Editor's Note: This article is the fourth in a series of twelve to lead you toward entrepreneurial excellence by our regular contributor George Hedley, owner of Hedley Construction and Hardhat Presentations.
As your construction business grows, you get to the point where you can't do it all yourself.
You really don't like paperwork, accounting or bookkeeping. But you have to pay your bills, balance your checkbook and collect your receivables to keep your doors open.
So you try and pawn off the accounting to your spouse or a friend you met at church who once did accounts payables for a retail store. This works for a while, until you finally realize you know more about construction accounting, job costs, receivables and cash-flow than they do. Now what?
This is a major crossroads for most construction company owners. Should you hire a professional full charge construction accounting manager to be your bookkeeper, controller and chief financial officer? Or do you continue to limp along with an untrained, behind the times, part-time accounts payable clerk managing your money?
As we discussed in previous articles on entrepreneurial excellence, step one begins with a picture of what you want. You want a business built on sound financial principles, systems and controls. Step two is to always make a profit. The only way to make a profit is to know your numbers and make them a top priority in your construction business. Step three is to develop and install solid organizational systems that produce consistent bottom-line results. Step four is to get control of your finances.
Hire a Pro Now!
As your business grows, one of your most important hires must be a professional accounting manager. This is a necessary investment in your future and required to build an excellent company. Without a "pro" managing your finances, you business can't reach its full potential or grow profitably. Hiring a qualified and experienced full-charge manager to run your accounting department is just as important as hiring a professional estimator and more valuable than any good superintendent or foreman.
A professional accounting manager knows construction accounting. This includes how to manage and control your accounts payables, accounts receivables, lien releases, financial reports, balance sheets, income statements, payroll, job costing, retention, collections, bonding, banking, month-end close-out, bank reconciliations and cash-flow projections. A professional accounting manager knows what software your company needs, can supervise its installation and fully maximize your return on investment. A professional accounting manager stays abreast of the latest construction tax and contract laws, construction accounting methods, industry financial trends, software upgrades, attends the Construction Financial Management Association training seminars and conferences and becomes a trusted partner in your business growth.
Install Financial Systems Now
Trying to build a construction business without organized and systemized financial management tools and controls in place is like building a project with an empty toolbox and no set of plans. You can't do it. You must also make it a priority to install the best possible systems, technology, reporting methods and tracking systems. This will allow you to make good decisions, hold people accountable, keep your eyes on the bottom-line and have time to focus on what makes the most money for your operation.
The construction business is tough. There is nothing in your control. It is even harder when you don't know what your finances and job costs are. Financial systems and controls are required to build an excellent business and hit your goals. Let's start with the basics. In order to run a successful and profitable construction company you must know where you stand at all times including:
- Equity and working capital
- Overhead and fixed costs
- Company and job profit
- Job costs and cost to complete
- Labor and equipment costs
- Accounts receivable
- Accounts payable
- Cash and cash-flow
Construction Accounting Made Simple!
As a business owner, it's important to have a clear understanding of these accounting terms:
Sales-Income or revenue you earn, invoice and collect.
Cost of sales or direct costs-Your field job costs. These include all costs required to build projects in the field: labor, labor burden, supervision, project management, materials, equipment, subcontractors, rentals, production costs and services required to complete your contracts.
Indirect costs or overhead-Your fixed costs of doing business without any projects under construction. Overhead includes your home office expenses, general and administrative costs, rent, utilities, estimating, bidding, marketing, sales, accounting, legal, staff, administration and company management. Your overhead markup compensates for the cost of doing business.
Equity-Total capital, retained earnings, net worth or the money invested in your company. It includes the current equity or net worth of your business.
Working capital-Often called net quick. It is your current short-term assets (everything you can sell and collect in thirty days minus your current liabilities (everything you currently owe now and for the next thirty days). Working capital does not include long-term assets like buildings, equipment or retention due.
Backlog-The unfinished amount of all your current contracts in progress. According to bonding company standards, your working capital needs to be at least 10 percent of your contract backlog. I don't feel this is enough. I recommend at least 20 percent of your backlog as working capital to avoid cash-flow problems and allow for profitable and comfortable growth. For example: if the total of all your contracts in progress is $2 million and you average 50 percent complete, your backlog would be $1 million. The required working capital to run your business would be $200,000.
Profit-Financial gain or return from the use of capital in a business. This assumes you started your business with an adequate capital investment to run your business properly without cash-flow problems. Profit is the remaining amount after all direct and indirect costs are deducted from total revenue collected. Note: profit is not "owner's compensation" for running the business. All employee compensation including the owner's must be included in either overhead or job cost. If you are the owner and work in your business, you should be compensated accordingly based on fair market value for the work you do. Profit is reward for taking business risks.
Return-Net profit as a percentage of equity for the year or current period.
Financial targets-Sound financial management includes tracking your targets and staying abreast of your progress. To build an excellent business, make it a priority to set annual financial goals in the following areas and then keep track of your progress:
- Job cost
- Net profit
- Average markup percentage
- Average gross profit percentage
- Sales to break-even
- Sales to hit gross profit goal
- Working capital
- Return on equity percentage
- Return on overhead percentage
- Average final gross profit percentage
- by contract type
- by project type
- by project size
- by project location
- Average job size
- Bid-hit ratio
- Volume and profit per key employee
- Current payroll report
- Never issue company cell phones-give employees a monthly lump sum amount ($75 to $150) to reimburse them for the use of their personal cell phones.
- Require owner or two management signatures and approvals on all.
- Keep perfect personnel, sick time and vacation records-this is a must and no exceptions for any employee including relatives.