Category “Open Book Finances”

Revenue Recognition in Managing Projects

June 22, 2010 by Joe Knight

One of the issues that the founders of Setpoint, Joe Cornwell and Joe VanDenBerghe realized early on was that they did not like the way the accountants did project based accounting. At the crux of the problem was the cost versus budget approach to revenue recognition. Under GAAP (Generally Accepted Accounting Principles) the rule for project revenue recognition was percent of cost complete. For example, if one spent $1,000,000 on a project and the total project cost budget/estimate to complete was $5,000,000 then the project would be considered 20% complete for revenue recognition purposes. So to complete this example if the project revenue was $7,000,000 then 20% of revenue would be $1,400,000. So the period profit and loss statement for that project would look as follows:

Revenue    $1,400,000
Expenses   $1,000,000
Profit         $  400,000

The Joes questioned the validity of that profit. They debated with their accountant. They struggled with the concept. Their issue was with the way their automation equipment business operated. A large machine can take 6-9 months to complete. A lot of the work is at the end of the project when the machine is starting up and being debugged. The problem with the GAAP accounting method is that the profit is recognized before the real tough work is completed. As an example say Setpoint builds a $3,000,000 machine that will take about 9 months to complete. In the first 3 months the machine’s materials are received and design is complete. Let’s say that material costs on the machine are $1,500,000 and the design cost another $100,000 in labor. So by the GAAP accounting method the machine is $1,600,000/$3,000,000 or 53% complete. Therefore, 53% of the projected profit can be recognized in the first 3 months. One the other hand, a small fraction of the total labor to complete the job has been incurred at that point.

Let’s assume that Setpoint estimates that the total labor costs will be $1,000,000. So by labor measures Setpoint has spent 10% of its labor budget or $100,000/$1,000,000. Yet the accountant will say that the machine is 53% complete. This discrepancy can create a false sense of safety early on in a project when little work is done. Furthermore, if there was large labor overruns later in the project during the startup/debug process those past profits could be overstated.

Because of this issue Setpoint decided to measure revenue in a different way. At Setpoint, we measure percent complete by labor only. We evaluate how much labor was spent on a project every week and then we estimate labor required to complete the work and use labor only to recognize percent complete for revenue recognition.

Setpoint uses two methods for estimating labor. First, for smaller projects we look at labor by discipline and estimate how much will be needed to complete the project relative to what has been spent. For our larger projects we look at these numbers based on schedule based earned value tools. We update these projects on a weekly basis so our project engineers can stay close to the performance of our projects and to make it possible to communicate our profitability to the entire company on a weekly basis. We will talk more on project tracking and earned value in a later blog.

We also have a white paper that talks more about our project management techniques, feel free to download it.

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Why does the huddle work at Setpoint Systems?

January 14, 2010 by Joe Knight

Setpoint Systems is an open book company. This means that our books are open to our employees. Even though we are a privately held company we choose to share our financial information.

When the company started in 1992, the engineer founders Joe Cornwell and Joe VanDenBerghe (aka the Joe’s) decided they wanted to share financials with their employees. As a project based company they found that the way their part-time CPA did the books with them did not give them a good measure of how the projects were performing financially on a week-to-week basis.

So the two Joes with the help of others developed a way of tracking their projects on a weekly basis that included hour tracking by labor section, material costs tracking, and earned value project management concepts. This allowed a fairly accurate measure of the financial performance for projects on a weekly basis. This type of the project financial analysis did not comply with GAAP (The Generally Accepted Accounting Principles). Their CPA did not like it but it made sense to them and their employees.

The weekly tracking process happens on a big white board where projects are measured for material costs and percentage progress every week. The key project number, that every employee follows, is GP or gross profit by project (at Setpoint GP is simply earned revenue by percent complete less actual material costs). After the gross profit by project is measured then we compare that to our week OE or operating expenses. You take GP – OE to measure our profit for the week.

We track closely three measures on our huddle board. First, is GP/OE. For us, 1.2 is good and anything less is not good enough to sustain the business. Second, we track what percentage of our labor is direct to our automation projects. Third, is GP per direct hour charged to projects. Everyone knows that if our GP per hour is over a key threshold and our percent direct is over a key threshold Setpoint will make a nice profit and GP/OE will be well over 1.2.

It’s actually a really simple system. We have a monthly and annual bonus that pays out based on beating minimum GP-OE targets for the month and year. We also train all of our employees on how the huddle board works and what the key metrics mean.

So why does our huddle work? Well I think that there are few things that have made this simple 15-minute weekly meeting work for Setpoint. First, it’s a simple way to track projects and everyone understands it. Second, we tie objective financial rewards to how the board looks. Third, we involve every employee in the process. In the weekly huddle every employee has a seat at the table.

The power of Setpoint’s weekly huddle is evident in the survival and success of this business. When a project is bad on the board, the assembly people blame the design and engineering people, the design and engineering people say the project was under funded when it was sold and blame sales. We are all together in the meeting and it needs to be worked out between these groups or we do not have a business. The huddle creates at Setpoint what I like to call ‘psychic ownership’. Ever though all the employs do not own stock in Setpoint they act like owners because they see the performance on a weekly basis and want the company to perform well.

We have seen this ‘psychic ownership’ express itself in many ways over the years. Recently, when a project was nearing completion some shop people approached our CEO and challenged the percent complete shown on a specific project. They were in final assembly and thought the machine was well beyond 90% complete but our project engineer had the number much lower on the huddle board thus lowering our GP-OE and bonus for the month. In short, our assembly people accused the project engineer of sandbagging on the project. After a brief review an adjustment was made. We’ve also had situations where percent complete has been challenged as being farther along than we really are.

With everyone involved the huddle really keeps us safe and accurate on our business. We believe the huddle process and the systems behind it is the single greatest asset that Setpoint Systems has.

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Cash Flow Traps

July 2, 2009 by Machel

Sweet!! Your company just received a 50% down payment on a project, let’s take everyone to dinner and buy that equipment we’ve been looking at.  Whoa there big fella, let’s think about this first.  Yes, you have cash, but the million dollar question is: Can you spend it?  Just like a lawyer the accountants answer is “not yet”, let’s look toward the future.  Just because you have a positive balance in your checking account, does not mean you have money to spend.  As opposed to the Government, they don’t think about this at all.

 The next question is: How long will this project last and what costs do I have before the next payment is received from your customer? Assume the project lasts 4 months, the down payment you received up front needs to be used to pay the salaries of the people working on that project, as well as any and all expenses associated with that project. Your company can get upside down in cash before you know it.  If you don’t receive any more money until the end of the project, you will have to borrow money from the bank or find some other financing just to finish the project. 

 Let’s assume some facts: 1st the total revenue on the project is $150,000 and you receive a 50% down upon receipt of order and the final payment is due when the project is delivered.  2nd costs for parts is 60% of the total project and you pay your vendors 30 days after receipt of PO from customer, and 3rd your operating expenses are $10,000 per month. 

 

Month 1

Month 2

Month 3

Month 4

Beginning Cash

0

$65,000

($35,000)

($45,000)

Received Cash

$75,000

0

0

$75,000

Cash Spent on Parts

0

$90,000

0

0

Operating Expenses

$10,000

$10,000

$10,000

$10,000

Ending Cash

$65,000

($35,000)

($45,000)

$20,000

 

As you can see, just because you have cash up front does not mean you have cash to use.  As a responsible company you want to make sure you have money in the bank to pay the salaries of your employees and pay your vendors.  You don’t want to be like California and issue IOU’s.  I’m not sure, but I don’t think that would go over well with your employees or your vendors.  If your employees don’t mind, please let me know they would be a great cash flow asset here at Setpoint.

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Bookkeeping

May 14, 2009 by Setpoint

When I first started with Setpoint I did not know much about QuickBooks, accounts receivable, or accounts payables.  My boss was very good at explaining what to do and letting me figure things out on my own.

It has been very interesting for me to learn how a company can start with a drawing and go through the purchasing to receiving end to putting it together to making a project work.  My job is to take care of the invoices after we have received the product.  I make sure that it has been received and the amount we ordered is right and from there we start the process of putting the invoice in QuickBooks.

When I first started there were some problem invoices that dated back over 1 year.  For the first 6 months I focused on getting every vendor paid and the problem invoices fixed so that now we do not have any outstanding problem invoices.  That has been my biggest accomplishment.  It’s so much easier to try to fix the problem when everyone remembers the situation.

Some of the problems when I first started were that a payment wasn’t made to the right invoice.  So there was some confusion on both parties.  And because it was so late none of the sales people remembered if we had brought it back or what really happened.

Now that I have gotten to know the vendors I just call and ask for the person who knows me and am on a first name basis with them.  It’s easier because they know me and seem more willing to help with the problem.  At the first of the month we receive a statement with all outstanding invoices, this lets me know what I need to work on or if there is a problem.

I enjoy my job and have loved getting to learn more about QuickBooks, accounts receivable and accounts payable.  It’s great to have this knowledge.

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Open Book Finance – Setpoint’s Projects Board

May 4, 2009 by Kara

Joe Knight, the CFO here at Setpoint, talks about open book finances and how we track our projects. In our latest YouTube video Joe walks through our project board that let’s us know how we are doing on each project. He walks through how GP is determined as well as how much we have earned.

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Open Book Finance – The Board

March 5, 2009 by Kara

What do your numbers mean?  Here at Setpoint we practice Open Book Finances.  Every week we look at the numbers that show us how far along we are on our projects.  In our newest YouTube video Joe Knight, our CFO, talks about how we know if we are making money.  He shows some key ratios that can be used in any industry to measure this.

 

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