Financial Management & Accounting
Many contractors fail not from lack of work but from poor financial control — running out of cash while waiting to be paid. This topic covers the basic financial statements and ratios, cash-flow realities unique to construction, and job costing. The concepts and formulas here are universal business fundamentals.
Financial Statements and Key Ratios
The balance sheet lists assets, liabilities, and owner's equity at a point in time (Assets = Liabilities + Equity). The income statement shows revenue, expenses, and profit over a period. Two liquidity measures matter greatly to sureties and lenders: working capital = current assets - current liabilities, and the current ratio = current assets / current liabilities. Example: with $240,000 in current assets and $120,000 in current liabilities, working capital is $120,000 and the current ratio is 2.0 — meaning $2 of short-term assets for every $1 of short-term debt. A current ratio below 1.0 warns that near-term bills may not be payable.
Cash Flow and Retainage
Construction is cash-flow intensive: the contractor usually pays for labor and materials well before the owner pays. Progress payments (periodic payments based on work completed) ease this, but owners commonly withhold retainage — often 5% to 10% of each payment — until the work is satisfactorily completed. Retainage strains a contractor's cash, so it must be planned for and generally passed through to subcontractors on the same terms. Positive working capital and a cash-flow forecast keep a busy company from going broke between billings.
Cash vs. Accrual and Revenue Recognition
Under the cash method, income and expenses are recorded when money actually changes hands; under the accrual method, they are recorded when earned or incurred, regardless of payment timing. Accrual gives a truer picture of a construction company's health. Longer projects often use percentage-of-completion accounting, recognizing revenue as the work progresses. Watching for overbilling (billing ahead of work completed) and underbilling helps management understand whether reported profit is real.
Job Costing and Overhead Recovery
Job costing assigns labor, materials, equipment, and subcontractor costs to each specific project so the contractor can compare actual costs to the estimate, catch overruns early, and learn which kinds of work are truly profitable. Overhead must be recovered across jobs through markup; if markup is set too low to cover overhead, a company can be busy and still lose money. Accurate job cost history is also the best foundation for pricing future bids.