What are your financial statements telling you?

It can be tough for contractors to find the time to analyze their financial statements and understand the story they are telling you about the present condition of your business and your future course. Besides the time involved, another major factor is many contractors do not have any training or experience in understanding financial statements.

One way to get the most from your financial data is to meet with your accountant on a regular basis and ask the right questions. For example, one of the key things your accountant can help you understand is the type of information lenders and bonding companies will be assessing when they look at your financial statements.

Balance Sheet

Your balance sheet is an assessment of your assets and liabilities at the end of each fiscal year. Despite being a good snapshot of where you land each year, its relevance diminishes as time passes. By the time you meet to review your balance sheet with your accountant — depending on the collection of your accounts receivable, asset purchases, taking on new debt and cash outlays — it may be completely irrelevant and you would be better off looking at a copy from your internal accounting system.

Comparing your current assets to your current liabilities helps to measure your ability to pay off short term obligations. The higher the number, the better your ability to cover short-term debts.

Comparing your current assets to your current liabilities helps to measure your ability to pay off short-term obligations. The higher the ratio, the better your ability to cover short-term debts.

Another critical ratio to look at is your total liabilities over your total assets. This tells you how many of the company’s assets are financed with debt, versus those which are self financed. The lower the ratio, the less reliant your company is on third-party debt.

Lenders review both ratios when deciding whether or not to lend to your business.

Income Statement

Your income statement is a report of how your business performed during the year. Its relevance does not diminish as time goes on, like the balance sheet. If a contractor is going to look at one statement in detail, it should be the income statement.

Ideally, a contractor’s income statement should separate the direct costs relating to your various projects from the general and administrative expenses not related to actual projects.

By breaking out the direct costs, your financial statements will show your gross margin. The gross margin is simply your revenue less the direct costs such as wages and materials for each project. The gross margin is disclosed as a dollar amount and as a percentage. You might notice larger jobs will have a lower gross margin percentage but greater over-all dollars. This information will help you with your future bidding process and help to determine your overall profitability.

Key ratios to do with your income statement lenders and owners should focus on are the company’s operating income over interest expense, and operating income over interest and principal portions of debt. Both are measures of the company’s ability to make its debt payments and stay current with its lenders.

Profitability

The other area a contractor should be focusing on is the profitability of their business. This isn’t just the bottom line on the financial statements, but how it relates to the revenue, costs, invested equity and assets of the business.

Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA)

EBITDA measures profitability without the effects of financing or capital assets against the prior year or industry benchmarks, as it focuses on operating profits. For example, when a company obtains financing to purchase new equipment, it incurs higher interest and amortization costs and a lower net income than a company which runs older assets - even though these new assets might have higher efficiency and capacity. Comparing EBITDA will allow companies to focus on the operating profitability that management was able to generate on sales regardless of financing.

Return on Assets (ROA)

Return on assets is calculated as net operating income divided by total assets. A higher percentage is more desirable because ROA measures how profitable your assets are. This is valuable when comparing ROA between different projects or investments your company is involved in, or against an industry benchmark, as it identifies which assets are generating the most income.

An example of the usefulness of this measure is to compare the ROA realized by operations versus other investments. Realizing a low or declining ROA would indicate to management it should assess whether the assets may be put to better use elsewhere, such as into new assets or operations to facilitate growth of the business, or into higher-yield investments.

Conclusion

These examples are just a fraction of what your financials can tell you. Every contractor will have a different area they are interested in. It is good to ask others in the industry what they focus on. By taking some time to understand the numbers of your business, you can increase the opportunities to increase your profits.

About MNP’s Real Estate and Construction Services

At MNP, we believe in being your partner in business. That’s why all sectors of the real estate and construction industry across northern B.C. rely on MNP for industry-specific expertise and services that go beyond traditional accounting and tax. From project structuring and tax minimization to asset protection and succession, our Real Estate and Construction team looks at your operation from all angles and develops personalized strategies to help you succeed.

Prince George, Quesnel and Vanderhoof

Andrew Adams, CPA, CA
Partner, Private Enterprise
T: 250.596.8311
E: [email protected]

Williams Lake

Kane Fraser, CPA, CA
Partner, Private Enterprise
T: 778.412.4200
E: [email protected]

Terrace

Michael Johnson, CPA, CA
Partner, Private Enterprise
T: 250.635.4925
E: [email protected]

Fort St. John

Peta Best, CPA CA
Partner, Private Enterprise
T: 250.794.5105
E: [email protected]