Editor's Note: Following is part three of our eight part series called "Better Next Year," by Fred Ode, CEO, chairman and founder of Foundation Software. To read the previous article, click here. To read the next article in the series, click here.
You are sitting in a medical examination room waiting for test results of a "mysterious" pain that won't go away. The doctor walks in, takes one look at the report and exclaims, "I'm no good at reading lab reports." Feel better?
So how do you feel about a construction business owner who says, "I'm no good with numbers"? It's equally unacceptable. Sure, accounting may not be a favorite (or strong) subject among contractors, but a company's long-term survival is dependent on the owner's understanding of the numbers.
In order to monitor and manage a company's overall health, owners need to perform and understand financial reporting on two levels: executive-level reports (which provide a quick project-by-project overview) and project-level reports (which fill in all the details). This article will focus on the executive-level (typically one-line-per-job reports). (Next month's article will cover the importance of project-level job reports.)
Luckily, technology today offers better tools for managing data and automating all the management-level reporting that contractors need. In addition to preparing basic financial statements (such as the income statement and balance sheet), a contractor's accounting software package should be capable of producing the following key reports for contractors to review on a regular basis:
Gross Profit by Job: The gross profit report by job shows contractors, at a glance, how their jobs are doing in terms of gross profit. When used and reviewed regularly, this report reveals the profitability (or loss of profits) for each job by listing total contract sales to date less direct job costs. Essential as it is, however, contractors need to make sure it's not the only report they use to measure success. Because the gross profit report shows only direct job costs and not indirect or overhead expenses, it can distort the view of the big picture.
Job Overhead Allocation: This report is essential because it allows owners to analyze overhead as a percentage of certain job costs and/or revenue and see net profits for each job. Owners will gain a better perspective of a job's true bottom line with this report.
With the right accounting software and a method that makes sense for the business, overhead allocation is much simpler to perform than many think. For example, a labor-intensive contractor may choose to allocate overhead based on labor costs, an excavating contractor might choose to allocate overhead based on equipment costs or a combination of equipment and labor costs, and so on. A CPA with a focus on construction should be able to tell contractors which method is best for their business. Once the formula is in place, good construction accounting software ensures that overhead allocation happens automatically.
Over/Under Billing by Job: This report, (also known as work in progress and percent/complete), is often required by banks and sureties to determine a contractor's current financial position. Because it shows where each job stands to date in terms of billings, it is also essential as a management-level tool. With just a glance, owners can identify jobs that are under-billed (leading to possible cash flow problems), as well as jobs that are over-billed (resulting in inflated company profits if not accounted for). Most importantly, when reviewed regularly, this report helps owners identify problem jobs in time to make adjustments.
Again, a contractor's integrated job costing system should have the ability to easily create and produce the over/under billing by job report on a timely basis, and it should automatically adjust the company's income statement so that profits are never over- or under-inflated.
Cash Flow by Job: In construction, monitoring cash flow is essential because cash pumps in and out of the business through many separate projects. The cash flow by job report provides an overview of the net positive or negative cash flows relating to each job, allowing owners to identify and take immediate action on jobs that are having cash flow problems. When contractors use a construction accounting system that attaches every transaction (i.e., accounts payable, payroll and accounts receivable) to a specific job, this report-and the monitoring of cash flow by job-becomes automatic.
Just as doctors are able to monitor your health by reviewing a series of X-rays, construction owners need to regularly review these four key reports to determine their company's financial wellness. When viewed over time, these "one-line-per-job" summary reports reveal both job trends and inconsistencies. This kind of data prompts further investigation that can be answered in more detailed project-level reports. Ultimately, executive-level reporting can lead to tighter control, better decision making and higher profits.
Want to ensure that your company's health is better next year? Then take the time to use and understand the executive-level reports that define how your company is performing.
Fred Ode is the CEO/chairman of Foundation Software, developer of construction job cost accounting software called FOUNDATION for Windows. For further information on FOUNDATION for Windows, visit www.foundationsoft.com. Ode can be reached directly by phone at 800.246.0800
Construction Business Owner, August 2007
