Accounting Considerations for the Trades
The finances of trade services seem like they should be simple: You have a leaky faucet, you call a plumber, they fix it, you pay them. From the customer’s side, it appears an easy transaction. For small business owners in the trades, however it’s much more complicated.
As though ladder falls, electrical fires, and rusty nails weren’t enough to worry about, skilled tradespeople also face the dangers of Department of Revenue audits and high-volume aged receivables. So for our month of industry-focused accounting, we’re focusing week two on accounting considerations for those in the trades.
Concern #1: Getting paid.
Performing a job, particularly if parts have to be purchased, can be a costly endeavor. If employees have to be paid for extra hours or extra help brought on, it can be even more expensive. So when customers don’t pay, you, the owner is severely put-out.
There are ways for business owners to protect themselves and prevent slow/no-payers. The first, most obvious step, is to take a deposit, at least enough to cover parts and materials that must be purchased. This way, even if the job is cancelled, you’re not stuck with the costs of materials you don’t need.
The second is to establish clear terms of invoicing and payment, and to make sure both sides understand and agree to them. This can be particularly important when doing commercial work, as businesses often have more rigid rules about how they are invoiced, how POs are issued, and how payments must be approved internally before being remitted.
The third is simply having a system in place by which you follow up on overdue invoices. We do accounts receivable work for some of our clients, and you would be amazed how much money can be collected by simply calling and reminding customers that a payment is overdue. Though there are exceptions, of course, most people do want to pay their bills in a timely matter, and are happy to make right on an overdue account.
Concern #2: Job-costing.
In the prior entry, we referenced the costs associated with an individual job, such as labor and materials. However, there is also travel time to be considered, as well as overhead allocations (how you proportion out fixed costs to specific jobs). Though it can be a lot of work to set up an effective job-cost tracking system, the data it provides is invaluable for business planning and expansion purposes, and for determining profitability of different types of jobs, and for pricing strategy.
In particular, tracking mileage and other travel costs can help immensely in determining how jobs are scheduled efficiently. Fuel costs alone can be significantly reduced with more strategic scheduling, as well as labor costs associated with travel time. Even things such as travel to vendors with preferred pricing can be optimized. However, if that data is not being tracked, it can’t be studied nor put to use.
Concern #3: 1099s.
It’s common in the trades, more than any other industry, to hire short-term help for only a single job or handful of jobs. Without proper preparation, this can be very dangerous for a business owner when it’s time to file 1099s. Essentially, the IRS requires that a 1099 be filed for every contract worker who received more than $600 in cash or check for services in a calendar year. (And there are steep penalties at both the state and federal level for failure to do so.)
To file a 1099, you have to have a W-9 from the worker. If you paid someone for a single job in February of the prior year, it can be hard to track that individual down several months later to get a W-9 (especially if they know it means you’re trying to report their income to the IRS). We strongly recommend collecting W-9s (and Certificates of Insurance, where applicable) from contractors prior to paying them.
Concern #4: Sales tax.
North Carolina Department of Revenue shook things up a few years ago in 2016 when they began requiring sales tax be collected on additional services. Under the change in law, sales tax is now charged on repair, maintenance, and installation of “tangible personal property”. This means that, for example, someone installing an HVAC unit would have to collect and remit sales tax on not only the unit, but on the installation service as well.
Where this becomes complicated is that the sales tax expansion does not apply to services on “real property” (i.e. homes or other buildings). However, to protect themselves, tradespeople performing services on real property should obtain Affidavits of Capital Improvement in order to confirm that sales tax is not applicable on each specific job. (This is particularly true for general contractors performing remodels, or their subcontractors.)
Because there is so much variability and “gray area” within financial accounting for the trades, we recommend you speak to your accounting professional regarding any questions you might have for your business’s unique situation. If you don’t have an accounting professional, we might be the right people for the job.
Contact us to schedule a free 1-hour consultation; we’re happy to answer your questions.
Digging into Profitability
If you're paying even the tiniest bit of attention to your books, you are familiar with your Profit & Loss statement: namely, how much you are making or losing over a period of time (whether monthly, quarterly, annually, etc.). It's possible that you have broken out your income and expenses to great detail, but there is still additional information you could be missing out on.
There are methods by which you can measure the profitability of different segments of your business, depending on your industry and the composition of your company. That can allow you to focus on the most profitable aspects of your business, while identifying areas for growth. Here are some of the most common ways we dig deeper into profitability on behalf of our clients.
Job-Costing
Job-costing is great for businesses who tend to work with a small handful of clients at a time, where the projects are long-term and clients aren't necessarily repeat customers. Job-costing is typically associated with construction, but can also be applicable for service-based industries that work on projects, such as large-scale marketing or software integration firms. In job-costing, each expense and revenue deposit is connected to a specific job, and P&Ls can be run by job, in addition to being run for the company as a whole.
Location-Based
Sometimes a company's business occurs in more than one place. Obviously, there are businesses such as dental practices, who have multiple offices. If those are managed independently, it makes sense to want to know the profitability of not just the practice overall, but of each individual location.
Location-based profitability tracking also works very well in the retail and service sectors. Anywhere one business has more than one location, they should be tracking how much money is location is making (or losing) for them. Additional education or possibly replacement might be necessary for General Managers who are not pulling their weight.
Firms with Partners
Sometimes there are businesses in which multiple individuals work within one location, but functionally act as separate business entities. In some law firms, for example, partners operate within the same space cooperatively, but it is still valuable to see who is bringing in the most revenue for the firm, and where expenses are being allocated. There are also certain health clinics or spas where multiple partners may offer complimentary services, and it is vital to track the revenues from each avenue.
Class-Tracking
Some companies have what are really multiple businesses operating as one. For instance, a farm might sell directly to restaurants in one area, sell to grocers in another, and operate a produce stand from which the public may purchase directly. Assigning a class to each transaction (again, both revenue and expenses), can allow the farmer to see the profitability of each segment. Class-tracking is also great when selling both directly and for resale, as sales tax is only applicable on certain sales.
General Rules
If you decide to implement additional levels of profitability tracking within your business, it is vital that you follow a few basic rules.
1.) Be consistent. Have an assignation for every transaction, every time. Otherwise, your data is inaccurate, and therefore, meaningless. (And it's been a waste of your time to do the tracking you have done.)
2.) Have clarity. Know exactly what your system will be for assigning transactions and have it written out, for either yourself or your bookkeeper. Make sure everyone who touches your financials is on the same page with the system.
3.) Be timely. We are always proponents of keeping financials up-to-date. However, this gets even more crucial when you need the additional level of detail required for profitability break-outs.
If you are interested in what profitability tracking might look like for your company, contact us for a free consult. We are happy to go over your financials and suggest ideas for growth and improvement.