accounting

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), incomecash 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 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, labor 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, organized 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, they [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 to 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 labor or material costs that increased since the initial bid and allows the contractor to make needed adjustments early on.

2. Overbilling and underbilling

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

  • Overbilling: Determine the total overbilling figure by summing overbilling amounts for all jobs where progress billings-to-date exceed the associated costs.
  • Underbilling: Calculate the underbilling amount by totaling the underbilling amounts for all jobs where costs-to-date exceed the associated billings.

Schulte further explains: “The main goal of tracking the over- and underbilling 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 recognize 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 (overbilled), they need to adjust revenue, assets, and liabilities accordingly. The same adjustments would need to be made if the subcontractor has underbilled during a given period.

“We like our clients to think in terms of over- and underbilling 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. Labor costs

Labor is one of the biggest expenses for most subcontractors. Tracking labor 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 labor costs clearly, tracking project profitability is useless because improperly costing labor can be huge. Labor 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 labor on each job in order to uncover the full labor 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 labor-related costs such as employer-provided equipment (mobile phones or personal protective equipment, for example), safety training, or even holiday parties.

Schulte recommends using the hourly cost calculator in QuickBooks to get a clear picture of the labor burden rate. “This is a great tool to use because it uncovers labor-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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