Magicians only perform a trick once for the same audience. A second time and the trick loses its luster. The third time around the audience figures it out. The trick no longer fools the audience and the magic is gone.
Legacy Tricks of the Trade
We contractors start small and our tricks of the trade work well enough in the beginning to keep our business afloat. With one or two jobs underway, contractors are often forced to borrow from Peter to pay Paul and then may have to bob and weave to pay for job #1 with job #2’s front load. We borrow a little from the bank and a little from our material suppliers and may have to low-bid a third project, even at a loss, to keep cash flowing. However, in my experience these legacy tricks of the trade start to wear thin as a construction company grows. As the company expands into a substantial business these old tricks can collapse like a house of cards. The old way ‘everyone does things’ in the contracting business only applies during the startup phase. Once the business is secure it is time to learn some professional tricks of the business trade.
Scientific Tricks of the Trade
Because most contractors start as engineers and/or skilled tradespeople they often overlook business management techniques that are common to professional business managers. My experience working with literally thousands of contractors when I was in the failure business taught me that most of them were unfamiliar with the tried-and-true practices that make up the science of business management. The following are the top ten management practices that should be consistently applied by construction industry leadership.
- Double Entry Bookkeeping
- Balance Sheet Management
- Strategic Planning
- Long Term Goals
- Profitable Acquisitions
- Managed Growth
- Transactional Integrity
- Board Of Directors’ Leadership
- Succession Management
- Chief Financial Officer Role
Double Entry Bookkeeping
We will start with the ancient science of double entry bookkeeping. Some may be offended starting with accounting fundamentals but bear with me and I think you may agree that double entry bookkeeping may not be as well understood within our industry as we think.
The need for a science of business was recognized as far back as the introduction of accounting to keep track of trade accounts in ancient Mesopotamia. The double-entry bookkeeping system evolved from the first principles of accounting back to the Romans and Medieval Middle Eastern civilizations. The first known documentation of the double-entry system was recorded in 1494 by Luca Paciolli who is widely known today as the ‘Father of Accounting’.
Double entry refers to a system of bookkeeping whose main purpose is to ensure that a company’s accounts remain balanced and can be used to present an accurate picture of the company’s current financial position. The simple science of double-entry bookkeeping relies heavily on the use of the foundational accounting equation, Assets = Liabilities + Shareholders’ Equity. This, of course, is the germ of what is known as a balance sheet.
Balance Sheet Wisdom
Double entry bookkeeping traps financial metrics in a unified system that portrays the changing financial status of a business immediately after every transaction. The portrayal is an immediate stress test, unlike any engineer would conduct. When you incorporate your company, you create a separate and independent financial entity that has a financial profile from the first formation transaction.
Deposit $10,000 from your savings into your new company’s bank account and enter the transaction into a ledger that always results in the balanced fundamental equation, Assets = Liabilities + Shareholders’ Equity. A debit entry in an account represents a transfer of value to that account, and a credit entry represents a transfer from the account. Since both sides of a double-entry bookkeeping entry must remain in balance, an account’s normal balance is based upon whether a debit or a credit increases the account. Normal entries for typical account types are listed here:
Account Type Debit Credit
Asset Increase Decrease
Liability Decrease Increase
Capital Decrease Increase
Revenue Decrease Increase
Expense Increase Decrease
The $10,000 initial equity contribution is entered into the ledger by “debiting” the asset Cash on hand. By the rules of double entry bookkeeping there must be a balancing entry of $10,000 to the right side of the ledger under a liability category. But since no transaction has taken place no liability can be increased so the $10,000 offsetting entry must increase stockholder’s equity.
From the first act of formation, the books are in balance. It is easy to see from this first example how the science of double entry bookkeeping will always produce an accurate picture of your company’s financial status. Next week we’ll continue to discuss the powerful management tool your balance sheet represents.
For more information on the tricks of the trade, read more at: TRICKS
For a broader view of the balance sheet, read more at: BALANCE
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