What Is an Income Statement for a Construction Project and How Is It Used?
As a construction professional, financial statements likely aren’t your favorite part of the job.
They are, however, a necessary part of securing working capital for many contractors and construction companies.
An income statement is a financial document that provides crucial fiscal information about a construction company’s history and project performance to:
- Company management
- Financial institutions
- Sureties; and
- Customers
This article will help you understand what the main components of an income statement for a construction project entails, along with when and why they are used.
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What Is an Income Statement?
In the construction world, an income statement is a summary of the results of a company’s operations and profitability for a specific period of time.
This report is one of the most common in construction and will typically cover a specific period of time, usually:
- A month
- A quarter; or
- A year
What Does an Income Statement Cover on a Construction Project?
Also commonly referred to as the profit and loss statement, or P&L, an income statement will generally include:
- Revenues
- Operating and administrative expenses
- Cost of sales
- Gains
- Losses
- Net income; and
- Earnings
When Is an Income Statement Used for Construction?
Financial statements are the most common source of a contractor or construction company’s historical performance.
An income statement is a type of financial statement for contractors and is often used to analyze the contractor’s business when determining:
- Lines of credit
- Loans and surety bonds
- Whether to allow a contractor to perform work
Construction companies use income statements and other financial statements to prove their company’s creditworthiness to:
- Banks
- Investors; or
- Sureties
Looking at a company’s income statement, sureties are able to compare a contractor’s finances year-over-year and period-over-period.
Sureties will look for:
- Consistency in performance
- Any significant changes in reported revenue and expenses
… and compare a company’s operational success to other companies in the same market.
Why Is an Income Statement for a Construction Project Useful for Contractors?
As a contractor, positive cash flow is of the utmost importance. And you’re likely painfully aware of the cash flow problems that are rampant in the construction industry.
Financial statements (including an income statement) can assist construction companies and contractors:
- Access credit
- Increase bonding capacity
- Improve cash flow
An income statement, in particular, can be extremely insightful for a construction company when analyzed over a few months or years.
Any spikes or dips you notice could point you to problems or trends in revenue you may not have been previously aware of.
Understanding why these changes happened (ie. a certain time of year) can help solve any potentially worrisome trends and prepare a company’s finances for the future.
Moreover, financial statements can also help contractors get paid on time and make more profitable long-term financial decisions.
For example, if a company is experiencing cash flow problems, an income statement coupled with additional financial statements can often help them get access to working capital at lower interest rates.
This move reduces carrying cost and works to improve the company’s bottom line.
To really reap the benefits, income statements should be reviewed regularly. Comparing numbers month to month will allow you to spot potential errors and analyze trends.
3 Major Components of an Income Statement for a Construction Project
The major components of an income statement are:
- Revenue earned
- Cost of revenue earned;
- Selling, general, and administrative expense
These elements together help to show whether a company or construction project was profitable.
We’ll review these in depth below and outline what exactly goes into each of these components of an income statement.
Revenue Earned
All construction contracts have unique types of profit structures, including the following contracts:
- Lump sum
- Fixed price
- Unit price
- Cost-plus; or
- Time and materials
Because revenue is determined differently with each of these construction contracts, they all require their own analysis to understand how a contractor or construction company is actually performing.
To comprehend the risk related to the accuracy of the financial statement, a company or contractor must note how much of the revenue is based on estimates.
The higher the revenue amount that is based on estimates, the higher the chance of the revenue being inaccurate, whether over or understated.
The way to ensure the income statement is as accurate as possible is by illustrating the cost of each type of revenue earned.
This will help demonstrate the true source of the company’s profit.
Cost of Revenue Earned
The purpose of the cost of revenue earned is to determine and state a contractor or company’s gross profit.
Cost of revenues earned is usually considered to be a variable cost, meaning it will either increase or decrease based on the…
- Contracts; and
- Volume of work
… performed by the contractor.
The true cost of revenues earned is made up of both direct and indirect costs. We’ll review what qualifies as direct or indirect costs shortly.
How Do You Calculate Gross Profit From an Income Statement?
The formula to calculate gross profit from an income statement is fairly straightforward:
- First, start with your revenue for the period of time or project you’re creating the income statement for.
- From there, subtract the cost of goods sold — meaning any expenses that went directly into projects or materials that you sold.
That first leftover amount is the gross profit.
To find the operating income for the period of time, subtract your general and admin expenses (office supplies, admin salaries, etc.).
Finally, to find the net income or loss for the period of time, add or subtract …
- Any other income or expenses that are not directly related to your business activities; and
- Tax expense
The definition of a direct cost is any cost that can be directly associated with the project.
On an income statement for a construction project, direct costs may include:
- Direct labor and materials purchased specifically for the project
- Subcontractors
- Equipment
- The purchase of land for the project
- Closing costs
- Permits
- Engineering work
- Architectural work
- Surveying
- Interest charges from the bank
- Direct insurance assignable to the project
Any cost that can be directly traced to a particular project should be included in direct costs.
What Are Considered “Indirect Costs” On a Construction Project
Any items that are not directly related to the performance of the work should be considered indirect costs.
These costs may include:
- Warehouse labor
- Depreciation on equipment
- Insurance
- Equipment repairs
Indirect costs can commonly be a source of inaccuracy on an income statement.
Two mistakes often made are:
- Including indirect costs as a true cost on a construction project.
- Not charging indirect costs to a project, and instead including them in the selling, general, and administrative expense section of the income statement.
If the latter happens, the contractor or construction company would be overstating the gross profit and the SG&A, resulting in an inaccurate income statement.
Contractors and companies should analyze and quality check indirect costs frequently as they can change over time.
By catching any potential mistakes early, a contractor may be able to:
- Prevent these costs being inaccurately applied to contracts; and
- Salvage the health of their financial statements
Selling, General and Administrative Expense
Selling, general, and administrative costs (or SG&A costs) are the expenses related to running the “back office” operations of a construction company.
These costs might include:
- Office staff
- Payroll
- Sales and estimating
- Monthly utilities
- General insurance
- Office expenses
Generally speaking, SG&A costs are fixed, since they neither increase or decrease with revenue and are incurred regardless of whether the contractor has booked current or future work.
Working to keep selling, general, and administrative costs to a minimum may help increase a company’s profitability.
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