This week I want to catch up on a few things that have been bothering me.
Are your books set up correctly? Too often, CPAs and bookkeepers try to make all businesses fit in the same chart of accounts. Your Profit and Loss Statement (P&L) should have five sections: Income, Cost of Goods Sold (COGS), Gross Profit (Income minus COGS), Expenses (or Overhead) and Net Profit. Things that can be charged to only one job belong in COGS. These are all the items you consider when you estimate a job. All other expenses should be listed in Expenses.
Here’s the problem. If you have items in COGS that are incurred for multiple jobs (like tools and small equipment), or if you have items in Expenses that should be in COGS (like permits or rental equipment), you won’t have the data you need to calculate your markup correctly.
Your markup is calculated by using your P&L to project your Income, COGS and/or Overhead (Expenses) amounts for the next year. Once you calculate your markup, you apply that markup to your estimated job costs. Estimated job costs become Cost of Goods Sold on your P&L after the job is sold and built. If your P&L doesn’t accurately reflect your job costs and/or your overhead expenses, you won’t be able to accurately calculate your markup.
For decision-making purposes, your P&L doesn’t need to match your tax return. I wouldn’t include depreciation in a markup calculation, so take it off your P&L. I talk about having an Operating Capital Reserve Account in the book Markup & Profit Revisited, and the easiest way to make it happen is by having it listed as an expense on your P&L. It isn’t an expense; it’s basically a savings account to tide you over the rough stretches in construction, but if it isn’t on your P&L you might forget to include it in your markup calculation. Ask your CPA or bookkeeper to add the category and begin setting aside the funds; they can adjust for the OCRA and the depreciation when they file your tax return.
If your CPA doesn’t understand your business and these principles, you are going to be the one who loses, because you won’t be charging the correct amount for your work. You need good info to make good decisions.
The data you use to develop your markup has to have some substance and longevity. By that I mean you should begin with job cost and overhead data that’s been compiled over a period of at least a year or more.
A year’s worth of data reflects what you’ve actually been doing. It’s real-life info, not a wishful dream. It reflects the type of clients you have, the buildings you work on, the expenses you incur, etc. Take your time to collect the data you need and get your numbers right. That will help make sure that you will always be able to pay your bills and take care of your spouse and children from the income you derive from your business.
Your P&L is the snapshot of how your business is doing. If it’s done correctly, you’re getting good info. If it’s done incorrectly, either your CPA needs training in how to setup the books for a construction company, or you need a new CPA.
One more thing on markup. If you don’t know the difference between markup and margin, we did a 3-part series on that on our blog. Make sure you’re using your numbers correctly.
However, what really matters is on your P & L, last page, bottom line, right hand number. That’s the number that counts. If it isn’t positive, something needs to change, today. If it’s less than eight percent, either you’re pricing jobs too low, you aren’t selling enough jobs, or your expenses are too high.
Next topic. I heard from a young guy earlier this month who mentioned that his CPA hasn’t filed tax returns for his company for the past two years. He’s in the process of getting a new CPA and getting his books back in order.
I hate paying taxes. I know they’re necessary to keep our government running and I’m willing to pay my fair share. There have been a few years we didn’t pay taxes, and that was because we were losing money (when I was attending SHK University, the “School of Hard Knocks”). I’d rather be making money and paying taxes than losing money, but I still don’t like paying taxes.
So why wouldn’t a CPA file tax returns on time? Either the CPA didn’t get the information they needed from the contractor, or the CPA is incompetent. Either way, there isn’t any excuse for not filing tax returns on a timely basis.
If you don’t file a tax return, whether or not you owe any money, you’re the one who will be in trouble. Your CPA who didn’t file the return will be fine; you and your business will be in trouble.
One last thing. In the right-hand column is our “To Do In July” list. One of the things we talk about every month is the need to plan ahead for your advertising. Right now, you should be planning your advertising for the winter slow months so you don’t have winter slow months. It is the advertising you start now that will get you the jobs you need at the end of the year.
Don’t depend on referrals to get the leads you need. Look back at the jobs you’ve completed in the last three years. Did you have all the business you could handle in the slow months? If not, it’s because you’re depending on referrals. On the other hand, if you had enough profitable work, what you’re doing isn’t broken, so don’t try to fix it.
It’s always a good idea to supplement your marketing efforts with a quality website and maybe two or three other forms of advertising. Who knows, you might be able to pick and choose the jobs you really like to do.