John Kenney, CPRC, CEO, Cotney Consulting Group
Last month in part one, we covered the business language, Accounting. We discussed accounting systems, percentage of completion and over-under billings. In this month’s article, we focus on revenue impacts, cost control, timelines, tracing costs and working without information.
Total revenue is the first line in the income statement and directly impacts stated profit or loss, which on a fiscal year basis directly affects assets or liabilities on the balance sheet. The accuracy of the total revenue figure is critical because of its impact on your company’s financial statements.
The following graphic describes how this information should flow through your company’s structure and be used to calculate total revenue:
As you can see, the percent completion of a project is seen most clearly in the field and the project manager uses this field data to prepare the estimate of the cost to complete. The accounting department then uses costs incurred and the estimated cost to complete to calculate the percentage
completion of the project and then use this calculation to determine total sales. It adjusts or justifies any discrepancy
between the project’s completion stage and the percentage billed on the project.
Because of the adverse effects on cash flow, a wise business owner would always avoid underbilling. However, the “cost in excess of billings” is too typical in roofing companies. Suppose you are not tracking your projects and correctly using the cost-to-complete
method. In that case, you will have no way of accurately knowing how many projects are underbilled, which puts you at risk of running out of operating cash.
To be a successful and consistently profitable roofing company, you must have an excellent job costing system that captures all of the project costs on time so that you know whether or not a job is making money. Timelines of information are essential because you need to see this information in time to do something about it. If sales are recorded in a timely manner and some costs are entered a month later, each job will look great on paper until a month after it’s finished.
The most sophisticated computerized cost control (job cost) systems are worthless if they contain partially inputted data or good data with the wrong dates. When this happens, getting the wrong information and relying on it to manage your company is worse than no information because your project management decisions are based on inaccurate information.
A roofing company needs timely profit and loss information by project and by cost codes. A job cost system does not control anything. Its purpose is to provide the necessary information about how the project runs against planned or budgeted amounts,
enabling management to oversee the project better. Your job cost system should collect costs in categories that can be tracked against the originally estimated cost for each activity.
The key to a successful job cost system is getting the information in time to make decisions on the project. Still, the information needs to be accurate to be of any value. Trading off accuracy for timeliness doesn’t work. Your company must have both. Therefore, all available information must be input immediately. If a bill for the membrane is received, it should not be delayed by waiting for someone to verify the quantities. It should be put into the system immediately as an incurred cost. If it has to be changed later, it can be changed in the system by a correcting entry. Having it entered is more important than finding out later that there is a two percent discount or that the invoice is in error by a certain percentage.
In the real world in which we operate, invoices will be missing from any system because they haven’t been received yet. The fact that your company hasn’t received an invoice doesn’t mean you haven’t incurred a cost. Your system should understate the profit rather than overstate it because there are enough pressures within our business without overstating performance and profits. There is a straightforward reason you do not want to overstate: when profit is overstated, no action is taken because you are content with how things are going. But when it’s understated, you are less pleased and take steps to improve performance.
Accounting for all costs may be more complicated than it should be if certain costs are tracked unnecessarily. For instance, subcontractor costs. Subcontracted costs are committed early in the project process as a subcontract for a fixed sum. Excluding
change orders, the total amount of this subcontract will be incurred as the job gets done. Knowing how much to pay against the contract as the job progresses is a different subject. These figures don’t come from the job cost system. It is the opposite. When a
subcontractor is paid, that information is fed back into the job cost system as the amount paid. Therefore, it makes sense to have your project managers track the subcontractor’s progress outside the accounting system when calculating their percent complete for progress payments.
Don’t use it if job cost information isn’t accurate or on time. Bad information is worse than none. The alternative is much better in these circumstances: trust your gut feelings. If you spend any time in the field, you will have a good sense for judging whether things are going well. And, it is beneficial if you act on these judgments. If you can’t get to the field, you need to talk to the people who do about their gut feelings. The people with the best performance perspective are those who visit the field periodically. Full-time field supervisors usually have an optimistic view of things and are hesitant to report bad news. If you don’t get a good feeling about what you’re hearing, you need to go to the field and find out for yourself. It’s time to use all your experience and know-how as a roofing contractor. What is felt on field visits is essential and roofing contractors should follow their instincts even if the paperwork discloses the opposite. Experience has taught us that our gut responses will be right most of the time. You should rely on them until you can establish an effective job cost system.
It may seem evident that contractors who fail to make a profit do so because they didn’t make money in the field. But it is not so straightforward once you realize that more than half of distressed contractors didn’t know they were losing money until it was too
late to do anything about it. Not evaluating contract profitability by project, month and cost code is one of the most severe and avoidable causes of nonperformance. Job costing is fundamental to managing a profitable roofing business. The only thing worse than losing money is not knowing it happened.
John Kenney, CPRC has over 45 years of experience in the roofing industry. If you would like any further information on this or another subject, you can contact John at jkenney@cotneyconsulting.com.
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