Why Financial Simplicity Wins for Contractors Under $5 Million in Annual Revenue

It's hard to get anything done without a good blueprint. If you're missing critical dimensions or the intended material is unclear, it's borderline impossible to achieve your desired outcome. It's just guesswork.

But what happens when the schematic has too much detail? Let's imagine for a second that someone put way more detail on a blueprint than you could possibly need. For some reason they marked the halfway point on all length dimensions. They wrote the structural properties of every material next to every element in the blueprint. They wrote underlying measurements on top of each other.

I don't know if that ever happens on jobsites for construction companies, but it certainly happens in their accounting. They build blind completely unaware that their accounting setup is providing a blueprint so messy you can't distinguish finishes from the foundation. And if you can't tell what is structural and what is decorative, how can you be sure the house won't fall down?

That's what I want to talk about today.

Complexity as a default

To begin, I want to say it's not your fault. You're not an accountant. When QuickBooks presents you with a default chart of accounts, there's no reason to think it's not going to serve you well. And as busy as you are, it can be hard to justify the time and effort to verify whether what you see holds up under weight.

With that in mind, I hope you'll journey with me for a second while I make the case that QuickBooks not only is poorly optimized for you by default, but actually sets you up for failure.

So what is it, exactly, that QuickBooks is including on the blueprint that obscures the valuable data? I find three fundamental flaws with QuickBooks default setup.

1. QuickBooks includes subaccounts where they aren't necessary for small businesses.

For those of you who don't know what a "subaccount" or an "account" is, I'll explain. In accounting, we group transactions into categories that we call "accounts." A "subaccount" gets nested underneath a "header account" and this allows us to see a total cost for that group of accounts plus the individual cost of each smaller category. We then use these categories to see how much money you've spent on each type of expense over a given period.

With that out of the way, let's discuss an example. The QuickBooks default chart of accounts includes Interest Expense with three subaccounts, Business Loan Interest, Credit Card Interest, and Mortgage Interest. To use this as QuickBooks intends, we would post credit card interest and mortgage interest to their respective accounts, and all other interest to business loan interest.

But there are three big problems with this.

First, businesses pay interest on more than just traditional debt. If you make a late tax payment, a late vendor payment, or a late license payment, you might owe interest as well. The label Business Loan Interest is misleading, and many clients put those expenses in the header account Interest Expense. Accountants don't want to see any transactions in a header account, which makes this incorrect by compliance standards.

Second, mistakes in categorization increase when there are more options. When you enter an expense and you type "interest" into the expense box, all four of these accounts will come up. If you're adding legitimate mortgage interest to the books but Business Loan Interest pops up first in the list, you might post it there because a mortgage in the business's name is a business loan. It's not what QuickBooks intended, but it is a common misunderstanding.

Third, if you're under $5 million per year, this information doesn't provide you value anyway! With those first two issues in mind, you'd hope added complexity would at least provide value so you can make better decisions as a business owner. But it doesn't.

Fun fact: I've worked with over 100 construction businesses under $5 million and I've only seen a legitimate mortgage on the books once. Most contractors this size rent an office or warehouse, if they have any space at all. This account is only relevant for 1% of my clients, let alone valuable!

At this stage of business, contractors typically face three main issues: cash flow management, keeping up with compliance, and bidding jobs correctly. Knowing how much interest you paid by type of interest doesn't solve any of these problems. But it does take your time and discretion to do it correctly.

If it were just the interest issue, it might not be so bad, but it's not. Business Insurance. Utilities. Office Expense. All the same issue. And I've seen it repeatedly: contractors DIYing their books make mistakes because of this setup.

Simplicity as a solution

The natural antidote to this issue is to reduce complexity. I tell clients frequently that if a number isn't giving them real information they use to run their business and it isn't a tax compliance requirement, it doesn't belong on their books.

Throw away the mortgage interest account until you've got multiple properties with mortgages and credit cards and lines of credit and interest variance can tell you something about your business. But that doesn't happen to businesses under $5 million.

When you do this, every number on Profit and Loss serves a purpose. You don't chase numbers that don't matter. You see a refined list of costs that help you run your business.

No longer is a 5% drop in profit disappearing into a cobweb of meaningless numbers. That 5% drop in profit can be directly tied to numbers you understand. Your electrician upped his prices 5%. Now you can up yours so you keep your profit.

Now your blueprint has everything you need, and only what you need. You know how long to cut the joists, you know the customer wants sheetrock not plaster, and you know where the plumbing will go.

And as you grow? Add complexity where it matters. Add subaccounts to supplies and materials for core groups like Lumber - COGS, Masonry - COGS, or Sheetrock - COGS. Those will help you price your future jobs. But until then, keep it simple.

Want help getting started?

I do construction accounting for contractors like you every day and I'd love to help. To get started, Book Your Free Discovery Call with me. It takes 30 minutes, and you'll leave with a clear picture of whether I can help you.