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Building Profit For Construction
Running a construction business shouldn’t mean working nonstop, chasing cash, or carrying it all on your shoulders. Building Profit is for owners who are ready to think bigger — and start making smarter moves with their numbers, strategy, and team.
Hosted by Steve Coughran of Coltivar, this show delivers straight talk on the stuff that actually drives profit: pricing right, controlling costs, forecasting with confidence, and building a business that doesn’t depend on you for everything. No fluff. No filler. Just real strategies to help you earn more and lead better.
Building Profit: Strategies for Contractors Who Want to Think Bigger and Earn More
Building Profit For Construction
116: When Do You Actually Earn Revenue? (The 5 Rules You Must Know)
In this episode of Building Profit, Steve dives into one of the most misunderstood topics in construction finance: revenue recognition. Just because the money hits your bank account doesn’t mean you’ve earned it, and messing this up could lead to chaotic books, cash flow surprises, and even bankruptcy-level mistakes.
Steve breaks down the five key rules every contractor must follow when it comes to recognizing revenue, even if you’re not a “numbers person.” From deposits to change orders to percentage-of-completion billing, he walks you through what matters, why it matters, and how to fix your process before it bites you later.
If your income statement swings like a rollercoaster—or you’ve ever looked at your profit one month and thought, “That can’t be right”—this episode is for you.
Disclaimer:
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When you collect a deposit from a customer, that's a liability because you haven't earned the money. But when you account for the liability that you're accumulating by taking on deposits and collecting money up front, it changes the game. If you're running a construction company, how you recognize revenue will make all the difference in the world when it comes to having financials that are useful and financials that are complete garbage.
So in this episode, I'm going to explain to you the five things you must know about revenue recognition, even if you're a non-financial person. Because if you don't, your financial statements are going to be complete rubbish. You're going to be guessing and you can potentially bankrupt your business.
I don't want this to happen to you. Not too long ago, I was working with a contractor and he's like, Steve, why does this matter? We have cash in the bank. If our revenue is off, we have plenty of cash to survive.
I'm not sure why this is so important. And I'm like, yeah, because you're using your customer's cash. And that's really a liability because it's a deposit on work that you haven't actually put in place.
It's money you haven't earned in other words. So that's what we're going to get into today. Let's start with revenue.
Let's take a step back. If you go to your income statement, also known as your profit and loss statement, this is where you see revenue expenses and profit. The very top line on this financial statement is revenue.
This represents all the income that's generated from selling your products and services to your customers. The reason why it's so important to recognize your revenue in the correct period when it's earned is because if you don't do this correctly, your profit is going to tell you one story that is totally disconnected from reality. Let me give you an example.
You're a contractor, right? You get a signed contract from your customer and you say to them, look, I need some money upfront. If you want to be put on the schedule, I got to cover mobilization and some initial material purchases. So they cut you a check for a hundred grand.
Great. All right. Now with most accounting software out there, when you create an invoice to give to a customer in this example, a hundred grand deposit, it records it immediately as revenue.
Well, guess what? You're not doing the work in this current month. You're going to do it next month. So in the current month, it shows revenue, a hundred thousand expenses, zero because you haven't started the work and profit a hundred grand.
That's great, right? Oh no, that's not great. It skews reality because then in the next month work actually begins. You go and buy materials, you mobilize, you start paying payroll for your field labor to put the work in place.
And guess what? You have zero revenue because you don't invoice the customer because you're burning through that deposit that they already gave you. In other words, you're not invoicing them for new work. So you have zero revenue.
You have, let's say $60,000 in expenses, and you show a $60,000 loss. This is called schizophrenia. I see this all the time.
I was just talking to another contractor not too long ago when I was looking at their financials. It's like one month, they had a lot of profit. Next month they're in the hole.
Then they add profit. Then they're in the hole. Then they add profit, et cetera, et cetera.
It's schizophrenia because the owner's like, we're doing great. And then it's like, oh, we're losing a ton of money. We might be going bankrupt.
And it's like, oh, we're making more money and we're going bankrupt. This is no way to run a business. This is why revenue recognition is so critical.
So I'm going to get into the five things that have to be true in order to recognize revenue. Okay. Number one, you have to have a contract in place, a signed contract.
Now in some States, there are rules when it comes to contracts. And sometimes you could get away with not having a written contract, but I would say for best practices, have a signed contract. When I was younger and I was running my landscape business, I remember doing this job.
It's like a $20,000 job and it's for a GC. And I got done installing this irrigation system and he didn't pay me. And I was out of pocket all this money because I didn't collect a deposit.
I had to take him to court. Eventually I won. Right.
But it cost me a lot of money in the process. After that, I'm like, I'm always going to have a signed contract. This is especially true when it comes to change orders.
And look, I know how things happen out there in the field. You're doing work. The customer's like, Hey, can you add some boulders over here? Can you run this wire over here? Can you do this additional work over there? Whatever it is.
And they're like, I got to go just do the work and I'll pay you. You do the work. And then guess what? When it's time to collect the money later on down the road, they're like, Oh, I thought that was included.
I didn't know it was going to be that much, whatever it is. That's why change orders are so critical. I was just talking to a plumbing company the other day, and they're out there doing TNM work.
And then sometimes they'll do light renovation when it comes to TNM work, time and material work. That's fine, right? You give a customer quote over the phone or over email, whatever it is. You say, yep, it's X dollars an hour to show up plus a trip charge.
Then we charge for materials and then you do the work and then they pay you. That's time and material. That's one thing.
But when you're doing fixed bids, like this plumbing company is doing for light renovation work, if you're doing that work and you're not getting a signed contract, you're putting yourself at extreme risk because in order for revenue to be recognized, part of having a signed contract is assuring collectability. Meaning you have to prove that you could get paid on this work and having a contract in place will help to increase your chances of this. So that's number one.
You have to have a valid contract. Number two, you have to describe the performance obligations. Say what? I'm just talking about scope here.
So in your contract, you have to describe your scope. All right. So you have to list out what are you going to do and you have to agree with the other party, what you're actually going to perform and what they're paying for.
So that's number two, outline your performance obligations. All right. Number three, you have to have a transaction price.
So you can't just have a contract and say, we're going to do this and this and that and not list a price. So you have to provide a price. And then this will help you once again, assure collectability, which is a big component of revenue recognition.
All right. So that's number three. Number four is a little bit more nuanced, but you have to assign a value to each part of your scope.
So that's part of revenue recognition. If you are doing demolition, then you're pouring a new slab, you're running wire or piping, whatever it is with your scope. You have to assign different values from a high level.
You have to break every single task down or every single unit item down, unless it's required with your bid submittal, but you have to have some type of assignment or allocation of the entire contract to your different scopes. Okay. So that's number four.
And then number five, I'm going to explain, and then I'm going to tell you the number one mistake that contractors make. And I'm going to give you a real world example. So you could avoid this.
Number five is you have to perform the actual work. This is all part of gap, generally accepted accounting principles. And these are the standards that accountants use in order to organize your books in a way that are readable that match economic reality, right? That meet compliance requirements.
That's gap. And there's a code. If you're a nerd like me, it's called ASC 606.
So you could look this up and these are the elements of revenue recognition. Okay. So I'm not just making this up.
This is how it works in construction. Most contractors, the sophisticated ones, they use a percentage complete method to do their billings and to recognize the revenue. In other words, at the end of the month, they'll look at their scopes.
They'll go down the line with their PMs or CMs and say, okay, where are we at with percentage complete on each of these? They'll do the math on the percentage completes. And then they'll translate that into an invoice based on work. That's actually been performed.
When I was a CFO of a mechanical contractor, we were out there putting the piles in the ground and building the racking for a solar farms. And so we would have our CMs at the end of the period, count the number of rows that were completed based on the total number of rows in the contract. And that's how we determined our percentage complete.
So however you do it in your business, you have to calculate what percentage of each scope is completed. And remember, you're assigning a certain dollar amount to each of those scopes and then do the math. And then you'll know exactly how much has been earned, earned.
Okay. So remember that example with a hundred thousand dollars up front, when you collect a deposit from a customer, that's a liability because you haven't earned the money, right? You have invoiced for the money and sure it may show up as revenue on your financials, but you haven't earned it. So it's not really revenue.
It needs to be reclassified as a liability. And this is where over and under billings come into play with your whip schedule, your work in progress schedule. So all of these components are super critical in that big mistake that contractors make is that they don't do revenue recognition correctly.
They just do invoicing. Like I'm talking about, they look at financials and they trick themselves into believing that they're doing better off than they actually are. But when you account for the liability that you're accumulating by taking on deposits and collecting money up front, it changes the game.
When as a CFO of an EPC, a large engineering procurement and construction company in the solar space, we're sitting on $90 million of cash on these big solar development projects. Cause we collected so much money up front. That wasn't our money.
We didn't earn it. And at any point, the developer could say, Hey, we're putting the project on hold. Give us our deposit back.
That's why it's a liability. So if you're running your business and you are not doing revenue recognition correctly, it can bite you in the butt. And I don't want this to happen to you.
So it's important to have a whip schedule to do percentage of completion, billings, and ensure you're following those five principles that I just walked you through. All right. If you need help with any of this, if you're thinking, Steve, I'm not a financial person, and maybe you have an accounting team, maybe you have a CPA, maybe you have a CFO, but you're not doing this.
It's a little bit more complicated, but when you set it up and when you create the system, then from there, you could have books that match the economic reality of your business. And that will actually help you to make better decisions for your company. So if you need help with any of this, you can always connect with us at Coltivar.com. We offer a 20 minute free strategy call, and we can walk you through what this may look like for your business.
All right. And that's all I have for you. And until the next episode, take care of yourself.
Cheers.