Accounting 101 for Contractors

While many accounting courses discuss accounting in depth, today’s focus will be on why accounting is essential and why your financials should be kept current. The Merriam-Webster definition of accounting is “the system of recording and summarizing business and financial transactions and analyzing, verifying, and reporting the results.” Our accounting definition goes a step further and includes managing and understanding your finances.

Accounting with Your Bank Account

Unfortunately, some people believe that just having their bank account accessible and reviewing their bank balance is enough for them to understand their business’s financials. The idea that the bank balance is enough is reflected in ideas such as profit-first accounting. In this theory, you have separate bank accounts for your expenses, taxes, and income, so you’re physically dividing up the money and watching that bank account. But accurate accounting goes beyond that. The goal is to be tax-ready at any point.

Tax-Ready? Is It Enough?

The issue is that tax time occurs only once a year, so in those other nine months of the year, many people do not think about their financials, which are not up to date. Accounting is essential for all 12 months of the year. Completing your books every month will give you better access to understanding your numbers and finances; that way, you can ensure that your business is paying estimated taxes as needed.

When you start a business, you want to make sure that it has a plan. You also want to ensure you have a financial plan to help you track your finances. Many small businesses fail in their first one to three years because they do not grasp their cash flow.

Tracking your Benchmarks

Another benefit of current accounting is that it is essential to track KPIs. KPIs mean that you can look at industry standards and see where your company is falling in comparison. For example, if you are in an industry such as HVAC, your KPI for advertising will be about 10%. Knowing if your business is higher than that can help you decide the best way to move forward with your cash flow. If you’re looking at a higher than 10% amount on advertising, the revenue you’re receiving for that advertising is insufficient to warrant continuing that expense.

Another thing that you can help track is direct labor versus indirect labor, especially in our home service professionals industry. You can even ensure that your divisions are cost-effective by breaking down your direct labor for commercial and residential projects. Division breakdowns can also be done for income, so you can directly compare how much you are putting into labor to what that labor is bringing in revenue-wise.

Being Ready vs. Understanding

Even when it comes to being tax-ready, there’s a difference between having these pivotal numbers and information about your accounting and having the numbers prepared for tax purposes. Tax purpose numbers will have all your materials, for example, in one block instead of breaking out your tools versus small supplies. Your monthly accounting will show you the specifics, so if you spend tons of money on tools, you should look into that. It could be that your techs are losing the tools. Wages are another expense reflected on one line for a tax return; however, if you spend 60% of revenue on wages and 40% of that 60 percent is going to office wages, you may need to consider your staff. Tax Ready is not going to tell you those breakdowns.

Up-to-Date Benefits

All of these benefits require having up-to-date financials. You cannot just look at your bank account and understand which division is bleeding through your cash flow or that you’re not spending enough on advertising. When looking at your bank account, all you can know is that this expense was for payroll. Not specific information, such as 45% of it was administrative, whereas the other 55% was direct to your technicians.

To do this, you must have a pretty efficient system. To break out income, for example, you would have to have a price book from a house called Pro that would allow you to map your income. To do department breakdowns on expenses, you must notify whoever is doing your books about the department to which each expense is attributed. Luckily, regarding labor breakdowns, many software, such as ADP and Gusto, have workarounds to allow mapping for those breakdowns.

Ultimately, there are so many benefits to having accurate numbers throughout the year. It’s also a time saver, so you’re not rushing to get everything together at the end of the year. Many accountants will get books that are not taxed-ready, and then it causes a mad dash to get the information and get everything caught up in time for filing. However, you need bond insurance in this industry if you’re doing big government projects. These will require financials to obtain those; if you’re not up to date, there’s another instance where you’ll be panicking and spending a lot of money to get up-to-date financials to do these jobs.

Setting goals to prepare for future expenses and ensuring that you are ready for any loans, insurance, taxes, and professional requirements that need up-to-date financials is invaluable to a company. When doing proper accounting, you’re not just looking at where the money is coming in from your bank and where the money is going out. You’re not looking at only revenue and expenses. Accurate accounting includes a balance sheet with all your assets as a business laid out before you. That balance sheet will help you look at cash flow because when you look at your bank account, you will see those loans coming out, but they don’t affect your net profit.

You can take accounting as far as you want to. It can show you stream details, even breaking your costs down by job so you can see the revenue versus the price applied to that job. If you want to take it even further than just having department breakdowns, we will have an entire blog on this precisely because it is an in-depth topic. 

Accounting is a broad term. However, when it comes to contractor accounting, the critical part is understanding your financials. This blog explains many reasons why ensuring that those financials are understood and up to date is essential.

Check out our YouTube video ACCOUNTING 101 FIRST CONTRACTORS with James for a first-hand recap. If you are still determining which plan works best for you, need additional help, or have any questions, Waterford Business Solutions is happy to help. Feel free to call us at 864-351-0852 or email us at Info@WaterfordBusiness.com.