The financial accounts which your accountant provides you with at the end of the financial year for tax purposes are backward looking and probably spark very little interest from you apart from how much tax you will have to pay. Many accountants say that they are interested in your business and that they will help you make money. However, when I speak with many of my clients, they do not feel that this is the case. They are reluctant to challenge their accountant as the accountant is a professional. Before I start working with a client they often say, “do not know what I don’t know” about what information can be obtained from their accounts and they trust their accountant as they have always been with them.
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, the work is project based. The accounts should be structured in the same way, as it is fundamental to managing the projects on site and pricing upcoming projects. The project-based approach allows each project to effectively have an ongoing “profit and loss” statement so you can compare it to how the project was priced and act at the appropriate time to deal with any issues.
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 knowing the true profit then accurately pricing future jobs in the marketplace 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 get 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 willing 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 of a project it is unlikely to make a profit. The pressure this will create on cash, potentially can lead to the demise of a business. 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 lead to profits which give you options.
If you would like help initiating a discussion with your accountant about providing a service which gives you the information you need to manage you business then get in touch.
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