I fully acknowledge that there is rarely much excitement or intrigue when it comes to financial statements. And to clarify, in this instance I’m talking about the Balance Sheet, Profit and Loss Statement, and Statement of Cash Flows. These are the main pillars of financial reporting, and they’re useful not only for managing an HVAC, plumbing, or electrical business, but they’re also the clearest way to explain your business to an outsider (investor, lender, business partner).
So, the dirty little secret? A surprising number of home service businesses do not have clearly understandable financial statements. Many don’t have financial statements at all. And these aren’t just the single truck, sole proprietors. I’m talking about companies doing $8 million or more in revenue per year.
The finance nerd in me panicked a little when I learned about this. It’s such a risky endeavor to manage your business based solely on the amount of money in your bank account. And the folks I’ve spoken to that manage their businesses this way were fully aware that it wasn’t a great idea. The fact is, their priority has been to grow their HVAC, plumbing, or electrical business. That is their passion, and that’s what they are good at. So no, they didn’t stop to translate their business into financial statements. They were busy running their businesses every day.
It also makes sense when you consider how many home service businesses get started. Someone starts in a trade as an apprentice and works their way up through the ranks. Eventually, they are the top performing HVAC tech, plumber, or electrician at their company and decide to try their hand at running their own company. Their company succeeds and grows over time. But as the size of the business increases, so does its complexity. And typically, throughout the many thousands of hours of training and experience they’ve acquired over the years, a Chart of Accounts and recurring journal entries weren’t on the agenda!
So, the bottom line: if you are running a home service business (or any business for that matter) and you don’t have financial statements, you are not alone. There are very understandable reasons why you don’t. But you need to have them. Like, yesterday. Without a Balance Sheet, Profit and Loss Statement, and Statement of Cash flows, you don’t really know how your company is performing. You might assume you are making money because your bank account is fat. And maybe you are making money. But maybe you’re not. And if you are managing your company by the bank account, you aren’t going to know you’re in real trouble until you start running out of cash. At that point, time will not be on your side.
Here’s a quick overview of the most important financial statements that you need:
The Balance Sheet
Just like it sounds, the Balance Sheet shows you the balances in certain key accounts at a specific point in time. This would be your cash, accounts receivable, accounts payable, and inventory. It will also show you some less obvious balances like deferred revenue, accrued expenses, and the equity that you’ve earned over time. The real value of the Balance Sheet isn’t just knowing what an account balance is at the end of the month or quarter. What the Balance Sheet can really show you is trends in your business over time when you compare historical statements. You will catch trends, both positive and negative, by being able to examine how account balances are changing. These trends can, for example, clearly show you why cash is getting tighter even though you feel certain that you are making money.
The Profit and Loss Statement
This is the big one. The good old P&L. This is probably the financial statement that most people are familiar with (if they’re into that kind of thing). It’s the most “exciting” because it shows you your sales, your costs, and at the very bottom, your profit…or loss. The Profit and Loss Statement contains most of the obvious numbers that business owners are interested in, other than perhaps cash.
The really cool thing about a properly constructed P&L is that it can give you some real insight not only into whether or not you are making money, but how you are making money. Consider, for example, a multi-trade home services company. The company offers HVAC, plumbing, and electrical services to both residential and commercial clients. And let’s assume that the business is profitable. A departmentalized Profit and Loss Statement might reveal that the HVAC system replacement business has great earnings. Plumbing residential service is doing ok. HVAC commercial demand service is losing money hand over fist, but its losses are being subsidized by the profits of the other departments! Yes, the company is making money overall. And yes, the bank account shows it. But they are paying money to do HVAC commercial demand service work.
The Profit and Loss Statement dives way deeper than your sales price, and your direct costs like labor and materials. It translates all of your business activities into a financial language that you can use to interpret performance. And if done correctly, the P&L will also enable you to benchmark your performance against other companies in your industry. This makes it much easier to objectively determine whether you are getting everything out of your business that you can.
The Statement of Cash Flows
This one sounds pretty straightforward, but can actually be a bit confusing at first glance. The Statement of Cash Flows reconciles the difference between your net income, and the change in your cash on hand. A simple example is that you bill a customer $1,000. You will see $1,000 in sales, and you will see $1,000 of income on your Profit and Loss Statement, but you won’t see any increase in cash. What you will see is an increase in Accounts Receivable until the customer pays. The Statement of Cash Flows will show you why you are not able to spend your $1,000 of income just yet. And likewise, it can show you why you might have more cash on hand even though you posted a loss last month.
Bringing it all together
So, as I’ve mentioned before, your financials are the language that your business speaks to you. Financial statements can seem like an afterthought I know. They can frankly seem like busywork on top of the “real” work you are doing every day in your business. However, if you plan to grow beyond a one- or two-person operation, you need to have a coherent financial management system, including financial statements. It will ultimately make your life easier and a whole lot less stressful if you are able to understand exactly what’s going on in your business in concrete terms. Your financial statements will not only tell you how things are going today, but also how you were doing in the past, and how you can expect to do in the future.
And for the moment you’ve all been waiting for- Norwood can create financial statements for your home service business. Included in the process will be training on how to read and interpret the statements, and (if your staffing allows) how to generate the financial statements yourself going forward. But self-promotion aside, even if you don’t end up working with Norwood on setting up financial statements, please find a way to get it done! It’s the only real way to make sense of all your hard work.