What was your total revenue in 2007? It's a simple question, but you'd be surprised how different the answers can be. Because this department in the magazine is concerned with measurement against standards, it's important that we're always comparing apples to apples — or at least red apples to green apples instead of some other fruit. That means agreeing on what we mean by terms like “revenue.”
And, by the way, we're talking here about revenue calculations for management purposes, not for tax preparation. There are perfectly legal tactics (and plenty of illegal ones as well) that you can use to manipulate revenue to reduce taxes, but they are counterproductive if they fool you into thinking that your business is healthier than it actually is.
CASH Most small businesses running out of a check-book use a cash system. This doesn't mean that you are literally getting paid in greenbacks; it means that revenue is recognized whenever money is deposited, whether it's cash, check, or money order. Annual revenue is simply the sum of all these deposits from the first to the last day of the fiscal year.
Easy, yes, but it can get sticky if there are other sources of revenue besides remodeling. These should be subtracted from the total to give a true picture of remodeling revenue. So if you rent office space back to your company, take it out of the calculation. Or if you earn extra money in the off-season by plowing snow, that doesn't count, either — at least not for benchmarking (it still counts for taxes).
Also, don't count deposits for work not yet started. And if you complete a job in December but hold the check until January 2, you may be fooling Uncle Sam, but it distorts your annual revenue total and all of the ratios built from it.
ACCRUAL Cash remodelers tend to lose track of accounts payable. They forget that some of the money in their checking account has yet to be paid to vendors.
The accrual method of accounting solves this problem because it recognizes expenses much earlier — for example, materials are expensed when they are ordered, not when the invoice is paid. Revenue is also recognized earlier, at the time it is earned, regardless of when the check is deposited. That means that a down payment for work not yet started is treated just the opposite as in the cash method; it would be counted as revenue the day the contract was signed, even if the check wasn't deposited until a month later.
PERCENT COMPLETE The accrual method is not, however, well-attuned to the way remodeling projects work. A six-month job that starts in the fall spans the end of the calendar year (also the fiscal year for most companies), and wreaks havoc on the system. Percent complete solves the problem by comparing the amount spent to the amount budgeted, thereby determining earned income.
The formula is simple (see example, above) and works best in all cases because calculating actual earned revenue every month allows you to truly understand company profitability. It ensures that you are comparing apples to apples, month to month, and year to year.