2.1 Financial Statements, Job Costing, and Cash Flow
Key Takeaways
- Balance Sheet follows Assets = Liabilities + Owner's Equity; sureties expect a current ratio of about 1.5:1 and a quick ratio near 1.0:1.
- Markup is on cost, margin is on selling price: a 25% markup equals only a 20% margin—convert margin to price with Cost / (1 − margin).
- Job costing separates direct from indirect costs; allocate general overhead via a burden rate such as overhead / direct labor.
- Retainage (typically 5%–10%) and underbilling drain cash even on profitable jobs; the WIP schedule reveals over/underbilling.
- Percentage of completion = costs to date / total estimated costs, the basis for progress billings.
Financial Statements, Job Costing, and Cash Flow
The NASCLA Contractor's Guide to Business, Law and Project Management treats financial control as the single biggest predictor of contractor survival. The exam expects you to read three core reports: the Balance Sheet (assets = liabilities + owner's equity, a snapshot in time), the Income Statement (revenue minus expenses over a period, also called the Profit and Loss or P&L), and the Cash Flow Statement (actual cash in and out). Confusing profitability with liquidity is the classic exam trap.
Reading the Balance Sheet
The accounting equation never changes: Assets = Liabilities + Owner's Equity. Current assets (cash, accounts receivable, materials inventory) convert to cash within one year. Current liabilities (accounts payable, accrued payroll, the current portion of loans) are due within one year.
Two liquidity ratios appear repeatedly:
- Current Ratio = Current Assets / Current Liabilities. A bonding company typically wants 1.5:1 or higher.
- Quick (Acid-Test) Ratio = (Current Assets minus Inventory) / Current Liabilities; 1.0:1 is a common floor.
Markup vs. Margin (the #1 numeric trap)
These are NOT the same number. Markup is added to cost; margin is a percentage of the selling price.
| Term | Formula | Example (cost = $80,000) |
|---|---|---|
| Markup % | (Price − Cost) / Cost | 25% markup → price $100,000 |
| Margin % | (Price − Cost) / Price | $100,000 price → 20% margin |
A 25% markup equals only a 20% margin. To convert a desired margin to a markup multiplier, divide cost by (1 − margin). For a 20% margin on $80,000: $80,000 / (1 − 0.20) = $80,000 / 0.80 = $100,000. Marking up cost by 20% would yield only $96,000 and undercut the job.
Job Costing and Overhead Allocation
Job costing assigns labor, material, equipment, and subcontractor costs to a specific project so you can compare actual to estimated. Direct costs tie to one job; indirect costs / general overhead (office rent, owner salary, insurance) must be spread across all jobs.
A common allocation method: overhead rate = total annual overhead / total annual direct labor cost. If overhead is $300,000 and direct labor is $1,200,000, the burden rate is 25%—add $0.25 of overhead to every $1.00 of field labor when bidding.
Cash Flow, Retainage, and the WIP Schedule
A profitable contractor can still fail from negative cash flow. Retainage (commonly 5%–10% withheld by the owner until completion) ties up cash you have already earned. The Work-in-Progress (WIP) schedule reconciles billings to costs:
- Underbilling (costs/earnings exceed billings) = you are financing the owner; a red flag to sureties.
- Overbilling (billings exceed earnings) = front-loaded cash, but it is a liability you owe in future work.
Percentage of completion = costs incurred to date / total estimated costs. If you have spent $400,000 of a $1,000,000 estimate, you are 40% complete and may bill 40% of the contract, less retainage.
A contractor's job costs $80,000 and the owner wants a 20% profit margin on the selling price. What price must be quoted?
On a $1,000,000 contract using percentage-of-completion, the contractor has incurred $400,000 of a $1,000,000 total estimated cost. With 10% retainage, how much net can be billed to date?
The Three Statements and What Each Shows
Know the role of each statement cold. The balance sheet is a snapshot — Assets = Liabilities + Owner's Equity (the accounting equation). The income statement (P&L) shows revenue minus expenses over a period, ending in net profit. The cash flow statement tracks actual cash in and out — a profitable contractor can still go broke if cash flow turns negative. Surety underwriters read all three plus the work-in-progress (WIP) schedule to set bonding capacity.
Key Ratios and a Worked Example
Three ratios appear repeatedly:
- Current ratio = Current Assets / Current Liabilities (liquidity; >1.0 desired, sureties often want ~1.5).
- Quick ratio excludes inventory.
- Working capital = Current Assets − Current Liabilities.
Worked example: Current assets $600,000; current liabilities $400,000. Current ratio = 600,000 / 400,000 = 1.5. Working capital = 600,000 − 400,000 = $200,000. Sureties often extend a single-job limit near 10× working capital, so this firm might bond a ~$2,000,000 job.
Job Costing and Percentage-of-Completion
Job costing assigns labor, material, equipment, and subcontract costs to each project so you compare actual vs. estimated. The percentage-of-completion method recognizes revenue as work progresses: % complete = cost incurred / total estimated cost. If $300,000 of a $1,000,000 estimated-cost job is spent, the job is 30% complete, and you recognize 30% of the contract revenue. Overbilling (billings exceed earned revenue) is a current liability; underbilling is a current asset and an early warning of cash-flow strain.
Common Exam Traps
- Trap: Profit equals cash. A job can be profitable on paper yet cash-negative due to slow receivables and retainage held.
- Trap: Reading the current ratio as working capital — one is a ratio, the other a dollar figure.
- Trap: Treating overbilling as good. It boosts cash now but signals you may run out of money to finish the job.
- Trap: Counting retainage receivable as immediately available cash.
A job has an estimated total cost of $800,000 and has incurred $200,000 to date. What is the percentage of completion?
Cash-Flow Forecasting and the S-Curve
Contractors plot cumulative cost over time as an S-curve — slow at mobilization, steep through mid-project, flattening at closeout. Because owners pay after work is performed and hold retainage, the contractor often fronts cash. Forecast each month's outflow (labor, materials, subs) against expected draws to spot the maximum negative cash position, the point of greatest borrowing need. A line of credit is sized to that trough. Front-loading the schedule of values (billing early items high) accelerates cash but is policed by owners and lenders as unbalanced billing.