Guest Article for Zweig Newsletter Just Published!
To view the complete issue click here.
What engineers need to know (but often don’t) about this critical financial tool and how it can help a firm succeed.
By John McCardell
At JBCI, one of our guiding principles is transparency. We embrace sharing relevant financial information through condensed income statements during management team meetings. These statements include key performance indicators that provide a snapshot of the short- and long-term health of the firm.
The income statement – AKA profit and loss or P&L – is one of these useful tools. A better understanding of the income statement is critical when analyzing KPIs because many of them are derived from the information contained within the income statement.
So what does the income statement include? It is simple and made up of three sections:
ONE: Revenue A firm’s revenue is a measure of how much raw income a company is generating from services rendered. In essence, this is the fee that is generated from the skilled and technical work that is produced. As an example, a firm receives a fixed fee contract of $100,000 in January. According to the percentage of completion method, the firm will recognize revenue on the income statement of 30 percent, or $30,000, in January, 50 percent, or $50,000, in February, and the final 20 percent, or $20,000, in March. For the first quarter of the year the revenue will be $100,000. The objective is to match the revenue that was generated to the expense that was incurred to earn that revenue (labor and materials, or direct expense).
Expenses. These are the inputs that are required to generate the revenue. These inputs come in many forms such as labor, insurance, communications, business development, employee benefits, and the list continues. All expenses fall into two categories:
Direct expenses. These are intuitive and tied directly to a project or a cost incurred to generate the revenue of a specified project. An example of a direct expense is direct salaries (billable hours assigned to a project through the timesheet process). Direct expenses can also come in many forms such as mileage reimbursement, printing expenses related to drawings, outsourced skilled services, delivery/courier services, and many others. These types of costs are assigned directly to a specific project number.
TWO: Indirect Expenses Also referred to as overhead, these are the inputs required for the business to operate as a whole but cannot be traced directly to a specified project. Some typical indirect expenses are: insurance, rent/lease, business development, marketing, your favorite financial manager, and various indirect time for business/professional development, sales/proposal preparation, paid time off/holiday, and administrative responsibilities.
THREE: Net income The result of the fiscal period being reviewed is commonly known as “the bottom line.” This is a direct result of the revenues recognized, or fees generated, minus the expenses incurred to generate that fee.
During our management meeting, the team reviews the income statement and begins questioning different items. Being analytically inclined, they crave more information and explanation. Engineers did not become engineers for the joy of reviewing financial statements; however, they do realize it is necessary to understand in order to manage and operate a successful AEC firm. This is where the controller or CFO can help.
As controller at JBCI, my responsibilities include managing and analyzing the income statement along with the many KPIs to get a pulse of the company. Essentially, all activity that occurs on a daily basis can be seen on the income statement, since the income statement is the revenue and expenses during the period the financial transactions occurred. The financial data, along with current market assumptions, is used to create financial projections well into the future and enable the firm to establish goals such as new markets, new office locations, promoting key members, as well as onboarding additional resources.
Having a solid understanding of financial statements, particularly the income statement, will enable you to make decisions in the present that set the firm up for growth in the future. The income statement is a direct result of the efforts of the highly skilled work which your firm delivers on a regular basis. Having this understanding can increase company profits, enabling your firm to take on new initiatives and invest in skills development or cutting edge technology. Next time you are presented with an income statement, I hope you feel more equipped with a better understanding of the information.
John McCardell is the controller at Joseph B. Callaghan, Inc. He can be reached at firstname.lastname@example.org.
The Zweig Letter is a truly unique management newsletter for the engineering industry. Each week, The Zweig Letter keeps A/E and environmental services firm leaders informed, inspired, entertained, and challenged. Learn more about Zweig here.