How to Avoid Accounting Surprises

Q. I run a construction company. I thought that 2014 was a banner year. We eclipsed $3 million in revenue. Unfortunately, when I got my annual financial statement, we had lost money. I was shocked. How can I figure out what is going on and make sure this never happens again?

A. Year-end surprises are horrible. They should never happen. By the time you see the annual financial statements, they should simply confirm what you already know has happened. We have four suggestions to make sure that last year’s disappointment doesn’t repeat itself.

Insist on monthly financial statements – You should be getting monthly financial statements. Not knowing whether your business is profitable until the end of the year is unacceptable. You must get accurate financial statements monthly and you must focus on them. If you don’t know how to read them, get help. You could have corrected 2014’s problems early in the year if you had known about them.

Ensure timely reporting – Getting monthly financial statements is great, but if you receive them six months after the fact, they will be less useful. Make sure that you get a complete set of financial statements within two weeks of the end of each month. Don’t accept excuses. We have yet to see a small business for which financial statements couldn’t be produced within two weeks of the end of a month. If your current bookkeeper can’t do it, you probably need a new bookkeeper.

Use accrual based accounting for management decision-making – Many small businesses use cash based accounting because it is easier. Revenue is entered when cash enters the business and expenses are recorded when cash leaves the business. Unfortunately, such systems do a poor job of matching revenue to expenses. Particularly in a business such as yours, where payment may come months after you pay for expenses, using cash based accounting will likely lead to large swings in monthly profitability.

This makes it almost impossible to tell how the business is doing from month-to-month. It is difficult to know if you should implement an austerity program or hire more staff. Using an accrual accounting system may create some complexity for your bookkeeper, but the clarity it brings to your financial statements will significantly improve your management decision making. This will more than compensate for any additional cost.

Calculate job level profitability – You should have a system that calculates the profitability of each individual job. Determining the revenue that each job generates should be straightforward. Record the materials you use on each job. This may mean splitting some invoices. For example, you might order nine yards of concrete and use six yards on one job and three yards on another. You’ll have to split the expense accordingly. To keep things simple, allocate lower cost supplies (e.g., nails, wire nuts, tape, etc.) to each job as a percentage of revenue. You’ll need a system for tracking the hours your people work and assigning them to each job. Obviously, you will need to charge the cost of any subcontractors appropriately.

Once you have such a system in place, you will be able to pinpoint problems and opportunities. Issues you might identify include poor estimating and quoting, too many hours being booked to a job and excessive material costs. Without such a system, these challenges are likely to go undetected.

Year-end surprises with regard to the profitability of your business should never happen. Following the suggestions outlined above will help to ensure that they never do.