We recently talked about accounting terms and financial reports and in both we talked about how a good financial base is needed to get accurate reporting for your construction company. You understand the importance and know that you need it to be right, but how do you know if your base is truly set up correctly? That can be a tough question to answer and it does depend on how your company operates and what your needs are. But there is good news. There are some key indicators for common pitfalls that are easy to spot.
Let’s dive right in!
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You do not have cost of goods sold accounts.
Take a look at your chart of accounts. Do you have cost of goods account types? If not, this is a good sign that your financial base may not be set up right for construction. When operating a construction business, you need to classify your direct costs (materials, equipment rentals, dumpster fees, labor, etc.) correctly – as cost of goods sold. Many mistake them as operational expenses and record transactions incorrectly. Remember that you would not have these direct costs if you didn’t have projects. This should be reflected and easy to identify on your financial reports.
Why it matters
If you are not measuring your direct costs through the cost of goods sold accounts, it will be very difficult to know how profitable you are on the revenue you are producing. When you have all of your costs mingled together on the income statement, knowing the difference between your direct and operational costs will be impossible and you won’t be able to tell if you are producing the best profit margins. Correctly breaking out these costs will help you understand what you’re spending on your projects as a whole and what it costs to operate your business. In the process, you might be able to improve your margins as well.
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You are using chart of account items as cost codes.
Chart of accounts are meant to be broader buckets of categories so you can get a high level view of your financials. Cost codes should be used to track the separate disciplines, like masonry or carpentry, for example. The chart of accounts are meant to provide information about your business and are not able to provide you with project detail. Note: If you find yourself wanting to get more specific, like track cost codes on your budgets, it is probably time to invest in construction project management software. You will get a deeper level of detail and also have more functionality when it comes to managing your budgets.
Why it matters
Your profit and loss report is meant to track your business financials, not your project line items. There are many reports you can view to give you project specific information and they provide more specific project information that the profit and loss could never do. Remember, the P&L’s purpose is to give you the 10,000 foot view of your company financials, not individual job profitability. When you need the deeper, project level profitability information is where having cost codes and third-party software come into play. It will give you a higher level of functionality to manage budget versus actuals.
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You create sub-categories on your chart of accounts to track types of work that you do.
If you’re doing this, it isn’t necessarily wrong but there is a better way to track and manage the types of services you offer. Your construction company might provide different types of services and potentially to different markets. For example, you could do residential and commercial construction, spec homes or new builds, and potentially subcontracting other services like landscaping or pools. When you offer different types of services, it can become confusing quickly, especially if you are not using the right accounts for transaction input (and they can show up incorrectly on your reporting). Using tags or QuickBooks classes might be a good first start to improving how you view this information.
Why it matters
Overall, you will be able to analyze your financial information multiple ways, when you separate out your services by types of work that you perform. Think of them as verticals on the financials. This is also important because each vertical likely uses the same account line items. This provides the opportunity of viewing different reports, giving you different information. This is not necessary, just a small tip if you care to see this information separated on the financials.
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You are creating cost codes that are too specific for budget management.
You can have two sets of cost codes—one for estimating and one to manage your budgets. Let’s look at the list of cost codes you would use to manage your job budgets. How many do you have? If your codes are extremely detailed, like using different units of measure for example, you may need to generalize them so they are easy to manage as the project budget. It is normal to have to be very detailed on the estimating side but once you win the bid, then you want to manage materials, subcontractor, direct labor and other costs. As an example, you might estimate using different codes for flooring, such as a code for tile, a code for hardwood, and a code for laminate, but once you have secured the project, you will want to manage them as flooring materials.
Why it matters
This makes managing a budget feel like a nightmare. It will be difficult on the bookkeeping side because one invoice might list multiple line items with costs that associate to all cost codes. You can’t separate it on the invoice—so you’re not sure which code to apply the costs. It can also make allowances a bit difficult to re-apply because you might be over on one line item, but under on the other. If you just managed the ‘bucket’ as a whole, you would be able to manage the discipline’s profitability much better. By going up a level of detail when managing your budget, it will be easier to make budget adjustments, allowance allocations and give you more flexibility while still maintaining the detail needed.
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You did not record the initial purchase of an asset.
You might be buying assets, like a truck for your crew, but you had to finance that purchase. It’s common to record the purchase of the asset (truck) but then forget to record the beginning balances of your loan. This becomes an issue when you have been recording your loan payments to the right loan account. It will show up as a negative on your balance sheet because it never had a beginning balance of the loan.
Why it matters
Your balance sheet will be incorrect and show a negative balance where there should be no negative amount. This is because you are recording the monthly payment (check/EFT) but do not have the related loan on the truck (liability) to match it up against. It is also recommended to attach all supporting documents when purchasing assets so should you need help correcting this, all the information is readily available.
Simple fix: when you purchase assets, record the purchase transaction right away.
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You’re mixing personal with business.
They say not to do it… you know, use business money for personal transactions. This is true but in “real life” you may need to break the rules and use cash from your business towards personal expenses. There is definitely a way to record it without adding your personal accounts to your financial file. There are different things you can consider doing, such as taking a bi-monthly draw, or taking the money as a transfer rather than auto drafting your personal transactions directly from your business bank account. To keep it clean, you should separate your personal accounts from your business accounts.
Why it matters
If you connect your personal accounts to your QuickBooks file, it means you have to account for all those transactions that hit that bank or credit card, whether business or not. This means they become part of your business financials and we know that’s going to interfere with giving you the right reporting. It may seem like you are saving time because they are connected, but in reality it creates a bigger mess with too many details to sort. It makes reviewing transactions difficult. It makes trusting your financial reports difficult. It makes it even more difficult to see patterns in your business. Not to mention, this makes it hard to maintain control of your cash.
Again, real life—If you need to use your personal money to cover, transfer funds to your business account from your personal account and record it as a transaction. This will keep your finances clean.
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Your transactions are recorded, but not reconciled.
Yep, these are two separate things. Many construction owners believe that just because you are updating the banking transactions, that your accounts are “reconciled”. Reconciling means balancing transactions to the factual documents (bank or credit card statement). This process doesn’t just check off that the transactions cleared, but by using the reconciliation function you can also find duplicate entries and transactions that may need to be voided.
Why it matters
Unless you have verified your accounts and reconciled them, you can’t truly trust your financial reports. This is the first step to making sure your transactions are ‘real’ because they actually hit the bank or credit card account. Sometimes, there are transactions that you research what they are for to find out they aren’t real and never hit the accounts in the first place.
You might be experiencing some of these items noted above but don’t worry, you’re not the only one. These are very common situations and scenarios. Recognizing what items need to be addressed is one step in the right direction. Some of these may seem minor but they are important to your company’s success and key to a good financial management process.
Don’t panic, there’s help!
We know the information given here is a lot to take in. Keep in mind, some of the pitfalls mentioned aren’t necessarily wrong, but if you are having issues with getting the financial information you need or it takes a long time to understand your financial reports, this could be why. 24hr Bookkeeper is here to help work through the pieces and get your accounting to the place where your numbers are easy to understand and you have what you need to run your construction business. Because we have experience in accounting, and specifically accounting for construction (which is a beast in itself), it means that we have seen these situations and can get your business on the right track.
We are here to help. Get a hold of us to see how we can help in your current situation!
