Construction Bookkeeping

Gross Profit Margin is the single most important number on our company’s Profit and Loss (also known as Income Statement).

Gross Profit Margin is a financial metric used to assess our company’s financial health and can be used to help us run our business. Revealing the proportion of money left over from revenues (sales) after accounting for the cost of goods sold (direct expenses). Gross profit margin is the source for paying additional expenses (overhead) and savings. Using our Gross Profit Margin we can determine if we can afford to hire an estimator or buy that new computer system.

The first thing we need to do is make sure we have our expenses in the proper categories. We need to understand our expenses and determine if they are direct or overhead. Direct expenses (Cost of Goods Sold) are those expenses that can be assigned directly to the job. Overhead expenses are the ongoing expenses used to operate our business. Examples are office rent, accounting fees, office supplies, and advertising.

Contract Income			75,000.00	100%
Material	11,250.00			15%
Labor  (including burden)	15,000.00			20%
Equipment	2,250.00			3%
Subcontract	26,250.00			35%
Other Direct Expense	1,500.00			2%
Total Direct Expense		56,250.00		75%
Gross Profit			18,750.00	25%

Now that we know our Gross Profit is 25%, let’s see how much we would need to increase our sales to hire an estimator.

Let’s say the wage to hire an estimator is $50,000 per year. Using our Labor Burden Calculator we know our burden is 16.45%.
50,000 x 16.45% = 58,225 per year total cost to hire an estimator.
58,225 ÷ 25% (gross profit) = 232,900.

We would need to increase our sales by $232,900 to hire an estimator.

Would you like the Labor Burden Calculator?  Contact us and we will send it to you directly.

You started your business with a dream, to do what you love and make a decent living at it.  If your business is not as profitable as you had hoped, consider reviewing your company’s financial reports.   Most contractors are not comfortable reading financial reports and so don’t.  It is our hope to make these reports easy to understand, maybe even fun.  Understanding the information they provide will enable you to make the best decisions in running your business.  In this series, we will start by explaining the basics of how to read your Balance Sheet and Income Statement also called Profit and Loss Statement or P&L.

Because your business is constantly changing and is affected by turns in the economy, you need to be able to reflect on the past, see the present, and anticipate the future to remain profitable.  The information contained in your financial reports, specifically your balance sheet and income statement, provides some helpful tools to accomplish this.

Balance Sheet

Your balance sheet is the financial portrait of your business at a given moment and is divided into three categories; assets (what you own), liabilities (what you owe), and equity (or net worth).  Paying attention to this information helps you know when you can afford that new equipment and when to hold off purchasing.  Your balance sheet also tells you how much equity you actually have in your business and how much your creditors have.

Income Statement

Your income statement is a financial representation of your business over a specific period of time.  Your income statement calculates your net profit by subtracting direct expenses (also known as cost of goods sold) and overhead expenses from income.  Understanding the information on your income statement will help you to calculate gross profit margin, manage expenses, find break even points, and allocate overhead appropriately during the estimating process.   Knowing these can save you time and money, as you know, there are times it is best to say no to a job rather than just be busy.

If you don’t know where to start, the first and possibly most difficult step is to make sure your bookkeeping is accurate.  Once you accomplish this, the rest will fall easily into place and is very rewarding when you use your financial information to discover opportunities and identify potential problems in the path of reaching your financial goals.

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Among the most important accounting concepts for contractors and construction companies to understand are the concepts of over- and under-billings and work in process (or WIP).Not accounting for over- and under-billings and WIP accurately can lead to a host of financial problems for contractors, including cash flow shortfalls and “profit fade,” or the recognition of profit too early (or late) during the job cycle. In addition to potentially wreaking havoc on your finances, these problems can also be a major red flag for sureties and lenders.

What Are Over- and Under-Billings and WIP?

Most construction projects are long-term in nature, with invoicing and costs spread out over a long period of time. The challenge is to match up accounting for invoicing and costs as closely as possible to the actual construction progress that’s occurring on the project. For example, let’s say you have completed 25 percent of a construction project. Ideally, you will have billed out about 25 percent of the contracted amount at this point. For a variety of different reasons, though, it can be difficult to match up billings with the amount of work that has been completed (or work in progress).

If you have invoiced 50 percent of the contract amount at the 25 percent project completion stage, you would be 25 percent over-billed. Conversely, if you have completed 50 percent of the project but have only invoiced 25 percent of the contract amount, you would be 25 percent under-billed. The problem with either scenario is that it results in an inaccurate monthly income (or profit-and-loss) statement. If you are over-billed, your P&L will reflect too much profit; if you’re under-billed, it will reflect too little profit.

Changes in projected costs, meanwhile, can result in profit fade. For example, suppose you are working on a one-year, $1 million project with projected expenses of $800,000. During the first six month, you bill half of the project total (or $500,000) and incur half of the expenses (or $400,000), realizing half of your projected profit (or $100,000). Expenses during the next six months, however, hit $500,000, bringing total costs up to $900,000 and dropping total profit to $100,000. But this profit was already realized during the first six months, which is now over-billed, resulting in profit fade during the next six months of $50,000.

Making a WIP Adjustment

Once you know the amounts that you are over- or under-billed, the next step is to post a WIP adjustment. This will enable you to utilize the matching principal — or in other words, to match your income and expenses to the same period of time — and produce an accurate monthly P&L.
Following are the steps for posting over- and under-billings

1. Make sure the contract amount and the job status are correct
2. Make sure a budget has been entered
3. Make sure all change orders have been posted and have the correct status
4. Run the Over/Under Billings report for projects with current status with the correct posting period selected
5. Post the over/under billing adjustment using the correct date and posting period  Note: WIP adjustments are typically “reversed in next period”

To Learn More

There are many subtle nuances involved in contractor accounting, including the concepts of over- and under-billings and work in progress. If you have more questions about these concepts or need help implementing them into your accounting practices, please contact On Track Business Management at (530) 478-9234 or send us a message

An important step in the process of keeping accurate books, is deciding whether your business will track accounting on a cash versus accrual accounting basis.

What is Cash Accounting?

When using the cash basis accounting method, transactions are recorded as income only when you receive payments from customers; similarly, expenses are recorded only when payments are made.  While cash accounting is easier, there are drawbacks; if in a given period, you collect little or no receivables and pay a large number of bills, you will have expenses without income — and you will appear to have lost money. On the other hand, if you collect payments and do not pay bills, your income will be overstated. This causes a major distortion of what actually occurred.

What is Accrual Accounting?

The accrual accounting method records income at the time of sale or completed work for a customer, whether or not you have received payment.  This in turn creates an account receivable from the customer – and a current asset.  Even though the cash isn’t in the bank yet, sales are booked as income increasing the seller’s revenue. Likewise, expenses are recorded when a purchase is made and an invoice created.  This creates an account payable –and a current liability.  The benefits of the accrual method is that it more accurately matches income to expenses and provides better cash control; you can easily track who owes you money and who you need to pay and when.  The drawback to accrual accounting is that it requires a little additional effort. The accrual accounting belief is that it is likely, if not certain, that the company will collect the cash from sales at some point in the future because the sale had been made.

When it comes to using your financial reports to help run your business, accrual accounting gives a truer financial picture!

What are your Financial Statements telling you? Contact us for a free consultation.

Everyone enjoys the ability to save money.  One way business owners are able to maximize their savings is by breaking out their credit card expenses.  Keep in mind that in order to deduct a business expense, the expense must be both ordinary and necessary.  By definition, an ordinary expense is one that is common and accepted in your trade or business.  A necessary expense is one that is helpful and appropriate for your trade.

When you break out your credit card expenses, you are able to find deductions and partial deductions that may go unseen.  Even though you cannot generally deduct personal, living, or family expenses, you may still be able to divide the total cost into business parts and personal parts, and then deduct the business portion.  For example, if you borrow money and use 70% of it for business and then remaining 30% for a family vacation, you can deduct 70% of the interest as a business expense.

Deductions are hiding in many different places.  The following list provides some of the most common deductions that could be missed:

• Auto expenses (i.e. fuel)
• Continuing Education
• Gifts for clients
• Meals and Entertainment
• Advertising
• Interest payments
• Internet and Phone
• Business Cards/Stationary
• Office Supplies
• Service Charges
• Dues and Subscriptions
• Rent and Utilities

For more accounting articles and helpful financial statement videos, check out our Financial Learning Center.

Resources

International Revenue Service – http://www.irs.gov/

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As you may already know, the Healthy Workplaces/Healthy Families Act of 2014 (California Paid Sick Leave) went into effect January 1, 2015.

While the accrual of paid sick leave does not begin until July 1, 2015, employers need to determine which method of compliance their company will adopt right away.

The Accrual Method

Using the accrual method, employees accrue 1 hour of paid sick leave for every 30 hours worked.  Employers can limit the annual accrual to 48 hours (or 6 days) and may elect to cap the paid sick usage to 24 hours (or 3 days), the balance would carry forward.  Accrual begins on July 1, 2015 for current employees and on the start date for all future employees.

Advantages of the Accrual Method:

• Employers who have temporary, part-time, or seasonal employees may choose this method to reduce the amount of paid sick leave accrued.

Disadvantages of the Accrual Method:

• Full-Time employees will accrue a larger amount of paid sick leave, or the cap of 48 hours if employer chooses to limit annual accrual. (Employers may elect to cap the paid sick used to 24 hours per year).

The Frontload Method

Using the frontload method, employers can choose to “frontload”, or provide all employees with the minimum required 24 hours (or 3 days) at the beginning of each calendar year, anniversary date, or other 12-month basis, hours would not carry forward to following years.

Advantages of the Frontload Method:

• Ease of recordkeeping: employers would not be required to track accrual based on hours.
• Confidence in compliance
• Employers who have full-time employees would not be concerned about larger amount of hours accrued.

Disadvantages of the Frontload Method:

• Employers are committing themselves to paying 24 hours (or 3 days) per year or other 12-month basis to each employee, regardless of full, part, or temporary status.

The law is not clear on whether employers will be able to use existing paid time off plans to meet the sick leave requirements, our research and consultation with HR professionals has led us to feel confidant only in the above mentioned methods.  Regardless of the method you use, these are the things all employers need to be doing right now:

1. Determine the sick leave policy and method of accrual your company will adopt
2. Distribute notice 2810.5 to all employees hired after January 1, 2015 and to all current employees by July 1, 2015.
3. Display compliant poster where all employees can see / have access
4. Draft or amend your policy and prepare to distribute to all employees by July 1, 2015.
5. Work with your payroll provider on compliant recordkeeping and wage statement requirements
6. Develop a strategy for out-of-state employees working in California frequently

Labor laws can be confusing, but non-compliance could be costly and catastrophic to your business, get started today on your strategy for meeting all of the requirements of the Healthy Workplace/Healthy Families Act of 2014.

For more information please refer to the Division of Labor Standards Enforcement (DLSE): http://www.dir.ca.gov/dlse/Paid_Sick_Leave.htm

Download Poster & Notice 2810.5 here:

Healthy Workplaces/Healthy Families Act of 2014 Poster

Notice 2810.5

Proper reconciliation of bank statements is important for any small business.  Reconciling statements is a procedure that should be done on a monthly basis.  Reconciling bank statements does not just refer to checking and/or savings accounts.  Loans should also be reconciled to ensure the proper amount is being applied to the principle and the interest.  There are several reasons bank statements should be reconciled on a monthly basis.  The following briefly touches on a few reasons reconciling has its benefits.

Catching Errors:

Reconciling bank statements serves as a great way to double check yourself as well as bank tellers.  For example, if a teller at the bank calculates a deposit incorrectly, your company could end up short of the funds needed to do business.

Following Up on Transactions:

By reconciling accounts every month, you are able to catch checks that have not cleared, which can help track down any potential missing payments.  Also, you can use the statement to make sure other company transactions are being processed for the correct amount.

Fraud Prevention:

If bank statements go unmonitored, or unreconciled, there is a higher chance for undetected loss.  Unfortunately, not all employees or accounting firms are honest, and you may miss money that has been taken for some time.  This is how some employees are able to embezzle large sums of money over time.

Overall, reconciling bank statements on a monthly basis provides a safety net for the assurance your money is properly taken care of.  We are all human, and unfortunately, mistakes are made.  Notice any mistakes sooner rather than later.  The amount of time spent on a regular basis could be time saved in the long run.

For more bookkeeping procedures and advice visit our Financial Learning Center.