The Disconnect Between Profit and Cash
One of the biggest frustrations I hear from contractors is that the net income they see at the end of the year on their profit and loss statement doesn’t line up with what’s left in their bank account. There’s a disconnect between what they think the P&L is supposed to reflect (what’s in the bank) vs. what it’s meant to capture (your business activity throughout the year).
To me, this question and the frustration it often creates is indicative of a wider misunderstanding of some core principles in construction accounting. Without a solid grasp on how these things work, you’re more likely to misinterpret your financial data, which leads to misinformed decisions. It’s a nasty feedback loop - and one I’ve seen do real harm to businesses.
If your goal is to take full control over your financial position and profitability, you have to understand these basic principles first. It starts with the six “buckets” of construction accounting:
- Income
- Cost of Goods Sold
- Expenses
- Assets
- Liability
- Equity
Let's dive into what should be going into each of those buckets and how this all rolls up to your overall business decisions.
🎥 Check out the full interview with Luke Holcomb.
Key Takeaways
- Profitability and financial position aren’t the same thing. To make the most sound business decisions, you have to consider both. The six “buckets” of accounting will help you do that.
- How you categorize income, expenses, and liability can have a huge impact on what your finances look like, and can overinflate your financial position if done incorrectly.
- Partnering with construction-specific solutions like a CPA, bookkeeper, or accounting software will help you gain clarity and control over your numbers.
Profitability vs. Your Financial Position
Before I jump into the six buckets, I want to make sure we’re all on the same page. I hear a lot of contractors talk about their business’s profitability and financial health as if they’re the same thing when they’re not. Profitability is reflected on your P&L, but it’s not reflective of how much money is in your bank account. This has more to do with the overall financial position of your construction company, and that information lives on your balance sheet.
This is important because you could have a profitable company without having enough money in the bank to fund a job or hire a new employee. You need to understand both to make informed business decisions.
That's where these six accounting buckets come in.
The "6 Buckets" of Construction Accounting
These “buckets” include several things you’re probably used to seeing when you look at your P&L, like:
- Income: Any money you’ve earned (this doesn’t include client deposits!).
- Cost of Goods Sold (COGS): Everything it costs you to perform work (lumber, subcontractors, rental equipment, etc).
- Expenses: All the costs associated with running your business (rent, utilities, etc).
Together, these three buckets on your P&L help you understand your business’s profitability.
The last three buckets are things that live on the balance sheet, where they help paint a picture of your financial position. These are:
- Assets: The money in your bank account, what you’re owed by customers, and other physical assets like company vehicles.
- Liabilities: Anything you owe to other folks (credit card balances, subcontractors, customer deposits, etc).
- Equity: This is the part most people get tripped up on. Equity is anything that, as an owner, you've put into or taken out of the business.
You need all six buckets For example, if you pay yourself by writing a check from your business bank account, it’s not coming out through payroll, it’s coming out through equity. Or, let’s say you pay down the balance of a loan to avoid paying extra interest. In this case, that money left your bank account, but it just pays off the balance of the liability - it doesn’t hit your profit and loss statement. All this to say, if you’re only looking at your P&L to understand your financial position, you’re not going to have all the information you need.
To get the full picture, you have to consider the buckets in both your P&L and balance sheet. This is how you ultimately answer the question, “How much money in the bank is actually mine?”. With the right accounting systems and processes, you can stay on top of these numbers and make sure you’re getting the most accurate view of your business.
Why Categorization Matters
When you’re categorizing all the costs and income for your business, you have to make sure each item goes in the right bucket. For example, I see a lot of contractors handle project deposits incorrectly. They’ll take a 10% deposit (let’s say that’s $100,000 in this instance) and create an invoice for it. At this point, there hasn’t been any work done yet, they’ve just sold the project. What a lot of contractors do though, is take that $100k deposit and treat it like income. Now it’s on the profit and loss statement, even though it’s technically a liability. At any time, the customer could call off the project, and realistically you’d owe at least some of that money back.
Your P&L is also going to show a skewed view of your profitability. Maybe in reality you’ve made $6k this month, but now it looks like $106k. That difference can make a huge impact on what kind of financial decisions you make. In this scenario, if you only look at your P&L, it’s going to look like you’re doing great, even though you didn’t actually earn that $100k. Putting the right numbers in the right buckets ensures you are making decisions your business can actually support.
What Can Happen When The Numbers Aren’t Right
When you understand your holistic financial position and not just your profitability, you’re able to answer small questions like, “Can I buy this piece of equipment?”, along with much bigger questions like, “How much work can I perform this year?”. Having the right numbers in the right places is huge because if you’re planning to take on more work, you’ll need a bigger cash cushion. If you’re operating under the wrong information though, it can create a domino effect that puts everything into jeopardy.
An old friend of mine once brought on a construction coach who advised him to sell as much as possible and get his income number higher. My friend took the advice and ran with it, but as we all know, growing can be expensive. There are learning curves, longer payment terms, and sometimes you have to take out loans to cover project costs - all of which make growing a careful balancing act.
My friend grew his operations but had to take out high-interest loans to support that growth. Even though his P&L was getting bigger, the value of his business was actually going down. By the time he realized that though, it was too late. He tried to shrink his project volume to make sure he was increasing the profitability and value of his company, but he couldn’t bring the business’s “buckets” back into balance. He was left without enough cash to service those loans, and now he’s in the middle of bankruptcy.
I share this real-life story because my friend wasn’t a bad businessman. He wasn’t greedy or rash. He simply made the wrong decisions with the wrong information, and it cost him a business he worked incredibly hard to build.
If I could step into a time machine, here’s what I would have advised him to do instead:
- Focus on growing the value of the business first. Don’t get tied up with the idea of having a higher income number.
- Get a good grip on how much money in the bank is actually yours - and make sure that number goes up every month. This might mean not taking on as much work during certain periods.
- Build good accounting and project management systems now, so that scaling the business down the line becomes easier.
How This Data Impacts Every Financial Decision
Like my friend’s story shows, understanding both your profitability and financial position is absolutely critical to running a sustainable business. You just can’t get the full picture without both. Whether you’re deciding to hire, buy equipment, or bid on jobs, you need this full picture to understand just how much money you’re really working with. If you try to make decisions based on profitability alone, you risk putting yourself in a financial position you can’t recover from.
Where To Go From Here
So where can contractors go from here? If you’re seeking out resources like these, you’re already halfway there. Stay curious about your money and keep learning.
Another practical step you can take is to make sure you’re partnering with people and systems that are dedicated to the construction industry. Construction accounting and project management are so niche, you really need people and software that specialize in them. For some, this means outsourcing your accounting to construction-specific experts. For others, it may mean switching over your accounting system to CrewCost. Either way, this lays the groundwork for you to build a more stable company over time.
Wrapping Up
If you want to ensure every project contributes positively to your bottom line, you have to understand your financial position - and that means knowing how much money in the bank is actually yours. Once you have this down, you’ll never be left wondering where all your profit went.
At TruBalance Accounting, we can help you answer the question, “How much of the money in my bank account is mine?”. Get in touch with us today and gain a new level of control over your financial position.