[EDITOR’S NOTE: VITAL holds monthly CI Business Mastery Classes where it addresses important CI business topics via a webinar. Each class is supported by an industry brand. VITAL has agreed to share some of the information from these classes with a monthly column of highlights from its most recent webinar. The second CI Business Mastery Class was on Accounting, and it was supported by HTA.]
Last time, we covered how to make an impact by changing your mindset, and this column is the test for that because this month’s topic is probably the least favorite of integrators: accounting.
Honestly, most integrators probably have a successful business and are measuring that in whatever way is important to them. We don’t want to challenge that — your accounting system may not be wrong, but our purpose here is to open you up to the idea that there is a better way that can produce better outcomes. Accounting is crucial because it provides data to make decisions and, more importantly, it gives you feedback on those decisions.
Before we go any further, let’s review some key terminology:
The chart of accounts is a listing of your accounts and balances. This is important for you to make management decisions and also at the end of the year for your CPA to do cash and accrual. This is the choice that you make in your business of how you account for transactions in your company.
Accrual record transactions is when the income is earned or the expense is accrued. Accrual is more accurate and best suited for businesses where income and expenses are not naturally aligned in the same period.
Progress invoicing is a method of recognizing revenue or income. As the project work is completed, products are delivered and labor is executed, and this better aligns revenue with expenses.
A customer deposit is money that you collect from customers in advance of work being completed or items delivered. These are like gift cards and it’s not money that you as a company own until that work is done or progress is completed.
Gross margin is the difference between the revenue collected from your customers and what you paid for equipment parts, labor payroll, and many other things, depending on how your company transacts. Net margin is your bottom line after all your expenses are paid.
A balance sheet is a statement of the assets, liabilities, and equity of a business. This is essentially a snapshot of your value at a specific point in time, profit and loss (P&L), or an income statement that shows a listing of the income and expense transactions for a given period of time with calculations for gross margin, net margin, and a few other things.
Backlog is the amount of unearned revenue on projects when using a progress billing method. This is a key metric that shows you how much revenue or project revenue has been sold or committed, but not yet installed. This is an incredibly good forecast of what months ahead will look like as those projects get completed.
The ideal situation for a chart of accounts is that it should be simple, not confusing, and answer all the questions that we have in the business. We should only be measuring data that we’re actually going to analyze. VITAL has a suggested chart of accounts for the CI industry that we’re happy to share (https://growwithvital.com/coadownload/).
Aligning revenue and costs helps you to know where you stand at all times. Revenue recognition models are key to the alignment of revenue and cost for that project. We know five different revenue recognition models in the custom integration industry:
- Cash received or requested. Some dealers recognize this as a revenue transaction when they ask their customers for money. The limitation here is that we end up recognizing revenue well in advance of any costs. So, if we’re recognizing that customer deposit money as revenue, we end up with these peaks and valleys, and we have to look over a very long time span of a year or more to get an assessment of the financial health of the company.
- Job completion. This one’s very common. The limitation here is that we end up recognizing revenue after the costs are incurred and we again have these peaks and valleys.
- Goods are received. This one’s pretty rare, but we have seen it. This is where an integrator will hold onto a customer deposit as liability, as they should, but as the equipment arrives, they invoice for that equipment like a retailer would. Then they set that equipment aside and invoice labor as some other transaction. This definitely has better alignment, especially on the equipment cost and revenue, but it’s not ideal on the labor side, especially since they’re recognizing labor revenue when the job is done. It is also a lot of work to create all these different invoices, and you are making a really ugly history for your customers.
- Billing on a percentage of completion. This is pretty common for those who understand the construction accounting methodology. Again, we’re holding onto customer money. As milestones are hit, we’re recognizing revenue and invoicing for a percentage of equipment and labor. This is definitely getting much closer to alignment, especially on the labor side, but it can wreak havoc if you’re tracking inventory, because, if you invoice for 50 percent of a television, we can’t have half of a TV in our warehouse. Inventory valuation and tracking becomes incredibly complicated in this scenario.
- Production-based. This is where we’re holding onto the customer deposit and then we recognize revenue as the equipment is delivered to the job and as the laborers perform, which is usually on a weekly or a monthly basis. This better aligns costs with revenue, giving you the most accurate picture of the business, your work in progress, and, more importantly, your backlog and your forecast.
When we embrace solid accounting practices, the benefits far outweigh the work that’s involved, and you will be rewarded with better financial outcomes. A solid scoreboard that helps you drive performance and reward success.
In our next session, we will break down CI profit and show you what’s possible from your company.
Each month, a different CI Business Mastery subject will be addressed. Participants will receive a CI Mastery Business Class Certificate at the end of the 12-month series. Dealers can register for live and recorded sessions at https://growwithvital.com/
Matt Bernath is a CE veteran with more than two decades in retail, wholesale, CI, and business coaching. In 2021, Matt and a group of partners acquired VITAL, and Matt now serves as the company’s president/CEO.