Have you ever had a really good year followed by a really bad year?
Was it because you were efficient in one but poorly managed the next? Or perhaps it was just an accounting anomaly.
The issue is that your profit and loss statement (P&L) represents a specific time frame, and this time frame may not match the time frame of your jobs. For example, your accountant might ask to see your nine-month financials to help you plan for the end of the year. When you look at the title of your P&L, it might say: "For 9 Months, ended September 30, 2008."
The problem with this statement is that it might represent the last 40% of one job, 20% of another job, numerous jobs that began and ended during the nine months, and a few jobs that have just started. The P&L represents a period of time, while jobs run at different time frames. I always joke that it would be great if they passed a law that all jobs had to start after January 1 and end by December 31. Then we could actually have a good stopping point to see where we are. But then again, if all jobs ended at the same time, we might be out of business.
Instead, we need to find a way to look at our P&L and have it truly reflect our current profit. But the $64,000 question is: When do you show the income in your P&L? (When you invoice the client? When you receive the money? When you do the work?)
Matching Principle
Your P&L is based on an accounting term called the "matching principle," which states that the income and expense you see on your P&L should be as a result of the same activity. If you show expenses that represent 45% of a job, then the income should represent 45% of the contract and you should be able to see 45% of the expected gross profit.
This is sometimes much easier said than done. And this is why so many contractors have trouble looking at their P&L and having it make sense. The costs appear daily and weekly but are not always matched up with the income. For example, if you invoice and receive 100% of a job prior to the start of any costs, then you are ahead of the curve and appear profitable the day you start the job. If, on the other hand, you have to pay for all the labor and materials before you invoice the client, then you will look like you are losing money until the end of the job.
These are all questions of timing. When do you time your income versus your expenses? And when jobs cross your fiscal year, you can overstate your profit using an arbitrary cutoff of December 31.
For Example
Let’s look at a sample job that was profitable: You charged the client $43,000 and spent $26,000. The job earned $17,000 gross profit and achieved a 40% gross margin. It took three months and started in November. Look at the example below. If we arbitrarily cut off our financials at the end of December, we show a $19,000 profit. But then in January, we have to finish the job and show a $2,000 loss. Even though the job, as a whole, was profitable, the arbitrary cutoff at the end of the year makes us look even more profitable than we really are!
Nov. Dec. This Year Jan. Total
Income 18,000 16,000 34,000 9,000 43,000
COGS 13,000 2,000 15,000 11,000 26,000
Gross Profit 5,000 14,000 19,000 -2,000 17,000
Gross Margin 27% 88% 56% -22% 40%
Don’t Just Appear Profitable
The key to understanding if a job is profitable is to determine the anticipated gross margin and evenly show that gross margin throughout the job. To do this, you will need to create a Work in Process (WIP) schedule. We will discuss how to create this schedule in my next article, but for now, I just want you to think about how you create your financial statements and how you use that information.
What if we used the above example to pay out bonuses or buy a new truck? We looked really profitable and thought that our company would continue at this rate. But then we had to finish the job.
Most jobs are profitable until the last 20% of the job. When you use your financial statements to help manage your company, you need to make sure you understand what they are saying and trust that they are telling the truth. And to do that, you need to make sure that your profit-to-date matches the percentage of job you have completed and the percentage of profit for the whole job.
--Leslie Shiner, an author, speaker, and trainer, has more than 20 years experience as a financial and management consultant for the construction industry. She is the owner and principal of The ShinerGroup, a consulting firm helping contractors maximize profits and gain financial control. Contact her at [email protected].
