Typical Accounting Terms and Definitions for Design/Builders and Remodelers
Early in my career as a remodeling business owner I struggled to learn about accounting and understand accounting principles. One big obstacle getting in the way for me was understanding the language of accounting. All too often I didn’t know the definition of terms seminar speakers and my accountant used when explaining things to me. Worse, sometimes I was assuming the wrong definition. What I came to realize was that I needed to learn the terms and the definitions if I really wanted to wrap my head around small business finances.
That learning experience and the difference it made for me sticks with me even today. For example, every time I start working with a new remodeler or design/builder as their business consultant or coach I make it a first priority to be sure my client knows the difference between margin and markup. Many a remodeler has made the mistake of figuring out the margin they need to cover overhead and profit only to assume they can then use that same number as the markup for establishing their project selling prices. When I explain the difference the light bulb goes off; shedding light as to why they are not achieving their required gross profit margin and therefore have no or even negative net profit.
KEY BUSINESS CONCEPTS TO LEARN AND UNDERSTAND
- The total amount of money that can be collected during one business year for work completed by the company should be determined based on past experience and/or the capabilities of the company. (Volume)
- Gathering known business operation expense figures for the anticipated volume of installed sales, you can create an estimate for what it will actually cost you just to be in business even if you don’t produce any work. These are expenses that cannot be assigned to a particular project. (Overhead)
- By being honest with yourself, rewarding yourself for the risk of being in business, and by planning for the future growth of your business, your business can plan for financial compensation. (Profit)
- Overhead and Profit added together make up the total Indirect Costs of the business.
- By knowing your overhead and what you want for planned profit, you can determine how much you need to charge over and above the estimated project cost to be successful. (Mark-up) Markup is determined by dividing the total Indirect Costs by the total Direct Costs.
- Predicting the cost of labor, cost of project related equipment, as well as material and subcontractor costs, you can determine what the production related cost should be to complete the project. (Estimate)
- By increasing the estimated cost with a predetermined mark-up amount you can establish the price your company must charge to successfully complete a project. (Sell Price)
- By keeping track of actual production related expenses (Direct Job Costs), and comparing the expenses against the estimated project cost you can measure the success of your production performance as well as the accuracy of the estimate that was created. (Job Costing)
- Through the use of job costing you will know how much money is left from the sell price after paying all production related expenses. (Gross Profit) This is expressed as the Gross Profit Margin. (GPM) To calculate the Gross Profit Margin, divide the gross profit for a particular project (or time period) by the total sell price of that project (or time period).
- After paying all overhead related expenses, from the gross profit, you can determine how much money is left to compensate the business. (Net Profit)
- It is important to know how much business your company must complete in installed sales before it actually starts making a profit. (Break Even) This is determined by dividing the known total overhead expense by the gross profit margin.
As a suggestion, post this list somewhere near your desk so it’s in view at all times. Next time you’re reading a blog or magazine article that uses one or more of these terms you’ll be able to quickly find or verify their meaning. You’ll be amazed how quickly you can commit this information to memory if you do so.