9.3 Financial Reporting: Statements, Accounting Methods, and Key Ratios

Financial Reporting: Statements, Accounting Methods, and Key Ratios

Quick Answer: Three statements answer three different questions. The balance sheet is a snapshot — $\text{Assets} = \text{Liabilities} + \text{Owner's Equity}$. The income statement covers a period and ends in net profit. The cash flow statement reconciles them by tracking where money actually moved. For a contractor, add a fourth: the work-in-progress (WIP) schedule, which exposes underbillings (you performed work you have not billed — you are financing the customer) and overbillings (you were paid for work you still owe — a liability, not profit). Contracts spanning reporting periods are normally reported on percentage of completion, usually measured cost-to-cost.

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1. The Balance Sheet

$$\text{Assets} = \text{Liabilities} + \text{Owner's Equity}$$

Retention receivable deserves its own line. It is an asset you cannot spend and often will not see for months.

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2. The Income Statement

The classification rule that gets tested: a cost traceable to a specific project is a direct job cost; a cost of being in business generally is G&A. Depreciation on a crane used on jobs is a direct or equipment cost; depreciation on a car used generally by the sales staff is general and administrative.

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3. The Cash Flow Statement

Three sections, and the first one is where contractors learn something:

• Operating activities — net profit adjusted for non-cash items (depreciation) and for changes in receivables, payables, and billings. A profitable company with exploding receivables shows negative operating cash flow, which is the early warning of the cash crunch described in Section 9.1.
• Investing activities — equipment and vehicle purchases and sales.
• Financing activities — borrowing, repayment, owner contributions, and distributions.

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4. Accounting Methods

Cost-to-Cost Percentage of Completion

$$\text{Percent Complete} = \frac{\text{Costs Incurred to Date}}{\text{Total Estimated Cost}}$$ $$\text{Revenue Earned to Date} = \text{Percent Complete} \times \text{Total Contract Price}$$

Worked example. A $400,000 commercial reroof with a total estimated cost of $320,000 has incurred $208,000 of cost to date.

$$\text{Percent complete} = \frac{208{,}000}{320{,}000} = 65\%$$ $$\text{Revenue earned} = 0.65 \times 400{,}000 = \$260{,}000$$

If the contractor has billed $235,000, it has an underbilling of $25,000: work performed but not invoiced, reported as costs and estimated earnings in excess of billings, an asset — and a sign the billing process is lagging production.

If instead it had billed $290,000, it would have an overbilling of $30,000: billings in excess of costs and estimated earnings, a liability. Overbillings feel like cash in the bank and are not — the contractor still owes the work. Spending overbillings on overhead is a classic route to a failed job and a failed company.

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5. Depreciation

Depreciation allocates the cost of a long-lived asset across the periods it serves, matching cost to the revenue it helps produce.

Straight line:

$$\text{Annual Depreciation} = \frac{\text{Cost} - \text{Salvage Value}}{\text{Useful Life in Years}}$$

A $54,000 roofing truck with a $9,000 salvage value and a 5-year life depreciates $(54{,}000 - 9{,}000) \div 5 = \text{\textdollar}9{,}000$ per year.

Accelerated methods (declining balance, sum-of-the-years'-digits) take more depreciation early, matching the heavier early productivity and repair profile of construction equipment. The federal Section 179 election and bonus depreciation let a contractor expense qualifying equipment in the year placed in service rather than spreading it — a tax timing decision, not an accounting-principle decision, and one to make with a CPA.

Depreciation is a non-cash expense. It reduces reported profit without reducing cash, which is why the cash flow statement adds it back.

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6. The Ratios a Lender or Surety Reads

A surety underwriting a payment and performance bond for a public works roofing project will look hardest at working capital, the debt-to-equity ratio, the WIP schedule, and whether the contractor's overbillings are funding operations.

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7. Keeping Books a Third Party Can Read

Use a construction chart of accounts that separates direct job cost from G&A. Reconcile bank and credit card accounts monthly. Close the month within about two weeks and produce a WIP schedule with it. Have a CPA familiar with construction prepare at least an annual compiled or reviewed statement — CSLB, sureties, and lenders all want statements someone outside the company stands behind. And retain records: injury records five years, payroll records three years, and tax records generally at least four years after the return is filed.