Measuring Up: Common Financial Mistakes
Coaching and contracting management styles may have more in common than you might think. Neither a coach nor a contractor must actually compile the numbers. Neither has to be physically in the field to make things happen. However, both are responsible for the operation and must rely on good information.
As the coach and leader of your company, you too need good information. On numerous occasions, I have talked about the importance of having accurate financial information. This is such an ongoing problem for contractors that I want to revisit the subject once again and offer some tips to help you avoid some common financial mistakes contractors make.
The First StepIt starts by setting up your books correctly. You must take control of your financial information and compile financial data in a format that makes sense to you and matches how your company estimates. While accounting programs have become easier to use, you still must create a chart of accounts that makes sense to you. Tax expenses can be deductible regardless of the format you use, but in order to compare your financial data from month to month or year to year, you must use a format that relates to how contractors think and operate their business.
Direct CostsContractors have two types of cost, direct and indirect. Direct costs are charged directly to a job and are part of the actual cost required to produce the job. There are four categories of direct costs; however, you can have numerous subcategories for each of these areas.
1. Field labor. This is the labor actually used on the job. It does not include secretarial, sales or administrative time. If you, as owner, still work on the jobs with your hands, you should split your salary between the field and office. Your field wages and only your field wages should be tallied in this area of your income statement. You can have numerous accounts or breakdowns for labor, and you should include field payroll taxes, workers' compensation and other payroll expenses. Whether you pay the money to the government or your insurance company, it is still part of your direct field labor expense.
2. Material. This is the cost for items you leave on the job and with the customer, including shingles, flashing, underlayment, lumber, etc.
3. Subcontractors. This cost is self-explanatory and represents any independent subcontractors you might hire.
4. Special job costs. These are expenses that are a one-time cost of a particular job; if you did not do the job, you would not have the expense. It might include items such as dump fees and trash removal, equipment rental for that job, travel pay, etc.
Indirect CostsIndirect costs can be broken into the following two categories: variable and fixed. Again, you should have numerous subcategories for each of these costs.
1. Variable overhead refers to costs of items that are consumables. The more work you do, the more of them you use, such as small tools, drill bits, saw blades, gasoline for field vehicles, field uniform rental, etc. While some of these items might be charged directly to a job, to do so for most of these would be impractical.
2. Fixed overhead refers to costs that cannot be charged directly to a given job such as office rental, administrative salaries, general insurance, office suppliers, etc. Owner salary for non-field time should be included here.
Financial Tips1. Don't set it up yourself. New accounting software programs such as QuickBooks can be relatively easy to use but difficult to set up. Have your accountant or experts with new software help you get started. Too many contractors make a mess of setting up accounting software in an attempt to save money. Do what you are good at, contracting, and hire someone else to help you with accounting setups. Once the basics are established, maintaining and using your software can be relatively easy.
2. Understand the difference between accrual and cash accounting methods. Cash accounting is done on a cash basis, which means it only takes into consideration money into and out of your checking account. Accrual accounting includes what you owe as well as what is owed you. Many contractors pay their taxes on a cash basis. For financial analysis, make sure you use an accrual format. It is easy to convert to cash at year end and pay your taxes accordingly. In some software packages, you merely push a button to make the switch. It is impossible to accurately determine your true profit or loss unless you take your payables and receivables into consideration.
3. Accurately record deposits. Many residential contractors take deposits as a way to help cash flow and ensure that the customer follows through with the job. Many contractors simply put this cash in the bank as a sale or income. This can distort your financial information. Deposits are really a loan from the customer and do not become a sale until the work is performed. Yes, this can all balance out in the long run, but it can create misleading financial information. If a contractor takes deposits in the spring and summer, records them as a sale and then finishes those jobs in the fall, the numbers are distorted. Spring startup looks more profitable than it really is, and the fall is less profitable than you thought it was going to be. It can also make it difficult to compare year-to-year performance, as your backlog and deposits change from year to year. Recording deposits as a liability rather than a sale may also be a tax advantage. Recording deposits correctly in accounting software can be a complicated undertaking. Make sure your accountant advises you on the correct way to do it.
4. Create accurate monthly statements and manage jobs in progress. Since contracting is a seasonal business, you should review financial statements monthly and compare them to the previous year. This gives you an excellent tool for strategic analysis and financial piece of mind. To ensure statements are accurate, a conscious effort must be make each month's data as precise as possible.
Bookkeepers are compilers of information. Too many bookkeepers see balancing the checking statement as the way to ensure that the monthly statement is accurate. Balancing the checkbook's cash is important, but it does not ensure that sales and expenses in the statement are accurate. Jobs in progress can wreak havoc on an accounting system. While accounting statements may end the last day of the month, jobs do not end at such a magic point. Payroll must be paid each week, but subs, suppliers and actual job invoicing may not line up with those expenses. An extra effort should be made to close out the month as accurately as possible.