic form. And right next to that, in big bold letters, is your profit margin percentage for a given project.”

She adds that business owners can access other reports that provide more detail.

“Within the ’projects’ module, [subcontractors] can also pull up a detailed P&L report to ensure that, for a particular project, everything is being entered correctly … all of the revenue and all of the expenses are being accurately entered into cost of goods sold accounts.”

Reviewing P&L statements for each project ensures that every job stays within budget and ultimately adds to the bottom line. Frequent review uncovers issues such as labour or material costs that have increased since the initial bid and allows the contractor to make needed adjustments early on.

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2. Overcharging and undercharging

This core performance indicator is important because it helps track the progress of each job in relation to billing. Overcharging and undercharging are determined as follows:

  • Overcharging: determine the total overcharging figure by summing overcharging amounts for all jobs where progress billings-to-date exceed the associated costs.
  • Undercharging: calculate the undercharging amount by totalling the undercharging amounts for all jobs where costs-to-date exceed the associated billings.

Schulte further explains: “The main goal of tracking the over- and undercharging is to employ the matching principle [that requires expenses to be reported in the same period as the related revenues earned]. This allows us to recognise revenue in the proper period. Essentially, this boils down to keeping track of what we actually invoiced against the job versus what percentage of progress we’ve made on the job … and making sure, on an accrual basis, that we are really where we should be on the project in relation to revenue.”

For example, if a business has billed 70% on the job but is only at 60% completion (overcharged), they need to adjust revenue, assets and liabilities accordingly. The same adjustments would need to be made if the subcontractor has undercharged during a given period.

“We like our clients to think in terms of over- and undercharging to help them better manage their businesses overall. It drives them to ask smart questions: Are they billing correctly? Are estimators providing accounting with good data? Is there good communication between those in the field and those working on admin items? All of this is important to track and understand,” says Schulte.

3. Labour costs

Labour is one of the biggest expenses for most subcontractors. Tracking labour costs and keeping them in line with budget directly affects overall profitability—making this one of the top must-have financial reporting items to review.

“If we don’t understand our labour costs clearly, tracking project profitability is useless because improperly costing labour can be huge. Labour often equates to around 40% of the job cost, if not more, so you have to get it right,” explains Schulte.

Contractors should take into account every single hour of labour on each job in order to uncover the full labour burden rate. The burden rate includes not just the wage a contractor is paying an individual but also adds in benefits, taxes and worker’s compensation. It can also include labour-related costs such as employer-provided equipment (mobile phones or personal protective equipment, for example), safety training or even Christmas parties.

Schulte recommends using the hourly cost calculator in QuickBooks to get a clear picture of the labour burden rate. “This is a great tool to use because it uncovers labour-related costs that often contractors don’t think about … costs that add up quickly and work against profitability,” Schulte advises.

Final thoughts …

While not an exhaustive list, this guide provides subcontractors with sound advice and insight on what to look for in their financial statements. Reviewing this key financial information monthly informs business owners about cash flow, net and gross assets, profit margins, and the overall financial health and sustainability of their business.

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