Financial Controls for Contractors

Financial controls are the systems and metrics contractors can use to manage their company’s money and build sustainable success. Trades companies face unique challenges, but with systems able to handle them, contractors can enjoy higher profits and fewer cash flow crunches.

Quick Snapshot

• Profit margins are the best indicator of your company’s financial health.
• An annual budget is like a plan for the year, helping you achieve (and afford!) your goals.
• Accurate estimating and job costing are key elements for smooth cash flow.

The 3 most important financial controls for contractors 

Over the past decade, Breakthrough Academy has worked with more than 1900 contractors across North America, often for stretches of two or three years at a time. 

Here are three financial controls that can significantly impact a contractor’s success:

• Profit margins
• Annual budgets
• Cash flow

Why contractors’ finances are unique

The trades, by their very nature, are operationally complex, leaving owners with many factors impacting their finances, such as:

• Managing multiple active project sites
• Dealing with supply chain struggles
• Adjusting work schedules due to weather shifts
• Accommodating vendors or subcontractors with unfavorable payment structures

…and this is on top of the regular day-to-day financial demands on your business, including:

• Equipment purchases and maintenance
• Insurance and licenses
• Payroll and other admin costs

How financial controls benefit contractors

Contractors that track their profit margins, budget and cash flow are well-positioned to handle the various instabilities of the industry and have seen significant improvement in both their account balances and their stress levels. 

On average, after their first year in Breakthrough Academy, contractors realize:

• Profit margin increases of $168,380 (that’s AFTER the owner pays themselves!)
• Revenue increases of $776,641

If financial statements tend to make your head spin, keep reading! This article will walk through each control and explain why it could be life-changing for you and your business.

Track your profit margins

Profit margins are some of the most pivotal financial metrics contractors need for managing their company’s finances. 

Profit margins can tell you:

• Whether a project will drain or grow your business
• Whether your company is likely to survive another year

They’re mighty metrics… if you understand them.

Along those lines, it’s worth realizing there are actually two profit margins. Each offers eye-opening, though separate, insights about the health of your business:

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Many contractors focus on revenue, just bringing in as much as they can, especially in the early years. But without a sense of your margins, that approach can put you on a perpetual hamster wheel, constantly working… with nothing to show for it.

That’s what happened to Brent and Chloë Mooney of Hashtag Plumbing. Despite running a million dollar business, their bank account was empty. But after joining Breakthrough Academy and implementing better financial systems, their net profit margins exploded from 0% to 28%. 

How profit margins help you identify profit centers

Contractors often don’t realize which projects generate the bulk of their profits, and examining the gross profit margins of your projects can reveal some surprising revelations.

For example, while big construction projects might bring in huge revenue for a landscaping business, lawn maintenance may have much higher gross profit margins and actually be a better service line to focus on from a financial standpoint.

The process of reviewing your margins by job is called job costing.

Why job costing matters for profit margin tracking

Job costing involves tracking every expense on each individual project so you can see whether the project came in on budget and met its intended gross profit margin. 

It can be immensely beneficial for your business, since a good job costing system allows you to:

• Have better visibility into your project costs
• Run projects more efficiently
• Create better estimates
• See how each project type contributes to your bottom line

How to tell if your profit margins are good or not

Once you’ve calculated your profit margins, unless you have numbers to compare against, it’s tough to know if your business is actually doing well.

In the course of analyzing thousands of businesses, Breakthrough Academy has been able to pull together benchmarks that show the average gross and net profit margins across various trades and company sizes.

The owners of Top Notch Roofing kept a keen eye on their profit margins while they worked with Breakthrough Academy, ultimately: 

• Increasing their net profit margin from 2% to 10%
• Expanding their team to 40 members
• Growing their revenue from $3 million to $8 million

The best part? They were able to reduce their work week from 80 hours a week to 45. For tips  on how other motivated contractors are doing the same, check out this free web class chock full of financial secrets for contractors.

Build an annual budget

An annual budget maps out how much you expect to spend in each area of your business during the upcoming year. 

A bulletproof budget will help you:

• Clarify the purpose of your business
• Achieve your corporate goals
• Be a more decisive leader
• Recruit – and keep! – great staff

To create a budget:

• Gather your previous year’s financials. If this is your first year creating a budget, use whatever numbers you have, even if they’re just ballparks.
• Go through each category of overhead and variable expenses and determine what you need for the year.

If your net profit margin is healthy, how will you use the excess revenue? For instance, will you:

• Expand your team?
• Enhance your marketing efforts?
• Purchase new equipment?

Be specific about any changes you intend to make and how you’ll ensure there’s space in your budget to accommodate them.

Why the accounting type matters for contractors

Managing cash flow for both projects and overhead costs requires extra care for trades businesses. This usually involves two main types of accounting approaches:

• Tax accounting – Financials are presented for the government who want to view the numbers a certain way and often involve balance sheets and P&L statements.
• Management accounting – Financials align with how your business actually operates and are generally more useful for making operational and strategic decisions.

On a daily basis, you’ll probably want to use management accounting, but come tax time, you’ll need your numbers formatted to please the government as per tax accounting practices. A good accountant experienced in working with contractors should be able to provide both. 

Another distinction between accounting practices that contractors should be aware of is cash versus accrual accounting. Here’s the difference:

• Cash Accounting – Tracks when income is actually received and expenses are actually paid. It should generally line up with the amounts in your bank account.
• Accrual Accounting – Records revenue based on when you send an invoice and expenses when you get a bill. While it has its uses, it can sometimes be misleading, depicting high profits even when the account is empty.

Breakthrough Academy generally recommends contractors use cash accounting as it tends to support better cash flow planning and helps you avoid cash crunches.

How to customize your budget

Your budget will be far more effective if you customize your chart of accounts, which means giving your line items names you understand and breaking out expenses in a way that directly relates to how you’re spending money.

Every expense will fall into one of two categories, or buckets:

• Variable costs – Project-related spend, including subcontractor labor.
• Fixed costs – Overhead expenses like office and admin staff or equipment that gets used across all projects.

Within these groupings, you can call the individual accounts whatever you like, and can be as detailed as you want. For example:

• Team lunches
• Truck maintenance
• Flyer printing
• Reviews software tool

If you’d like to score some resources to help get your company’s financial house in order, you’ll be off and running with this free webinar.

Keep tabs on cash flow

Cash flow is the balance between income and expenses moving through your account at any given point. It can be a powerful forecasting tool that helps you predict whether you’re likely to have enough cash on hand to cover upcoming costs.

A cash flow tracking system helps contractors avoid stressful money moments when you need to cover your overhead and staff payroll, despite:

• Unexpected change orders
• Late customer payments
• Seasonal fluctuations
• Higher interest payments on equipment loans 

Here’s how to ensure you always have enough cash in your account:

• Don’t assume that increasing your revenue will fix cash flow problems. Without good systems in place, more money coming in usually just leads to more money going out.
• Know where your money is going. This means project expenses and overhead.
• Do proper job costing.
• Pay yourself a regular salary.
• Beware shiny stuff. When it’s planned for, a new truck is a capital expenditure. When it’s not, it’s a budget bomb.
• Review your budget monthly, quarterly and annually. Make adjustments as needed.

How to make estimates more accurate

Building a job estimate for a customer shouldn’t be a guessing game. If you are doing job costing properly, you’ll know how much similar projects generally cost, and estimating becomes a breeze.

You can:

• Fine-tune the amounts for the specific project
• Work out how much is needed to cover overhead costs
• Decide what the gross profit margin must be
• Calculate a reasonable contingency
• Tack on an appropriate markup 

Approaching the estimating process this way puts you in control of your profit margins, instead of them being at the mercy of whatever’s left at the end.

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