Editor's Note: The following is the sixth part of our ten part series called "Management Basics," by Fred Ode, CEO, chairman and founder of Foundation Software. To read part five, click here. To read part seven, click here.
If you're anything like the typical entrepreneur, you are focused, ambitious and product-driven.
You have confidence in your skills and the intelligence to carry through on your business goals. But do you have another all-essential attribute that is critical to long-term success? Do you know your numbers?
Number knowledge is the sixth attribute in my "Top 10 Management Basics" for businesses that stand the test of time. Number knowledge either comes naturally, or it must be learned. But without it, no business can survive in the long-term.
Fortunately for some contractors, they have an intuitive sense of finances and know how to use these skills to improve their company's financial well-being. Paying attention to numbers all along, they know instinctively when to allocate costs to overhead, how to manage cash flow and exactly why some jobs are more profitable than others.
Far too many contractors, however, focus more on their trade expertise than on their company's finances. They are contractors first and business owners second. And because they dedicate very little time to the financial side of the business, they have only a vague idea of where the company stands in terms of profitability and productivity. Amazing as they may be at what they do, the business has little chance of growing or prospering.
The good news is that business owners, even non-finance types, can come to know and understand their numbers. With the help and advice of an experienced accountant or CPA who specializes in construction, as well as construction-specific accounting software, any business owner can make sense of on-hand information and make decisions to improve financial performance.
At an absolute minimum, the construction business owner needs to regularly review and understand the following:
- Balance Sheet-This is the quantitative summary of a company's financial condition at any given point in time. It gives management a snapshot of assets, liabilities and net worth. When viewed over time, it helps owners understand how profits are being used to finance operations and if the company has enough cash for growth.
- Income Statement-Otherwise known as "profit and loss," this statement records all revenues for a business during the given period, as well as the operating expenses. Aside from helping owners identify areas that are over or under budget, the income statement, along with balance sheet, is one of the basic elements required by banks, lenders and sureties to determine credit limits and loan rates.
- Overhead Allocation-How rare it is to find a contractor who properly allocates overhead costs, or even allocates overhead costs at all. But now that construction-specific accounting software is capable of automatically allocating overhead costs to jobs, there is really no excuse not to. Without overhead allocation, it's impossible to know actual profit or loss on your jobs.
- Job Cost Reporting-Whether it's the production report for a heavy highway contractor or the unit cost report for an electrical subcontractor, a good job cost report can provide the immediate answer to the question, "Am I making or losing money on this job?" And they should be timely enough to answer that question before it's too late! With the right amount of drill-down detail, the job cost report can identify areas that are over budget-as well those that are under budget-and identify areas of strength and weakness in budgeting, scheduling, procurement and actual construction.
- Percent-Complete Reporting-In construction, it's not uncommon to see over billing or even, heaven-forbid, under billing going on. It's all part of the delicate dance contractors do to manage cash flow. The important thing to understand is exactly where you stand in terms of billing and percent-complete on the job, regardless of the method you choose to calculate the percentage of completion (from actual dollars versus estimated, quantity complete or others). Ignorance of this situation can be fatal to your business. Good accounting software can help with that, automatically adjusting the income statement to over or under billing so that revenue is not inflated.
- Cash Flow-Simply put, cash flow determines your company's solvency. If you run out of cash and your credit line is tapped out (regardless of how much money is owed to you) your company may very well go out of business. Knowing and understanding cash flow helps the business owner anticipate future expenses and income, thereby managing cash flow instead of reacting to it.
If you are among the small percentage of construction business owners who know and understand all six of the above financial reports, congratulations! You are in a very small, but elite, class. If not, don't worry; the tools you need are readily available.
Business owners intent on growing their business and staying competitive need more than just a better understanding of their books. They need to put the people and processes in place to make sure that their financial data is accurate and appropriate for their particular business. Hiring an outside CPA firm with an expertise in construction allows the contractor to seek expert advice. What's more, construction-specific accounting software has evolved to the point that contractors can expect sophisticated job costing features at reasonable costs. But regardless of what tools you choose to better know the numbers, it is still the owner's job to stay involved, ask questions and review the numbers until they become meaningful and understood.
There is no magic formula for acquiring number knowledge. Whether it comes naturally or not, you simply must learn how to translate what you do into earnings and profit. No one else has the experience or working knowledge of every facet of the company. No one else can make the decisions which will impact the solvency of the business. If you hope to lead a company that will stand the test of time, knowing the numbers is an absolute must.
Construction Business Owner, February 2006
