It’s hard enough to keep up with managing your construction business. And to be successful, now you need to know accounting in addition to what you are already doing. And on top of that, bookkeeping probably isn’t your most favorite part of your day, right? We totally get it… you didn’t start a business so you could do accounting! You don’t have time to give it the attention it needs (and really don’t want to do it) but it is extremely important if you want to grow your business.
Understanding these terms could be the difference between failure and success. It is that important. So let’s try and make some sense out of some common accounting terms.
Chart of Accounts
A chart of accounts is the list used to categorize your expenses, income and everything that happens in your construction business. Think of it as the foundation of a building—a foundation sets the groundwork for the entire building and the chart of accounts is the core of your accounting. Without it, you would not be able to track your financials and if it is not set up correctly, your financial process will not work.
PRO TIP: If you feel like you aren’t getting reports that you want or need, it’s time to take a look at your chart of accounts. It could be the culprit.
Cost Codes
Cost codes are codes set up to help you manage, track and report on your job costs from a materials, subcontractor and direct labor standpoint. They are the line items on your budget and you will use them to track costs down to the trade or discipline level. They can tie to your estimate codes but you likely have a set of more specific codes for estimating. The codes used for estimating provide more detailed information (like units of measure, etc.) that information isn’t necessary to manage your budget.
PRO TIP: Make sure to track what you are cost coding against the actual estimate throughout the course of the job.
Assets
Assets are everything that hold value in your business, such as cash, receivables, equipment, lots, etc. You will need to manage your cash, receivables (how much money people owe you) and when you make large purchases for vehicles or equipment and make sure that they are recorded appropriately. The general rule is that if it costs over $2,500, that purchase needs to be recorded as an asset and can not be expensed out.
PRO TIP: It is extremely important to record vehicles and equipment assets in the correct location on your financials so your CPA can calculate depreciation at tax time.
Liabilities
On the flip side of assets, liabilities are what you owe—what you owe to vendors, what you owe to credit cards and what you owe to banks.
Your accounts payable are liabilities and you will be able to see what you owe to all of your subs and vendors as a whole, not just by vendor, etc. which can be managed through other reports.
Credit card balances also can be managed through liabilities. This will help you manage and have a good grip on what you owe in credit cards.
It is important to point out that liabilities are different than expenses. Expenses are the costs of a company’s operation and can be paid immediately with cash. If payment can’t be made and needs to be delayed, it then turns into a liability. Make sense?
PRO TIP: You should not have any negative line items in your liabilities. This is a sign that you are missing or have not recorded all of your transactions.
Equity
Equity shows you how much you have invested in your construction business and is another number that shows your financial position. It reflects how much money you put in, how much you personally take out of the company and how your company is doing from a net income/loss standpoint (we’ll talk about this more soon). A way to think about equity is how much money would be left over if you sold all of your assets and paid back all liabilities. Monitor this number to keep debts in check and to help grow your construction business.
PRO TIP: Your equity balance will be incorrect if your profit & loss is not accurate.
Revenue
We are throwing this in there just as a refresher. Revenue is income generated from your services. It is how much you bill your customers throughout the project, how many houses you sold, etc. Simple terms, it is money in the door!
PRO TIP: It is not the interest on your savings account.
Net Income/ Loss
Net income/ loss shows if you’ve made or lost money. It is your revenue minus the cost of doing business and is your bottom line number. This is really what you should be looking at to make important business decisions. And if your numbers show that you are losing money, you need to identify why. It could be that your bookkeeping is off but you definitely need to know that for sure.
PRO TIP: If your net income/loss does not match what you think is realty, it is a good indicator that there is a problem that needs to be fixed. Again, it could be a record keeping problem to be solved.
Profit Margin
Profit margin is a way to measure the profitability of your construction company. There are two ways of talking about profit margin and they show different ways of looking at profit. There is gross profit margin and net profit margin.
Gross profit margin is your revenue minus cost of goods sold, so it shows the percentage of revenue that exceeds cost of goods sold. If you have a high gross profit margin, you are doing well at generating profit for every dollar of cost.
Net profit margin shows profitability after your company has operated. If you have a high net profit margin, you are doing well and managing your operational costs.
It sounds simple, but if you are not tracking your profit margin, you will not know if you are making money.
PRO TIP: Managing your profit margin will show you if you are sticking to what you originally estimate and plan to do.
Your Partners in Accounting
These terms are just one small piece of managing and understanding your financials. But having a basic understanding of these general terms is so important and will help you see the bigger picture on your reporting and within your company. We know you want your business to be successful and these terms and tips will help get you on the right path to success.
Like we said at the beginning, this can be confusing, especially if it isn’t your area of expertise, and even more so if you don’t have time to focus on it. A good workflow and a great financial partner can make all of this much more manageable. If you do need more help with your construction business accounting, that is what 24hr Bookkeeper is here to do. Our team will manage your accounting so you can focus on actually operating your business. Reach out or set up a meeting with us today to see how we can help in your unique situation!
Speaking of financial reports, check back for our article next week where we will talk more about financial reporting and how the details above play into the reports!
