Construction Income Statements: Understanding Financial Performance

In the construction industry, an income statement offers a snapshot of financial performance over a specific period of time. By analyzing income statements — along with other accounting documents such as the balance sheet and cash flow statement — stakeholders can evaluate a contracting firm's financial stability and operational health.

This article will delve into the composition of income statements, how they're assembled and their importance to project managers and lenders.

Key Components of a Construction Income Statement

Construction income statements, while varying in granularity, typically include:

• Revenue: All invoiced goods and services over the given time frame
• Cost of Goods Sold (COGS): Direct operational costs such as materials, labor, and equipment
• Gross profit: Revenue minus COGS
• Selling expenses: Costs associated with marketing and promotions
• General and Administrative Expenses (G&A): Overhead costs, including office expenses and executive salaries
• EBITDA: Gross profit minus G&A and selling costs
• Depreciation and amortization: The allocation of large asset expenses over multiple periods
• Operating income: Also known as Earnings Before Interest and Taxes (EBIT) — income from business operations before interest and taxes
• Interest and other expenses: Costs such as interest on loans impacting profitability
• Earnings before tax (EBT): Operating income minus interest and other expenses
• Income taxes: Taxes owed for the period based on EBT.
• Net income or loss: The company's final profit or loss after taxes

The Difference Between Income and Profit & Loss Statements

While "income statement" and "profit and loss statement" (P&L) are terms used interchangeably within the industry, they serve related yet distinct purposes. 

A P&L is an operational tool that displays the company's billed amounts versus its costs, ultimately detailing the net income generated.

Conversely, an income statement offers a broader insight, including aspects like earnings before interest, taxes, depreciation and amortization (EBITDA). EBITDA is particularly useful for financial analysis as it focuses on the company's profitability before considering the impact of non-operational financial factors.

Income statements apply to both the entire company and individual projects, where they take the form of a job cost summary or project P&L.

Income Statement vs. Cash Flow Statement

Though closely related, income and cash flow statements serve distinct purposes. The income statement measures profitability irrespective of the company's immediate cash position. In contrast, the cash flow statement tracks the actual inflows and outflows of cash, providing a real-time picture of financial liquidity.

Preparing an Income Statement

Preparing an income statement is a multi-step process that includes compiling information from a given time period, then reviewing the information to ensure all the necessary pieces are present and assigned to the correct time period.

Since months are not standard length or end on standard days, a company will name a date, like the last Saturday of the month, to use as the end of the accounting period. All invoices dated that day or before will be included in that period's income statement, while any entries after that date will be included in the income statement for the next period.

Once accountants are confident the information is complete (usually by performing reconciliations), they can check for deviations from prior-period income statements. Comparing other periods helps identify whether any missing elements should be included in the document. 

With a clear communication process and document sharing, checking and closing an income statement may only take a couple of days after the period has ended.

Utilizing Income Statements in Construction

Companies often produce income statements each month, but they may also combine statements to determine financial health over a longer period of time — such as quarterly or annually.

Contractors

A contractor will use an income statement to determine actual performance compared with estimates. For example, if the contractor is expected to earn a 10 percent profit on all projects, the income statement should reflect a 10 percent profit after all the checks come in and the bills are paid.

Project Managers

A project manager may not realize it, but their budget is essentially the "EBITDA" portion of the income statement. By managing this cost estimate against their prime contract amount (or Revenue) they are actually managing an operating income statement specific to their project.

Lenders

Lenders and bond agents will use an income statement to determine a contractor's profitability. For instance, a lender will check to see whether the contractor has the cash flow from projects to cover obligations without going into debt and whether that profitability number is trending up or down over time. Lack of profitability may mean a contractor represents a risk to lenders.

Contractors may include footnotes in financial statements to provide context to particular financial events. These annotations can clarify one-off changes that don't represent a pattern, assisting stakeholders in making informed assessments.

The Nuance of Creative Accounting

Occasionally, contractors may want to change the financial narrative their income statement is telling. In some cases, a construction business may want to show more revenue at the end of the year to hit a specific goal, or maybe push some revenue off until the next tax cycle to avoid paying taxes on it until the following year.

The generally accepted accounting principles (GAAP) outline when a business should recognize risks and opportunities in financial statements, and deviating from those principles can be risky. For instance, a contractor may artificially boost revenue in December to reach earnings goals. When January's actual costs hit the books, they may turn out to be considerably higher or lower than expected. Tinkering with those numbers could result in a loss on financial statements in a subsequent month because of overestimated profitability.

When outside stakeholders look at financial documents, they may recognize that big swings on estimated profits mean there have been some changes to the WIP profit margin estimates, and may ask for an explanation before drawing conclusions based on the documents.

Accounting Expectations and Categorizing Expenses

Project managers may estimate costs conservatively to avoid tough conversations about unexpected losses. Accurate, conservative forecasting helps manage expectations and avoids amended returns from premature revenue recognition.

Accountants often leave notes underneath risky entries to explain the calculations that lead to the numbers, and who signed off on those decisions. Thorough record-keeping and notes can go a long way to avoid confusion and misunderstanding when producing an income statement.

Many companies have internal controls to check and recheck the allocation of large expenses. They may dictate that any expenses over a specific threshold, say, $50,000, will go to the AP clerk, the project manager, and finally to the executive before anybody pays the bill. Internal controls can ensure everything gets coded to the correct account for the correct amount as agreed upon in the contract terms.

How Income Statements Have Changed with Technology

Standard income statements have not changed much with the advent of technology — in the days of paper and pen (or dot-matrix printers), income statements tallied a company's revenue and its expenses to spit out a profit margin.

However, software systems have greatly expanded the uses for all that job data. It all comes down to what information the project team is putting in and how the software can parse it out. For instance, with the correct inputs and cost codes, accounting software can drill down to show how much of a project's labor cost was represented by union versus non-union labor, which could inform future cost predictions when bidding in a union or a non-union locale.

Income Statements Get Better with Time

Consider a contractor who finds the income statement reveals there was not as much income in the current period as in the past two periods. That contractor will find more answers in the financial documents if the team has been putting in detailed information for a number of accounting periods, by noticing which particular lines are different to start generating questions on what's driving the change.

One way of comparing income statements is to add another column to the side to compare line by line the percent change from one period to the next to identify the big swings. Often, the reasons for the change are identifiable and reasonable. For instance, A contractor might realize that their revenue is much lower in Q1 of 2024 than in the first quarter of 2023. A look at the weather app will support the explanation that winter storms and rain have kept them from mobilizing and working as efficiently as the mild and sunny first quarter of last year.

Contractors use income statements as a tool to judge the profitability of their businesses. The more detailed and consistent those inputs are, the more answers they will provide.

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