To grasp this concept the reader must first understand some history associated with mark-up. Next, a modern approach is adopted which requires an understanding of hard and soft costs. Once the two types of construction costs are incorporated, the contractor will learn how to read and interpret a basic profit and loss statement. With this knowledge and given the various margins for the respective type of contractor they then can calculate the mark-up needed to achieve financial success. It all begins with a little historical perspective.
Costs of Construction
Costs of construction is the section of the profit and loss statement for a contractor. Costs of construction identify both direct and indirect costs of projects.
The contractor’s chart of accounts is significantly different than the traditional chart of accounts. First off, the layout is more dependent on the balance sheet than the income statement (profit and loss) accounts. Furthermore, the income statement accounts are laid out to present a resource based costing presentation than a job costing format. To add another layer of complexity, the chart of accounts is somewhat oriented to the method of accounting selected by the contractor.
Roofers depend heavily on labor to accomplish their task. They are also highly susceptible to weather conditions and dangerous conditions. There are a multitude of issues they face. If properly managed, an owner of a roofing company can make a good living and profit. Experience is absolutely the best ally for the roofer.
The whole goal of financial reports is to gain an understanding of financial performance and identify the key issues for changes to make improvements. In accounting we referred to this as a continuous feedback loop method of financial improvement. Insert data, report the data, discover opportunities for improvement; make changes and insert data and begin the whole process all over again. If you are even mildly alert to what is going on, you should easily identify opportunities and make financial improvements and ultimately maximize profitability for your business. It is not going to happen overnight but it will dramatically improve your bottom line within 2 years.
But all of this starts with the estimate for the project.
Construction accounting consists of three major groups of accounts. The first and most understood set are the accounts found on the profit and loss statement. Customarily referred to as Cost of Goods Sold or Costs of Construction, these accounts convey the total costs of construction against the revenue earned for those contracts. The second major group is located on the balance sheet in the current assets section. This group is called the ‘Construction in Process’ (CIP) accounts. The third major group is also located on the balance sheet down in the current liabilities section and is called ‘Construction Billings’ or ‘Construction Deposits and Draws’.
This article explains the balance sheet accounts related to Construction in Process. I will explain how they are designed, formatted and presented. In addition, I’ll explain the impact either the completed contract or percentage of completion method has on the corresponding project’s account balance. Finally, I’m going to explain to you how to interpret the information presented.
In another article I will go into detail related to Construction Billings and the corresponding deposits and draws. This article will focus on the Construction in Process/Progress or what is commonly shortened to CIP.