United States
Hong KongReading a financial statement
The balance sheet shows position at a point in time, the income statement shows performance over a period, and the cash flow statement shows money moving. Profit and cash are different, and the difference kills contractors.
Three statements answering three different questions. Contractors who read only one usually read the wrong one.
The three
| Statement | Shows | Covers |
|---|---|---|
| Balance sheet | Assets, liabilities and equity | A point in time |
| Income statement | Revenue, cost and profit | A period |
| Cash flow statement | Money in and out | A period |
Why profit is not cash
You can complete work, invoice it, record the profit, and have no money in the bank because nobody has paid you yet.
Add retainage held back and a payment cycle measured in months, and a growing contractor can be profitable and insolvent at the same time. They are different things.
Every new job requires materials and payroll before any payment arrives. A contractor doubling their volume needs roughly double the working capital, and that is where fast-growing firms fail. The exam expects you to know this.
What a surety reads
Working capital, net worth, the current ratio, and whether the balance sheet supports the size of job you want bonded.
A state licensing board may look at the same figures, and some set minimum net worth requirements as a condition of licensure.
Percentage of completion
The usual method of recognizing revenue on long contracts: a share of the contract value proportional to the work completed.
It matches revenue to effort rather than to payment, which is why the income statement and the bank balance disagree.
Under and over billing
Billing ahead of work completed improves cash and creates a liability. Billing behind ties up cash you have already spent.
Both appear on a contractor's balance sheet and both are examined as concepts.
Common questions
What do the three financial statements show?
The balance sheet shows position at a point in time, the income statement performance over a period, and the cash flow statement money moving.
Why can a profitable contractor run out of cash?
Because work is completed and invoiced before payment arrives, and retainage holds back part of it.
Why does growth consume cash?
Each new job needs materials and payroll before any payment arrives, so doubling volume needs roughly double the working capital.
What does a surety look at?
Working capital, net worth, the current ratio, and whether the balance sheet supports the job size.
What is percentage of completion?
Recognizing revenue in proportion to work completed rather than to payments received.