Business Finances
Knowing how to build a job, price it, track the money, and pay your taxes is what keeps a contracting business alive. This chapter walks through cash management, estimating, financial statements, and the federal and California tax rules a licensed contractor must understand.
Cash Flow Management
Cash flow is the timing of money coming in versus money going out, and it is a different thing from profit. A job can be profitable on paper while you still run out of cash, because you must pay for labor, materials, and equipment weeks or months before the owner pays you. That timing gap is the single most common reason otherwise healthy contractors fail. The cure is forecasting: project your expected receipts and payments week by week so you can see a shortfall coming and arrange a deposit, a progress payment, or a line of credit before it becomes a crisis.
Job Costing: Direct Costs vs. Overhead
Job costing means tracking exactly what each project costs you so you know whether it actually made money. Direct costs (also called job costs or costs of goods sold) are expenses you can tie to one specific job: that job's labor, materials, equipment rental, permits, and subcontractors. Overhead costs are the costs of running the business as a whole and cannot be tied to any single job: office rent, the bookkeeper's salary, insurance, your truck payment, advertising, and licensing fees. Every job must carry a share of overhead, or the business loses money even when each individual job looks profitable.
Estimating: Markup vs. Margin
Markup and margin both add money on top of cost, but they are calculated from different bases and are easy to confuse. Markup is the amount added to cost, expressed as a percentage of cost: price = cost x (1 + markup). Margin (gross profit margin) is profit expressed as a percentage of the selling price: margin = (price - cost) / price. To convert, margin = markup / (1 + markup), and markup = margin / (1 - margin). Example: a job costs you $10,000 and you apply a 25% markup, so you charge $12,500. Your profit is $2,500, but as a margin that is only $2,500 / $12,500 = 20%. A 25% markup is NOT a 25% margin — pricing as if it were is a classic way to underbid.
Overhead: Fixed vs. Variable Costs
Within overhead it helps to separate fixed and variable costs. Fixed costs stay roughly the same no matter how much work you do — office rent, liability insurance, license and bond fees, salaried office staff. Variable costs rise and fall with your volume of work — fuel, hourly field labor, materials, equipment fuel, and disposal fees. Understanding the split matters because fixed costs must be covered every month even in a slow season, while variable costs shrink when work is slow. Knowing your monthly fixed overhead tells you the minimum revenue you must produce just to keep the doors open.
Break-Even Analysis
The break-even point is the level of sales at which total revenue exactly equals total cost, so profit is zero. Below it you lose money; above it you earn profit. The formula is: break-even sales = fixed costs / (1 - variable-cost ratio), where the variable-cost ratio is variable costs divided by sales. Example: your company has $8,000 in monthly fixed costs, and variable costs run 60 cents on every revenue dollar (a variable-cost ratio of 0.60). Break-even sales = $8,000 / (1 - 0.60) = $8,000 / 0.40 = $20,000 per month. You must bill $20,000 every month before you earn a dollar of profit; the difference 1 - 0.60 = 0.40 is the contribution margin, the share of each sales dollar left to cover fixed costs.
Budgeting, Planning, and Budget Variance
A budget is a written plan that estimates the revenue and expenses you expect over a future period, usually a year broken into months. It turns goals into numbers so you can decide whether you can afford equipment, hires, or marketing. A budget variance is the difference between what you budgeted and what actually happened. A favorable variance means you spent less or earned more than planned; an unfavorable variance means the opposite. The point of variance analysis is not to assign blame but to find the cause early — a rising materials variance, for example, may mean it is time to re-price your bids.
The Balance Sheet
A balance sheet is a snapshot of what a business owns and owes on one specific date. It is built on the fundamental accounting equation: assets = liabilities + owner's equity. Assets are things of value the company holds — cash, accounts receivable, tools, vehicles, inventory. Liabilities are what the company owes — accounts payable, loans, unpaid taxes. Owner's equity is what would be left for the owner if every asset were sold and every debt paid; it is the owner's stake in the business. The two sides always balance: every dollar of assets is funded either by a debt or by the owner.
The Income Statement and the Cash Flow Statement
The income statement (also called a profit and loss or P&L statement) covers a period of time and shows whether you made a profit: revenue minus cost of goods sold equals gross profit, and gross profit minus overhead and other expenses equals net profit. The cash flow statement also covers a period and shows where cash actually moved — from operations, from investing, and from financing. The two answer different questions: the income statement says whether the business was profitable, while the cash flow statement says whether the business actually had cash in hand. A company can show a net profit and still run dangerously low on cash.
Cash vs. Accrual Accounting; Percentage-of-Completion
There are two basic accounting methods. Under cash-basis accounting you record income when money is actually received and expenses when they are actually paid — simple, and common among small contractors. Under accrual-basis accounting you record income when it is earned and expenses when they are incurred, regardless of when cash changes hands — required by GAAP and for many larger or incorporated businesses. For long, multi-year construction projects, accrual accounting often uses the percentage-of-completion method: you recognize revenue gradually as the job progresses. If a $400,000 contract is 30% complete, you record $120,000 of revenue for that period rather than waiting until the final payment, which gives a far more accurate picture of an ongoing job.
Federal and State Taxes
A contractor with employees needs a federal Employer Identification Number (EIN) from the IRS to file business taxes, run payroll, and open business bank accounts. Workers must be classified correctly: an employee gets a W-2 showing wages and withheld taxes, while a true independent contractor paid $600 or more in a year gets a 1099-NEC and pays their own self-employment tax. Because no tax is withheld from their own draws, self-employed contractors and corporations must make quarterly estimated tax payments — federal to the IRS, California to the Franchise Tax Board — generally due April 15, June 15, September 15, and January 15. In California, an employer also registers for an Employer Account Number with the Employment Development Department (EDD) to report wages and pay state payroll taxes.
Payroll Taxes
When you have employees you owe payroll taxes on top of wages. FICA covers Social Security and Medicare; it is split evenly, so the employee and the employer each pay half. FUTA is the federal unemployment tax, paid entirely by the employer. California adds its own employer payroll taxes administered by the EDD: State Unemployment Insurance (SUI) and the Employment Training Tax (ETT) are paid by the employer, while State Disability Insurance (SDI) is withheld from the employee's pay. You must deposit the federal taxes you withhold on the IRS schedule — most small employers are on a monthly schedule, larger ones on a semi-weekly schedule — and missing deposits triggers penalties.
Loans, Depreciation, Working Capital, and PACE
Contractors borrow to buy equipment or to bridge cash gaps. Simple interest is interest = principal x rate x time; a $20,000 loan at 8% for 2 years accrues $20,000 x 0.08 x 2 = $3,200 in interest. Depreciation spreads the cost of a long-lasting asset, like a truck or excavator, across the years it is used rather than expensing it all at once, which matches the cost to the income it helps produce. Working capital is current assets minus current liabilities — the cushion of cash and near-cash available to run day-to-day operations — and the current ratio (current assets / current liabilities) measures the same health: a ratio above 1.0 means you can cover short-term debts. Finally, PACE (Property Assessed Clean Energy) is a California financing program that lets property owners fund qualifying energy and water improvements through an assessment repaid on their property tax bill; contractors who offer PACE-financed work must follow specific consumer-disclosure rules.