Why Contractors Don't Know Their Numbers

Irealize that contractors don’t like me harping on knowing your numbers, and contractors as a whole don’t like accounting and bookkeeping. I also recognize I must sound like a broken record. However, 90% of the financial problems we see contractors struggling with have something to do with numbers and usually poor financial information. I am dedicating this article to helping you understand why and how to combat that. First, let’s discuss what causes this problem prior to offering some ideas on how to fix it.

Leave it up to the accountant attitude: Many contractors simply delegate financial tallying to the CPA who handles payroll and taxes, including the payroll and income requirements. The problem is that the accountant is merely acting as a scorekeeper and makes no decisions regarding the business. This would be like a basketball coach going to the score-keeper once a month to determine what plays to run.

Tallying records for taxes instead of for cost analysis: If you don’t record information in a format that matches how you estimate and do jobs, it will not be helpful. Taxes are calculated on the bottom line, and while the profit total may be the same, accurate and quick financial analysis is impossible when accounts are not set up in a logical format. Frequently, contractors will fax us a 10-page statement and say they don’t understand it. I write on the top that I don’t understand it either and fax it back. Since you must go to the trouble and expense to tabulate data for taxes, it makes sense to compile the information in a useful format.

Overly complicated records and falling victim to fast/slow brain activities: In his book, Thinking, Fast and Slow, Daniel Kahnema discusses the brain’s two systems: System 1 operates from recall quickly and automatically, and system 2 handles more complex information. As I read the book, I realized this brain system contributes to contractors’ inability to grasp financial information. Try the following exercise. Add one number to each digit to come up with the next number series.

Example:

Add 1 to each digit 16; the new number is 27 (1 + 1 = 2; 6 + 1 = 7).

Add 1 to each digit 253; the new number is 364 (2 + 1 = 3, 5 + 1 = 6 and 3 + 1 = 4).

Now do the following numbers as an exercise, and do the next number as fast as you can. Notice how much harder it becomes to process the answer as the number of digits increases. Simply repeat each answer quickly, and then go to the next.

12

283

3576

47652

874875

2654274

17549428

I bet as the numbers get longer, it gets harder to concentrate and do it. That is because your short-recall brain can’t merely answer the problem from recall as the complexity of the problem increases.

So herein lies the problem – contractors are busy. Frequently, financial information is not laid out in a simple format, and it is hard to concentrate and follow through. Rather than dig deeper into the complex numbers and figure it out, the contractor merely moves on to one of the many tasks that are nagging him or her. So here are some simple guidelines to use:

Set a specific time and date each month for reviewing financial information: Performing tasks that require concentration also requires scheduling. Turn off your cell phone and email and spend some time working on it. It takes a while to get into the slow brain transitions.
Have an agenda of what to cover: Review your profit and loss statement and balance sheet in an accrual format. Even though your CPA and the IRS may accept a cash format, never use a cash format, as it is not an accurate reflection of your current financial position. Also, review accounts payables (what you owe people) and accounts receivables (what people owe you) to see where you are. Compare it to the previous month and the past year.
Close out the month: To the bookkeeper, closing out the month means the checkbook is balanced, but that is not enough. Try to bill everything as soon as possible. Even if you don’t do jobs in progress, try to post part of the sales so you have the job billed in your accounting records. Record materials in the month they are used, even if you have not paid the bill yet.
Set your statement up in a simple-to-read format: Use the same titles and logic you would use to bid a job. This will help you quickly understand the numbers. Of course, these are arbitrary numbers, but in its simplest format, an operating statement would look something like this.
Total Sales . . . . . . . . . . . . . . . . . . .$500,000

Direct Costs

Field Labor . . . . . . . . . . . . . . . . .$120,000

Labor Burden (payroll taxes, workers’ comp, etc.) . . . . . . . . . . . . . . . . . . .$15,000

Material . . . . . . . . . . . . . . . . . . . . .$85,000

Subs . . . . . . . . . . . . . . . . . . . . . . . .$60,000

Special Job Costs (travel pay, dump fees, lifts, etc.) . . . . . . . . . . . . . . . . . . . .$20,000

Total Direct Costs . . . . . . . . . . . .$300,000

Gross Profit . . . . . . . . . . . . . . . . .$200,000

Variable Overhead (gas, vehicle repair, small tools, maintenance, etc.) . . . . . . . .$20,000

Gross Profit . . . . . . . . . . . . . . . . .$180,000

Fixed Overhead (rent, owner’s salary, depreciation, advertising, etc.) . . . . . . .$120,000

Net Profit . . . . . . . . . . . . . . . . . . . .$30,000

The above detail is not enough for financial analysis, but you can have multiple accounts under each of these categories. Use the totals and logic to help see what is going on in the business. In the above example, labor is 24% of sales ($120,000 divided by $500,000). If labor is 40% of sales one month, something is wrong. Possibly a job has not been billed, you have a losing job or something unusual is going on.

In the above example gross profit before variable overhead was 40% ($200,000 divided by $500,000). If it is only 25% one month, what is wrong? Do you have a job that was a big loser, or has something not been billed? Variable overhead is normally 4%, but suppose year to date it is 8%. What is wrong? Is someone stealing gas? Have gas prices increased, or are your trucks getting old and require too much maintenance? By keeping things simple and matching your accounting logic to your job logic, you know where you are and what is going on. By using your records, you will also have better records.

Keep score in a format that makes sense to you.

APC

Monroe Porter is president of PROOF Management Consultants, a company specializing in seminars and business consulting for contractors. He is also founder of PROSULT Networking Groups, developed to help noncompeting contractors. He can be reached at (800) 864-0284 or monroe@proofman.com. For more information, visit his website at www.proofman.com.

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