Construction Accounting 101: What Are Financial Statements & Why Do They Matter?

In this article:

• 

  Generally Accepted Accounting Principles (GAAP)

• Key Performance Indicators (KPIs) for construction projects

• Evaluating the financial health of a construction business

• Key terms successful construction companies use to track accurate costs

• Basics to help track income and protect narrow profit margins

A recent call with a client sparked an interesting conversation about how something as seemingly basic as accurate financial statements can be confusing.  Consultants sometimes take things for granted, namely that our clients understand everything that we are telling them. Phrases like monthly close process, reconciled monthly statements, or financial statement package can seem straightforward to one person and completely foreign to someone else. In this case, some straight talk about financial statements may be in order.

"Financial statements" generally refers to the combination of three company-level financial reports: the Balance Sheet, the Income Statement (also called Profit and Loss Statement or P&L), and the Cash Flow Statement, which are generated from a company’s accounting system. These reports form the basis of a monthly (or quarterly or annual) financial reporting package, and they provide a record of the financial position of the company at a given point in time.

Of course, financial statements are only as good as the data they are based on, and the reader’s subsequent ability to analyze that data and make decisions about the daily operations of a business. In fact, understanding the data within a company’s financial statements is key to understanding the business and having good financial management.

Let’s look at 9 of the most important things that a construction business can learn by looking at its financial statements:

Cash

Cash is king as the saying goes, and a company’s Cash Flow Statement (CFS) gives the reader quick insight into how much cash is going in and out of a business.

Cash Flow Statement (CFS)

A CFS recaps the amount of cash in a business at the start and end of any given period and shows if the company is keeping or spending more of the money it makes. Manage cash flow well and you'll have an easier time tracking the financial health of your construction business.

Revenue

Revenue is the total amount of money that a business generates from the services it provides in any given period without accounting for any expenses.

Gross Sales or Top-Line Revenue

• As it generally sits at the top of the Income Statement, Revenue is also known as Gross Sales or Top-Line Revenue.
• Revenue recognition is key to many construction accounting processes; including assessing project profits, direct and indirect costs, and other business finances.

Direct Costs or Costs of Good Sold (COGS)

Direct costs are what a construction company spends to complete its projects and deliver on the scope of the work outlined in a contract. They are found on an Income Statement directly below Revenue and are key to accurately assessing project costs for your construction projects.

These costs usually include:

• Material costs
• Labor costs
• Subcontractor costs
• Equipment costs
• Mobilization costs
• General Conditions costs
• Any unexpected costs required to perform or complete a project

Overhead and Indirect Costs

Overhead and Indirect costs, also referred to as SG&A (Selling, General, and Administrative expense) or Operating Expenses, are everything a company routinely spends on the general operations of a business.

In a construction company, overhead costs usually include things like:

• Office rent and utilities
• Company insurance
• Technology (laptops, phones, etc.)
• Project and Construction Accounting Software
• Salaries for employees that cannot be attributed to a project
• Company vehicles and insurance
  

SG&A is generally found on an Income Statement below Direct Costs and are a supremely important data point for tracking how much money a company spends on itself and ultimately, how much profit is left at the end of a month, quarter, or year.

Gross Profit

Gross Profit, also called Gross Margin when expressed as a percentage, is the amount of profit that a company makes before Operating Expenses, or Overhead, is taken out.  It is calculated as Revenue minus Direct Costs.

Gross profit is typically the number that construction businesses will aim to make on a project when it's originally bid. Gross profit is a key performance indicator, or KPI, that tracks how a company is doing in its estimating, project management, and field operations, and is an essential statistic for accurate bookkeeping and financial management. 

Net Profit

Net profit, also called net income, is the amount that a company makes after Direct Expenses and Indirect Expenses are taken out.

Net profit is usually found at the bottom of Profit and Loss Statements and is the most accurate number to see how much money a construction business is making on its operations after paying all its project costs, salaries, insurance, administrative, and operating expenses.

Assets

A company’s assets are located at the top of the Balance Sheet and show everything in a company that has value.

Assets at a construction company typically consist of things like:

• Cash in a business bank account
• Receivables (money that has been billed to a client that has not yet been paid)
• Retainage on a project that is not yet collected
• Equipment that a company owns
• Any payments that have been paid in advance (e.g. yearly general liability, or worker’s compensation insurance premiums)

Liabilities

A company’s liabilities are located in the middle of the Balance Sheet and show everything that a company owes to someone else.

Liabilities at a construction company typically consist of:

• Payables (payments to be made to a subcontractor or vendor)
• Balances due on a credit card(s)
• Any outstanding loan or debt payments
• Any expenses that have been accrued but not yet paid such as employee wages

Shareholders’ Equity

Shareholders’ Equity, simply put, is the amount of money that a business owner has invested into the business.

Shareholders’ Equity can be money put directly into the company when it was founded, and any money put into the business over time to help grow and sustain it, such as the previous year’s profits.

Shareholders’ Equity is a good way to see how much value a company has and whether an owner has reinvested (or not) into the business.  

Keeping Good Records of a Construction Company’s Financial Health

Financial statements are valuable reports that inform a business owner in a variety of ways, especially when accurately prepared and regularly delivered to those stakeholders who control how a business operates and grows. Investing time into reading and understanding a company’s financial statements makes it easier to understand how that business is performing and Understanding a company's financial statements is crucial in making informed decisions for operating a successful business. It provides a clear and insightful view of the company's financial health, allowing owners to make strategic decisions that positively impact the business.