Many businesses work on short-term projects for clients and add value during the life of the project, but when should the profit be counted in the management accounts?
Imagine you are a web design business and the majority of your work involves three or four-month projects for clients.You always agree an invoicing schedule with a client before you start a new job, let’s say it’s 50% up front, 25% after two months and 25% on completion.
You run a lean business with few permanent staff and you bring in outside contractors for software programming, design, photography etc. to suit each project. The contractors will send you their bills as the project unfolds and some will only bill you when the project is completed.
Finally, your’s is a well run business with monthly management accounts that should reflect business performance. But how do you reflect the profit of a contract like this?
There’s no right answer – just be consistent and sensible
Firstly, make sure your accounting software can track individual projects and show you the profit / loss on each one. Change your software NOW if it can’t.
Secondly, although you have to account for the sales invoices and contractors’ bills, don’t confuse getting paid or making payments with profit. And if you are being paid upfront, resist the temptation to think you’re richer than you really are. Make sure you keep enough money to one side to pay the bills that will come later.
Thirdly, establish some rules for profit recognition on short-term projects. This may well be very different from your invoicing schedule. For example:
- 30% in month 1, 30% in month 2, 40% in month 3
- 10% in month 1, 40% in month 2, 40% in month 3 and 10% in the month after completion
There’s no right answer so don’t look for one. Be prudent and load more of the profit to the back of the project to be recognised in your accounts once you can be fairly sure the project will complete successfully, most of the risks have been dealt with and you have a really good idea of what the final profit on the project will be.
And be consistent.
Yes, each project is different and there’s always an argument to make something a special case, but try not to. Particularly if the effect of your one-off exception is to bring forward the profit.
Don’t let the accounting obscure the profit
Accurate and consistent management accounts are a key tool for monitoring and improving business performance and they should be tailored to the needs and nature of your business.
If your business has a series of short-term projects during the year then you need to be doing something along the lines explained in this blog because if you don’t then you’ll never know how well you’re doing and you won’t see any performance problems until it’s too late.