You have worked hard to build your business and are justifiably proud of the results. Now, perhaps you are looking at getting a loan to expand the business or you are thinking of selling the business. In either case, you need a clear picture of what your business is worth based on assets in hand and projected cash flow. This article is about real revenue and how it is used to show the real worth of a business that uses subcontractors and materials in construction.
Real revenue is your total income from all business operations minus the cost of materials and subcontractors. As a rule, real revenue is taken into consideration when the cost of subcontractors and materials is twenty percent or more of total income.
Although twenty percent of income coming from materials and subcontractors is the cutoff for using the real revenue calculation, the percentage can easily be more. For example, the owner of a construction business finds himself in a building boom. He knows from experience that this boom will last two or maybe three years. Using his own crew he will be able to build ten family homes and one office building a year for three years. But, if he subcontracts much of the work, he will be able to do three times as much building. And, since each home or office building will result in a profit, he goes ahead and takes on as much work as he and his subcontractors can do until he sees that the boom is starting to cool off.
During the housing boom, the cost of materials may rise a bit but so may the price of a home. So, materials, as a percent of the cost of the home, will not change much. But, the cost of subcontractors will go up a lot. Maybe be the builder always subcontracted for electricians and plumbers but now will be subcontracting bricklayers, general carpenters, and a lot of unskilled labor.
Just as an example, maybe his cost of materials and subcontractors in normal times is about 15% and now it is running at 35%. He needs to do a real revenue calculation to understand the true value of his business.
Using the Profit First method the business owner allocates to profit, owner’s pay, tax, and other accounts on the tenth and twenty-fifth of every month. But, how about all of those expenses that he is managing for subcontractors and materials? How do they figure into the percentage allocations to his various bank accounts? Deposits are managed like this. All money goes into a total income account. Materials and subcontractor costs are moved to their own bank account. The rest of the income is moved to a real income account. From there the Profit First allocations take place to the profit, tax, and the rest on the tenth and twenty-fifth of every month.
Real revenue is a valuable accounting method for making it clear just what a business is worth and for keeping the books correctly when doing Profit First allocations twice a month.
If you still have questions or are interested in implementing Profit First in your business, visit our website, ExigoBusiness.com, or contact us at (816) 394-6818.
Click here to watch the YouTube video about real revenue and how it is used.