From Chaos to Clarity: Mastering Your Chart of Accounts Like a Pro

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ℹ ABOUT THIS EPISODE

Your chart of accounts is the foundation of your financial success - if it's wrong, you're lost and broke. Join us as we break down how to build a bookkeeping system that actually tells you where your business stands. 

Learn the difference between chart of accounts and cost codes, how to avoid analysis paralysis, and why you can't just copy-paste someone else's system. 

Whether you're running service calls or multi-million dollar projects, this episode gives you the framework to build books that work for YOUR business.

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⌚️ Key moments in this episode:

• 00:09 The Importance of Proper Financial Structure
• 00:27 Building a Great Set of Books for Contractors
• 01:06 Understanding Cost Coding Systems
• 02:01 Framework for Effective Financial Management
• 04:05 Challenges in Job Costing
• 05:13 Tailoring Financial Systems to Contractor Needs
• 07:11 Reporting Requirements and Compliance
• 10:51 Practical Tips for Financial Management
• 19:09 DIY Financial Management Kit

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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com

Transcript

Wade Carpenter: [00:00:00] Your chart of accounts is a map. If it's wrong, you're lost and broke. You think you're making money, but the numbers say otherwise. Or worse, they say nothing at all. Today we're gonna talk about the structure underneath your financials and how to build it so it actually tells the truth. Welcome to the Contractor Success Forum. I'm Wade Carpenter with Carpenter Company CPAs, alongside Stephen Brown, with McDaniel Whitley Bonding and Insurance.

Today we're diving back into a question I get all the time. How do I build a great set of books for a contractor? And before I start preaching, Stephen, am I crazy or does this hit home?

Stephen Brown: No, it absolutely hits home, Wade. First of all, listeners, this is not a warning that accounting jargon and geeky business modeling is coming. This is top secret stuff here, tha t's not so top secret.

Here's the most fascinating thing about this whole topic, Wade, is it really does set everything in place for going forward. And just like [00:01:00] building a foundation properly to start a building, everything has to be perfect. But Wade, how do you do it? Explain a little bit more about how the coding works for those of us that aren't accountants.

Wade Carpenter: We did a episode more than a year ago on Chart of Accounts and Cost Coding systems. I think I gave a lot of good information in that. I get calls all the time about this. And this is something that I think a lot of people don't know how to really approach it.

I think when we originally did that episode, I gave the analogy of you got a thousand piece puzzle that's turned upside down. All the puzzle pieces are laying flat, all you see is the gray cardboard. You have no picture on the box and you don't know what it's supposed to look like.

A lot of people also, it's like, okay, gimme a chart of accounts that I can use, that I can copy and paste. Part of what we're wanting to talk about today is you can't really copy and paste. I mean, you can, but you if you're really trying to get something out of there, then, it's better to build it from the beginning [00:02:00] so that you can get there.

I'm trying to give some kind of framework for people today. Because there's a over complication that this analysis paralysis, we've got 600 cost codes and we never know which one to use. Or we bidded it using this cost code. But the guy in the field chose the project manager put it on this cost code. And it sounds similar but they never line up. Those kind of things.

Stephen Brown: Yes.

Wade Carpenter: You know exactly what I'm talking about there. So it's like a question of overcomplicating versus oversimplification. I caution when I say that, because I'd rather have contractor that has some level of viewing how they're doing versus no level.

The other part is they mix the direct costs of sales with the overhead. And so you may bid it at 30%, but it shows 30% up in the cost of sales, because that's what you put in there. But the true cost of your business, the job is not really reflected and you can't see that from a 30,000 foot view.

I said I wasn't gonna preach here, but, [00:03:00] just like building that puzzle, most people are gonna start with all the edge pieces and start building from there. Because you can find the edge and then you got some kind of parameter, right? Where I see it, contractors will start off, sometimes they have no books, they have nothing.

At least getting some kind of parameter around what's going on. Maybe the first few years you got a bunch of receipts, took it to your CPA or maybe tried to do things on your spreadsheet. After a while you finally realize that hey, you're not gonna really make it and really know where you're going without something, so you go buy something like QuickBooks online and then maybe you start putting some of these edge pieces around there.

Everybody always wants more information. This is high level right now. But everybody wants all this detail. And part of it is a question of do we have the structure, first of all to set it up? But then having the systems to actually implement that.

I would rather have some kind of system where we are just getting the top level, like labor [00:04:00] materials, subs, equipment, other, those kind of buckets, rather than a contractor that has no clue at all. So that's one level of job costing.

Getting into the detail phase code, cost code type structure, where we can actually look at estimate versus actual, that is where a lot of people love to be, but they don't realize either how to build it or if they have the systems or can put the systems in place because they don't have the back office to do it or the people to do it that are trained properly.

Let me stop there. Does this make any sense?

Stephen Brown: It does, I'm grasping the concept of it, Wade. The practicality of it is such a good analogy. You've got a lot of moving pieces that you have to account for. You account for them by giving those moving pieces a code. You have to train it to go where it's supposed to go.

I think of money itself as not being trained in any way, shape, or form. You have to manage it. You have to manage every bit of it.

As I think about the puzzle analogy you were talking about [00:05:00] where all the pieces are flipped upside down and you don't have a picture of what it looks like, but you're trying to put it together, you got to start somewhere. I would imagine this is different for every type of trade of contractor too.

Wade Carpenter: That's part of what I wanna talk about today is, how do you start building that structure? And just like getting those edge pieces. Maybe you got QuickBooks online, you do your bank feed accounting but you really have no idea where you are versus you finally start getting it in the chart of accounts level. Maybe that's the couple of levels from that edge pieces on the puzzle. But to really get a clear picture of where you are, are you trying to get to that detail?

When I talk to somebody about doing this, I ask 'em a whole bunch of questions. And what you brought up, first of all, is what industry are you in?

But it's not just the industry. It's okay, you could have a plumbing contractor that does commercial work and big, large projects, sometimes multi-year projects, versus a service type plumbing company. That's [00:06:00] part of the idea is you can't just copy and paste one. You really have to look at what does this contractor do and how should we structure it?

Stephen Brown: That makes sense. After you talk to someone and you're advising them on how to set this up and you understand what they do, what's the next step?

Wade Carpenter: A lot of times I'll spend an hour talking through some of these things: you know, are you bonded, where you have to do WIP schedules? Do you have construction in progress? What type of business would you have construction progress? Or is it just more service work and you're in and out and you're done?

There's some quirks to construction, obviously. You have these draw schedules and do you have retainage receivable or retainage payable if you're a general contractor? You have all these things like, if you're a developer, are you capitalizing some of the expenses or a home builder that's doing custom homes, you basically are not recognizing any profit or expenses until you go and sell that home. So all that money you put in there, that's a completely different spin on what most people do is put everything on the P&L. 

So again, [00:07:00] there's a lot going into this, and I'm not trying to make everybody crazy. I wanna try to bring some order to this. So before you get overwhelmed, just hang with us for a little bit, if that's okay.

Stephen Brown: Okay.

Wade Carpenter: We talk about it. What is your industry? Do we have a General Contractor that self performs maybe a drywall part of the work or something like that. Electrical, we've had some general contractors that do that. How are we gonna set this up and what does it look like to be able to support that industry? If you're a general contractor, you've got all your general requirements and demo, electrical framing, whatever it is.

Again, going back to the industry and all that, sometimes you have some things like defense contracts. DCAA has a very specific chart of accounts that you have to report with them. Some of the federal stuff, they have a very different way of looking at it versus, US Generally Accepted Accounting Principles and there's not always one right answer.

Stephen Brown: Your system, it's based on needs. The needs for the [00:08:00] bonding company like a WIP. The needs for a job that's requiring certified payroll reporting, because there's fringes involved, or it's an owner controlled insurance program. That's another need. You're talking about the different trades and how specifically you set up their chart of accounts and code things properly so it flows to give you the information you wanna get out of your system.

Wade Carpenter: Yeah, you led straight into where I was going with this. If you haven't certified payrolls, or you got fringes you gotta track. If you got a union shop versus a non-union shop. If you're trying to satisfy the bonding and lenders and those kind of things, having a true Work In Progress and being able to have that structure where we can actually pull a WIP schedule and it doesn't take three or five months to pull that WIP schedule when you need a bond tomorrow.

Stephen Brown: Yeah. What a dream. Yeah, that's a dream for a bond agent.

Wade Carpenter: I also think about who are you reporting to? Whether it's just compliance or say a developer, a home [00:09:00] builder, or even some custom homes. Sometimes you have to turn in your draw request in a specific format.

It could be just like those basically phase code type things. Electrical, plumbing, HVAC, whatever those systems are. Sometimes the banks or the lenders have specific requirements for that. I don't think you can always make everybody happy, but you have to be able to get the information you need from the structure.

Also, if you're doing Generally Accepted Accounting Principles, as long as you got the structure, ideally you have it perfectly aligned where you've got your labor burden and equipment burden, those kind of things allocated to your job cost. As long as you're tracking it properly and the accountant can convert it, you may not need all that.

I always recommend you get more detail. But what is practical? It all sort of goes back to, is the bookkeeper trained to be able to put this together? Is the structure there to be able to get it in the right place?

Stephen Brown: I think about the role as you say this, the role of a [00:10:00] Chief Financial Officer of a large construction company. Their role is constantly to pull out this data and provide it where it's needed, from management, to banks, to bonding companies. Their ability to do that is only as good as the systems you have put in place to give you that information.

Wade Carpenter: Yeah. And whether it's external pieces there are definitely some challenges to cash flow. That's what my book is all about, you know, cash flow for contractors. And the reality is there's a lot of things, like we already said, retainage, accounts receivable or payable.

You've got sometimes job deposits or things like that that you've gotta track. Those kind of things where you got draw requests and maybe you have to keep up with a construction loan type thing. It all goes back to, do we need more of an item code, a cost code structure, a phase code cost code structure, or can we get by with just the chart of accounts?

Stephen Brown: Would you explain to me again the difference between those two, the chart of accounts and the cost code?

Wade Carpenter: That's a good question. Thank you for asking that. [00:11:00] From a QuickBooks online standpoint, essentially all you're going to get is a chart of accounts level. That would be more like, okay, labor, materials, subs, equipment, other.

The cost codes are a different level. Most of the contractors are living over here. You gotta have the chart of accounts level. That's the first part of it. But the second part, if you ever want to get the detail of, this is my line item on my budget and this is my actual cost, you can actually pull a report up and see where you are at any given point instead of having to pull out a piece of paper or Excel spreadsheet or all those things that take so much time to really figure out where you are, that you're never really on top of it.

By the time you get the accounting done and all this stuff, if the contractor needs that, we want to be able to give them as close to real time books as we can where they can actually look at, this is what the budget said, and we are actually going over on this particular line item. So what can we do to get that back on track [00:12:00] before things completely go south?

Stephen Brown: No, you literally hit the nail on the head. Your information should be able to tell you that. What can we do about this, what we're seeing here? How can we dig deeper into it, and how can we know how this is really gonna affect the job, or this particular project? 

Wade Carpenter: Well, we preach that all the time. Practically speaking, I'd love to say, everybody could actually go and do this. But a lot of people don't need that or they're not going to look at that detail. I've gotta be realistic about it. That's why I say, I would rather a contractor be able to at least look at the top level, those main codes and say by job that will tell you something more.

Just to stay on point here, what goes into designing a system? Are you self-performing? Are you subcontracting everybody else? If you're self-performing, you've probably got labor, your own labor that you got payroll taxes, workers' comp, those kind of things.

If you're self-performing things like, you know, heavy equipment guy, has a bunch of equipment, then you got the insurance on that [00:13:00] equipment and the maintenance upkeep, the fuel and all that stuff that goes into equipment. That's a huge part of what is costing you to do business. So again, that's just another high level part. What are the inputs? Materials, and what are the equipment, you know, That's another component of figuring out where the system should be.

Stephen Brown: That makes perfect sense. What if your particular project just terrorizes tires? Like a demolition contractor? You can take that maintenance, you can take that vehicle maintenance, and you can break it down into some real cost factors.

Wade Carpenter: That's a good point. I was just talking to a contractor that's building out in the mountains and tearing up some trucks, going through trucks, just because they got really poor roads and things like that. That's a good point. And it's something that you should probably think about, be cause obviously you can spend some time and some money on the equipment and just even getting there. So that's a great point.

Stephen Brown: Yeah. Or moving a [00:14:00] lot of dirt. That just terrorizes equipment too. Breaks it down. Tractors dump trucks, pans. All of that is being strained and beaten up by the weight of the dirt being moved.

Wade Carpenter: Yeah. Another consideration, obviously writing my book Profit First for Commercial Construction, there are some adaptations that we need to make for a contractor, and they're not hard, but they are very specific to construction. So I need to take that into account when we're designing a chart of accounts and mapping those things out.

One of the main things the job expenses or Job Ex as I call it, operating, you know, some of those other things that, splitting out payroll, again, I'm not gonna go deep into that. We talk about CapEx, cap expenditures and keeping up with your equipment. All that can play into it.

I'm trying to paint a big picture here. Wide picture.

We've already talked about the level of detail. Just yesterday, I was talking to somebody that was talking to us for the first time, and he's got, some specialty HVAC stuff. But he's also [00:15:00] going into spec home building. He's got a team of accountants that are not trained in construction and he knew about classes. QuickBooks has classes. So you could take Chart of Accounts and he was like, okay, I know I need to get this on my balance sheet. I don't know how. I would love to just run this by class. Because I have some rental properties and then I can look at a P&L. Well, the problem with that is the fact that you cannot run classes on balance sheet items.

So if you're a developer or spec home builder, those kind of things where we're capitalizing those kind of things, but the point is, there are ways to do that and there are some things to know there, but sometimes there are different ways to skin the cat. In his case, he was spinning up a new division and he's like, okay, well I don't know that I really have the budget for that right now and I'd love that detail. I want that detail. I just don't know how I can actually manage that right now. So we were working with him, to sort of like, okay, let's, what are the choices? Can we do it at the chart of accounts level?

He is going to [00:16:00] be having spec developments. The bank is gonna require him to put this specified structure of the single level cost codes, but also the phase codes. You could just say concrete or you can say concrete footings or all the different, if you ever look at the CSI master format, there's 20 pages of codes. There's tons of them.

I guess we'll link to the previous episode where we talked about this stuff. A lot of it for contractors is they get this analysis paralysis, they don't know where to start, and maybe they've jumped into something like Procore or Buildertrend or... I'm not knocking any one of them. But they do have ways they interrelate. If you don't build the structure properly or you just take their canned chart of accounts as well as the canned cost codes. It's overwhelming and I get it. So that's why I have to spend a lot of time talking through this.

I would also mention looking at who the reporting requirements are. We've talked about this, but maybe designing backwards. If I want that level of detail, we're going to have to [00:17:00] take that into an account for the system. If you're wanting to look at the estimate versus actual, you're gonna have to back that up. If you're trying to get GAAP financials, that's where the big picture and knowing what it's supposed to look like is a tough thing to do. And it only comes from years and years of doing this. 

Stephen Brown: No Wade, look, I totally get what you're saying. You've been doing this for years and you have customers that need certain things. Or they don't know they need certain things until you tell th em that they need certain things. For example, Work In Progress reports you mentioned earlier, in my mind, it's the most single, most vital part of getting you bonding. But so many contractors are not able to provide that. Do you not realize how powerful that is? If it's powerful to a bonding company of predicting the future, why wouldn't it be powerful to you? And where did I or the accountant miscommunicate the importance of that? All you can do is like a bank or anyone else, demand those reports. And that gets something done.

This can be [00:18:00] so overwhelming that you just don't do anything about it. At the same time, you can think this is more complicated than it is, but getting it set up properly is the key to getting the right data that you need to operate your business.

Wade Carpenter: Well, again, I appreciate you letting me explore this today because it is something that I get a couple of calls a week on. That episode when we gave more of the structure and the way it can look like. It really didn't do a justice first of all. But second of all, I've gotta be realistic. When you have Sage 300 or something like that, or Foundation, you can spend 20 grand or more on the software, but typically you're spending two to three times the cost of that software to get a consultant to get it in place and set up right.

A lot of that consulting is incredibly expensive. But those people are trained. Okay, this is how we can get this into a structure that makes sense for your business. And it does take quite a bit of time. So I guess what I'm saying is to protect my calendar as well, i'm glad to try to help. That's [00:19:00] why we put this information out. We were all out about helping contractors.

What I'm trying to do in exploring this and getting multiple calls, I want to help people. So I've put together a Do It Yourself Kit. Basically a course and you know, the considerations that need to go into this. This has been a lot of years in the making, but a lot of thought has gone into this.

So we are going to be launching very shortly and we'll put that in the show notes if you're interested. Basically a Do It Yourself course. Because too often people come to me, either years after and they've never, I had one, 5 $6 million last year, tha t had none of this in place. And they're like, I can't continue running the business this way. But also the spin up contractor that's just working on the shoestring budget cannot afford to pay somebody thousands of dollars to put this stuff together.

That's really what my model is more of, okay, let's help. Do the back office kind of stuff. This is my attempt at helping the industry to finally find some kind of [00:20:00] good handle on, not just okay I got this chart of accounts off the internet. I'm just gonna copy and paste it, when it doesn't fit.

Stephen Brown: Right. That's very laudable that you're doing this because our listeners can get the fundamentals and learn about it. Like anything, when you hire a consultant, what you know about what you want them to accomplish keeps your costs down for hiring a consultant. You don't just throw this and go, I don't know, you handle it and tell me what to do. Well, you can have that attitude, but if you take a few minutes just to learn the fundamentals of what you want them to do, it's gonna save you a fortune, and it's gonna make you understand what they're doing. You can say, no I don't want that, I want that, no, you're going off track. You've gotta know enough about in order to tweak this properly. I would imagine this is an ongoing process, isn't it, Wade?

Wade Carpenter: Well, the idea is let's get a structure we can live with and not have to redo every time we turn around. Or I see people like, okay, well I'll change from Buildertrend to Procore or something like [00:21:00] that. The chart of accounts is never got it set up right over here, but now we're going over here and we spent three years of paying a monthly fee and we never really got anything out of it. That's what I want to help people avoid. That's my goal.

Stephen Brown: Okay.

Wade Carpenter: So with that I know we've gone a little long today, but I appreciate you letting me explore it today. I appreciate our listeners. I hope you've gotten some good information if you hung with us this far. We will be putting some stuff in the show notes about the do Do-It-Yourself Kit if you're interested in some of that. We've also had some free templates, like checklists that you can get as well.

With that, if this episode made you think about it, if you had thoughts, comments about what we talked about today, if there's a particular avenue that you're struggling with, I'd love to see them in the comments below, and maybe Stephen and I can kick it around in another episode.

If you've made it this far, we appreciate it. We do this every single week and we ask that you please share, subscribe. It always helps us out on the channel.

Anyway we'll see you on the next show. [00:22:00] Thanks.