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In Defense of Accounting

Getting your books in check does more than please the tax man — it gives you a clear look into the health of your business.

[EDITOR’S NOTE: VITAL is in its second year of monthly CI Business Mastery Classes where it addresses important CI business topics via webinars. Each class is supported by an industry brand. VITAL has agreed to share some of the information from these classes in a monthly column of highlights from its most recent webinar. The topics are the same as the previous year’s classes, but the content is refreshed. This CI Business Mastery Class was on accounting, and it was supported by the Home Technology Association (HTA).]

Too many integrators in our world run their businesses off the balance in their bank accounts, which is wildly inaccurate and, frankly, pretty dangerous. You have no idea how much of that cash is yours and where that cash needs to be spent in your business to produce the biggest return on investment.

Business Accounting
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Ninety-seven percent of CI companies are using the same accounting software — QuickBooks. Yet, even with the same software across the country, we find that nearly every integrator has a different method of accounting, which is fine if you don’t mind being a data point of one and figuring out things along the way. But how much wasted effort do you have in that process? Plus, you lose the ability to compare yourself against the best in the business.

Talking the Talk

Let’s review some key accounting terminology. The “chart of accounts” is a listing of all your accounts and balances in QuickBooks or whatever financial system you use. These accounts are like buckets for all the financial transactions to be categorized in your business.

“Cash and accrual” is how you account for transactions in your company. A purely service-based business works well on cash — you’re regularly paying payroll, and then, of course, you invoice daily or potentially weekly for the work you completed. Accrual, on the other hand, records transactions when the income is earned or the expense is accrued. Accrual is more accurate and is best suited for businesses where your income and expenses are not naturally aligned in the same period.

“Progress invoicing” is a method of recognizing revenue or income as those goods and services are delivered to your projects. This helps to better align your revenue with your expenses in your company.

“Customer deposits,” or money you collect from customers in advance of work being completed, are actually gift cards, not revenue. This is liability in your company that you owe your customer. When you buy a Starbucks card for $25, Starbucks puts that on their account as a liability — that’s money they owe you. When you use that card to get coffee, the coffee becomes the revenue item.

“Gross margin” is the difference of revenue collected from your customers minus what you paid for the equipment, parts, and sometimes labor payroll, but before any business expenses are paid. “Net margin” is after everything is paid — revenue, costs, and expenses.

A “balance sheet” is a statement of the assets, liabilities, and equity of a business. Assets are what you own as a company, liabilities are what you owe, and the equity is the difference between the two. The “P&L” or “profit and loss” or “income statement” shows a listing of all the income and expense transactions for a given period of time with those calculations for gross margin and net margin.

Lastly, our “business forecast backlog” is the amount of unearned revenue on projects when you’re using a progress billing method. It shows you exactly how much revenue has been sold, but not yet installed. This is an incredibly good forecast of what the future months in your business will look like.

Revenue Recognition Models

Aligning your revenue and costs helps you to know where you stand at all times. Revenue recognition models are key to the alignment of revenue and costs in your organization. We know of five common revenue recognition models in the custom integration industry.

First, is cash received or requested. Some dealers recognize this as a revenue transaction — I’ve asked for money, they’ve given me money, and that’s revenue. The limitation here is that there is zero alignment between revenue and costs.

The next revenue recognition model is job completion. These integrators focus on billing out the project when it’s done. The limitation here is that we can end up recognizing revenue well after the costs are incurred. Again, we end up with these peaks and valleys, and we have to look over this really long time span to get the health of the company. There really is no alignment between the costs and the revenue.

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The next one is when a dealer recognizes revenue when goods are received, so, they’ll hold onto the customer deposit money as the equipment arrives, invoice for that equipment, and then they set it aside. This is getting closer to alignment because if you buy and recognize revenue in the same month, you’re getting a little closer. It’s still not ideal, especially on the labor side, because if we’re incurring payroll costs over a number of months and then we get this one big labor revenue, it’s not ideal.

The fourth model is billing or recognizing revenue as a percentage of completion. Again, they’re holding onto customer deposit money and, as work is completed, they bill out a percentage of equipment and labor. This is getting much closer to aligning the revenue and the costs, but it can wreak havoc on your inventory valuation because we can’t have 50 percent of a television in stock. We have seen this done very well, and it’s getting much closer to our recommendation, but there’s a better way.

Production-based revenue is the ideal situation in a revenue-recognition environment for your company. This is where we hold on to customer deposit money and recognize revenue as that equipment is delivered and as the labor is performed, usually on a weekly or monthly basis. This better aligns your costs with revenue, giving you an accurate monthly picture of your business, including gross margin, work in progress, and a very clear backlog forecast, so you can plan your staffing needs and your projects into the future.

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