Financial Reporting Structure for a Contracting Business

by James Leichter

Accounting is the basis of business decisions. While you may not be an accountant, or even like accounting, you are likely a decision-maker. You are asked to make numerous business decisions every week and your decisions need to be correct the vast majority of the time.

Will we need to borrow money soon? How much cash should we have on reserve? Does each technician produce a profit? How many gross profit dollars do you need per day? Should we buy or lease? How much should we charge? These questions and others are much easier to answer with great financial reporting.

The accuracy and completeness of your financial reports depends heavily on your company’s financial structure. Here are the main elements of a great financial structure.

Cash Versus Accrual Accounting

On the accrual basis, income (sales) is recognized at the time the product or service is sold. Expenses are recognized when the inventory is used. This method is GAAP compliant and is a necessity to properly manage your business.

With cash basis, income is recognized when you receive the money. Expenses are recognized at the time the money is actually paid (and cleared the bank). This method is not GAAP compliant and is not useful for business management purposes. Do not use cash basis accounting to manage your business.

Don’t let the subject of income taxes confuse you. That is a different subject entirely. That decision is related to tax management, not business management.

Divisions and Departments

We recommend creating a set of divisions such as HVAC, Plumbing, and Electrical. These should be separated as Residential and Commercial. Create a set of departments within each division. Examples of departments might include Demand Service, Replacement and Addon, IAQ and Accessories, New Construction, Design and Spec, Remodel, and others. All financial transactions must include a department.

Chart of Accounts

Financial transactions are recorded with a set of codes called the chart of accounts. These codes are classified by assets, liabilities, equity, income, cost of goods, overhead, and more. The chart of accounts is the foundation of your financial reporting system. It should be detailed and very well thought out.

Fixed and Variable Overhead

It is very important to separate your overhead into fixed and variable types. Fixed overhead remains essentially unchanged within a certain range of income. Examples include salaries, liability insurance, and rent. I like to refer to variable overhead as “somewhat variable overhead” because it varies slightly with changes in income. Examples include gasoline, small tools, office supplies, and legal fees.

General Ledger

The general ledger (GL) is a master accounting document that provides a complete record of all the financial transactions in a business.

Thick versus Thin GL

This is a standard accounting term used to describe how much detail your GL contains. A thick GL contains a robust chart of accounts. Additional information will be added to each transaction. This includes marketing, product categories, departments, employee names, labor minutes sold, labor minutes paid, fixed assets, warehouses, warranty, callback, service agreements, and more.

Budgeting

A budget is an essential piece of your company’s financial structure. It is a projected income statement and establishes your company’s financial goals. A budget may also include a balance sheet, statement of cash flows, and other reports. A budget is an action plan that helps you allocate resources, evaluate performances, and formulate plans.

The basic process of creating a budget starts by listing your business's monthly fixed and variable costs. Your next step is to predict what your monthly income will likely be. Finally, decide on the allocation of funds to achieve your goals.

Putting this Information to Work

Extensive financial and business information is used to create highly detailed reports, performance dashboards, and key performance indicators. Now you are ready to make better, more informed business decisions.

Departmentalized Income Statements

You will have the ability to produce income statements by department, right down to net profit. You will be one of a very small group of contractors that have divided their financials into important segments and knows exactly how much net profit (or loss) is generated from each one.

The Power of Breakeven

(Income – Cost of Goods Sold) = Gross Profit

(Gross Profit – Variable Overhead) = Contribution Margin

(Contribution Margin – Fixed Overhead) = Net Profit Before Taxes

When contribution margin dollars cover your fixed overhead, you are at your breakeven point. Every single contribution margin dollar becomes net profit.

Imagine the power of knowing the exact day of each month where your company breaks even. Based on facts, you can offer discounts to fill unused capacity or turn down low-profit work in favor of something more beneficial. You can offer performance bonuses with confidence.

Performance Dashboards

A detailed set of dashboards offer a deep look into every finite detail of your business. There will be complete transparency regarding technician production, department profitability, sales lead production by employee, marketing success, customer experience, health and safety, HR, and so much more.

Specialized Accounting Software

If you want the things mentioned in this article, but do not know where to begin, invest in great software and use it properly.

Do not let your employees or an outside accountant tell you what software to use. If your accountant suggests generic store-bought software, get a better accountant. They are more concerned with themselves than your business.

You need specialized contracting business management software that puts a strong emphasis on accounting and financial structure. Do not be fooled by bells and whistles or the promise of “this software is super easy to use.” The only way to make software easy to use is to cut out important features and remove options.

You likely invest significantly in training for your technicians. The same should be true for people that use your financial software. If you have great software, it is vital to use that software to its fullest extent and the way the designer intended it to be used.

To download a free training package of powerful financial resources including industry research, how-to financial plan development materials, “The 7 Commandments for Financial Success,” and much more, visit EGIA.org/CBS-Financial.

James Leichter is a founding faculty member at EGIA Contractor University. Learn more about EGIA and Contractor University. He is a longtime HVAC contractor, consultant, and public speaker. Leichter is president and CEO at Aptora Corporation, a maker of contracting business management software. He is the editor of MrHVAC.com and BlackBeltContracting.com, and a majority shareholder at RA Tax and Accounting, Inc.