The accounts which your accountant provides you with at the end of the financial year are backward looking and probably spark very little interest from you. Many accountants say that they are interested in your business and that they will help you make money but in in speaking with many of my clients, people do not feel that this is the case and are reluctant to challenge an accountant as they are a professional and my clients “do not know what they don’t know” about accounts to ask probing questions.
Thinking back to when your business started, getting work was more a priority than managing the money, so the selection of an accountant was probably done on price and not their appropriateness to your type of business. For contractors & consultants how the accounts are structured, as work is project based, is fundamental to gaining information so that you get the price right for upcoming work. Another issue is that your accountant has probably been employed to do both your company accounts and your personal tax. Whilst the submission to HMRC is made separately they aim to maximise your personal income at the expense of having market rates of pay for your activities in the business which blurs the true profit of the business. Without know the true market rate profit then accurately pricing future jobs in the market place is going to be impossible.
Generally, business owners provide information to their accountant and expect them to sort it out. The accountant may ask a few questions but to keep things simple for everyone they often make assumptions about what everything is for. The business owner does know what they need to know, so they provide no further information and accept what gets returned. As a result, whilst the accounts will be satisfactory for tax purposes, they are not any use for helping to run the business.
If the owner, submits the information in a structured manor then what will be returned could be analysed and used to run the business. The following suggestions will be a step towards getting a set of management accounts to run the business which can also be used to compile the financial accounts for tax purposes.
Project information & gross profit per project.
Each project should be given a unique code. All costs associated with that project can then be associated with it and by subtracting the costs from the tendered price, the gross profit can be worked out. For projects over a long period, monthly reconciliations can be carried out to see how projects are going and if they are going to make a profit at the end.
If you do a variety of work, knowing the gross profit on each type of work is useful to know, as it will help you decide if it is worth continuing that type of work, or if you should be thinking about how you go about the work to improve the gross profit.
Overhead costs
Any other costs, or expenses, which is not a project cost are an overhead. Examples are premises, accountants’ fees, Insurances, marketing, etc. The components of the categories can be grouped together, so you know what your marketing costs are, legal and professional fees and so on. By grouping them you can see how they compare to a previous year and if you are getting a good return on the investment. So often costs are allocated to categories which the accounting software suggests which are meaningless to the owner, who should be thinking in business functions. A discussion about the categories and how to allocate costs is worth having so some analysis can be done.
Calculation of operating profit.
All the Overheads are deducted from the Gross profit to leave an Operating profit. The cost of the overhead is effectively shared between the projects in proportion to the value of the project. The greater the value of the projects, the less overhead cost each one has to bear.
It should be noted at the stage dividends have not been taken.
Operating profit.
Having established the operating profit, the next cost to be accounted for is Tax which leaves the Net Profit. The owner can use the remaining money in a number of ways, either keep it in the business as retained profit, invest it the business or pay some out as dividends.
Dividends
Dividends are the last thing which should be take when accounting for everything in the right order. They indicate if a business is truly profitable. Dividends are taxed at a lower rate than pay, so accountants cast the figures, so you take a low pay and higher dividends, the problem with this is that you think you are more profitable than you are, and you cannot substitute other people into your role, as the pay is not at a market rate. To avoid this, you need a set management accounts which have been recast to show the adjustments made by your accountant to at a true picture.
The recast accounts
The recast accounts can be used to calculate the mark up required on each project to cover the expected overhead going forward, given your forecasted income. They will give you your break-even costs when estimating to which you can add the desired profit to arrive at the tender price. If the accountant you initially engaged when you started the business is not will to help to structure the accounts correctly and persists with total income and expenditure, without considering the projects then it is probably time to find one who understands the construction sector.
Conclusion
There is a business mantra, Turnover is vanity, Profit is Sanity and Cash is King. The mantra holds true in all cases, but the important point to note is that Profit is Sanity. With construction projects, unless the price is right at the beginning a profit is unlikely to result. It therefore cannot be emphasised enough that having a clean set of accounts and using a system to maximise profits when tendering is the most sensible way forward and will give you options.
But even if a project is bid to make a profit and secured, then there are many things which can jeopardise the cash flow on the project or erode the margins. Keeping on top of the project finances is an area that is usually managed by a quantity surveyor combined with information from the accountant. This is covered in a separate blog https://www.profitablecontractor.co.uk/post/the-importance-of-cost-value-reconciliation-cvr-for-building-contractors For help with this and setting up a clean set of accounts, please contact me for an informal discussion. Peter.Searle@ba4cs.co.uk
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