Direct Materials and Subcontractors, COGS or OPEX?

| Categories: Business Tips , Cash Management , Contractors , Profit First

Blog by Fuel Accountants

Having a great relationship with your material vendors and subcontractors is critical, especially as your business transitions and grows over time. Making sure they are paid on time is an important part of maintaining those relationships. So we want to show you how to manage your cash flow using our Profit First Cash Management System (PFCMS).

Direct Materials:

When implementing Profit First , it is important to distinguish between materials used to produce your customer products or projects, and non-direct materials used more generally in your business.

We treat the two differently for very important reasons. Direct materials expense always follows the volume of sales. When you sell more, this expense goes up. When you sell less, this expense goes down. But you MUST always have the adequate availability of these direct materials in order to protect your customer delivery due dates. 

Many times, we find businesses struggling to pay their vendors on time for their direct materials. When that happens, vendor relationships degrade, and you may lose the ability of getting materials as you need them. You may also lose the ability to negotiate better pricing, and get preferred delivery on special or rush orders.

Here is how we handle taking care of direct materials in our PFCMS:

  • When cash is received on sales, we take the amount spent on direct materials and put that money into a separate account.
  • Now you have the funds ready to pay that vendor, when the payment is due


 In Profit First language a Subcontractor is someone whose services you are reselling as part of your product, but which is not part of your core business.  For example, a builder pays a plumber to put in the pipes - this is a true subcontractor in PF terms, but hiring an independent contractor to supplement your team of regular workers is not.  Just because someone is an independent contractor doesn’t necessarily make them part of the Subcontractors category in PF. They need to be subcontracted to do something your company does not do, or can’t do.

When using our PFCMS, subcontractors get treated similarly to vendors. When you collect funds from your customer, part of those funds do not belong to you. They belong to your subcontractor. 

So we segregate those funds into a separate account and have them available to pay the subcontractor when they become due.

Here is how we handle taking care of subcontractors in our PFCMS:

  • When cash is received on sales, we take the amount received for our contractors, and put that money into a separate account.
  • Now you have the funds ready to pay that sub, when the payment is due

Profit First Allocations:

We only apply the allocation percentages after deducting the amounts received for direct materials and subcontractors - these were never your revenue so we exclude them.  We call that the “Real Revenue” amount - it’s the income you have earned to deliver your product and run the rest of your business.

Stay the Course:

It takes a little discipline to not “steal” money from your vendor or subcontractor accounts and use it elsewhere in your business. And we find that we occasionally need to fine tune the allocation percentages to make the cash management system work. But holding true to the process will force you to think differently about how you plan and manage your cash flow. 

PFCMS discipline ultimately leads to your financial success. We see it happen EVERYDAY!!

We are expert implementers of PFCMS, so call us if you need any help…

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