In my July/August 2004 column (“A Is for Accounting,”) I introduced a series of tests that will help you evaluate your financial management systems. This test will help you evaluate how effective your financial reporting system is.
But first, let’s go over the three key financial management reports that a custom builder should be preparing and reviewing on a regular basis: income statement, balance sheet, and job cost reports.
Income Statement. The income statement (also referred to as statement of earnings or profit and loss statement) is a summary of the revenue, expenses, and net income (earnings) or loss of a custom builder’s operation for a specific period of time—a month, quarter, or year. Net income or loss for the period becomes part of the balance sheet by increasing (net income) or decreasing (net loss) the owner’s capital.
Proper analysis of the income statement will assist you in evaluating the overall profitability of your business. In the upper part of the income statement the overall amount of revenue and costs relating to earnings from construction activities should be shown. The lower portion of the income statement reflects the expenses that were incurred in the operation of the business. For custom builders I suggest categorizing these expenses into indirect, sales and marketing, finance, and general and administrative expenses.
In addition to monitoring the percentage relationships that the various expense categories have to revenue, the income statement should be used to compare budgeted revenue, costs, and expenses against the actual amounts incurred during a given period of time.
Balance Sheet. The balance sheet shows the assets, liabilities, and equity of a custom building company at a specific date. Assets are those items owned by the business while liabilities include items that the business owes. Equity is the owners’ interest in the enterprise. The balance sheet tells the business owner things like how much cash is in the bank, how much money he’s owed, what he owes, and what the business is worth at a given point of time.
Proper analysis of a balance sheet will help you understand and evaluate your company’s financial strength, liquidity, and leverage. It will also provide management with information that will help in the formulation and monitoring of company goals and plans.
Comparing the balance sheet for the current month to the prior month can help you understand your company’s structural changes and liquidity patterns.
Job Cost Reports. While the income statement assists the custom builder in evaluating the overall profitability of his jobs, it does not provide an analysis of profitability on a job-by-job basis. That’s the purpose of the job cost report; it provides you with timely information on each job and can help you identify potential cost overruns and correct them before it is too late. At a minimum, job cost reports can be used to compare estimated to actual expenditures for various areas of work performed on each job. More sophisticated job cost reports will take into account projected costs to complete as well as variance reporting. Here is an example of how you can use your income statement and job cost reports as analysis tools.
Start by looking at your overall results for the period broken out by open and closed jobs whose totals tie to the revenue, costs, and gross profit reported on the income statement.
