Contractor Law Class

Business Finances

Official exam weight: 15%

Official subtopics

  • Recordkeeping requirements and retention periods
  • Federal and state tax obligations; payroll taxes
  • Cash vs. accrual accounting; profit and loss
  • Estimating, overhead, and markup
  • Bankruptcies and financial responsibility

Study note

Business Finances is about keeping a contractor solvent and understanding what the records say. The official exam outline gives this section about 15% of the Law and Business examination and names cash management, budgeting and planning, taxes, and financial reporting. A useful first step is to separate three views of the same business: financial position on a date, operating results over a period, and cash expected to arrive or leave on particular dates.

A balance sheet is the position snapshot. It groups what the business owns or is owed (assets), what it owes (liabilities), and the owners' residual interest (equity); the basic equation is assets = liabilities + equity. An income statement covers a period and organizes revenue against costs and expenses to show whether operations produced income or a loss. A cash budget is a forward schedule of receipts and payments. A profitable job can still create a cash shortage if payroll and suppliers must be paid before a progress payment arrives, so compare the timing of cash needs with the payment schedule instead of treating profit as cash in the bank.

Classify costs consistently. A cost that can be traced to one project, such as job materials or hours worked there, can be assigned to that job. Shared costs such as bookkeeping, office rent, or a vehicle used for company administration support the business as a whole and should not be charged again as if they belonged entirely to one job. For example, if a worker earns $32 per hour and the employer's actual payroll taxes, benefits, and required insurance add $8 per hour, the employer's labor cost for a ten-hour task is $400. Those added amounts are often called labor burden; use actual applicable obligations and plan terms rather than treating the example as a tax rate.

Financial ratios summarize liquidity, leverage, or profitability, but always identify the exact accounts and formula being used. Working capital is current assets minus current liabilities, while the current ratio divides current assets by current liabilities. With $72,000 in current assets and $48,000 in current liabilities, working capital is $24,000 and the current ratio is 1.5. A debt-to-equity ratio can compare total liabilities with owners' equity; lenders may define the debt portion differently, so read the stated formula. Net profit margin divides net income by revenue: $18,000 of net income on $120,000 of revenue is 15%. These measures are clues, not guarantees: slow receivables or cash already committed to payroll can leave a contractor short even when a ratio looks comfortable. Review the underlying records and timing as well as the ratio.

A contractor may also need outside capital to bridge the time between buying materials, meeting payroll, and collecting from a customer. Equity financing brings money into the business in exchange for an ownership share; debt financing creates a repayment obligation and usually interest. A loan can increase cash and liabilities without being sales revenue, while an owner's investment increases cash and equity. Compare any repayment schedule with the cash forecast and the work's expected payment dates. The SBA's investment-capital page describes debt and equity in the context of its licensed investment-company program; those program details do not determine which financing is best for a particular contractor.

Keep business records that support each entry: signed contracts and changes, customer invoices, supplier bills, deposit records, payroll detail, bank reconciliations, and tax filings. Cash-basis books generally record receipts and payments when cash changes hands; accrual-basis books record earned revenue and incurred expenses when the transaction occurs. The timing can make the same month look different under the two methods. Do not mix personal and business transactions, and use a qualified tax or accounting professional when choosing a method or preparing entity-specific statements.

Taxes depend on the business form and the activity. Federal Publication 334 covers individuals who report a sole proprietorship on Schedule C; it is not a complete guide for corporations or partnerships. IRS Publication 15 and California EDD's Employer's Guide address employer payroll responsibilities. IRS Publication 946 explains tax deductions for depreciation, but a tax deduction does not determine the company's internal job-cost category. In an internal cost plan, depreciation on a vehicle used for general sales or office work is a shared administrative cost; if the vehicle also has measurable project use, allocate a supportable share consistently and avoid charging the same cost twice. Federal construction contracts have their own cost-allocation rules, so apply those only when the contract makes them relevant. For California contractor-license consequences tied to qualifying unsatisfied judgments, read Business and Professions Code section 7071.17 itself.

Use this section to practice reading a statement, checking cash timing, calculating a simple liquidity measure, and tracing a number to its record. Bid assembly, markup, and job cost control belong with Contract Requirements and Execution; see that section for a separate worked estimate. The government references below are supplementary. Tax rules and amounts change, so check the current agency publication and controlling law before relying on a rate, deadline, or deduction.

This is an original study note written for this site. It summarizes what the section covers so you can plan your studying; it is not legal advice. Practice questions in this section cite the underlying California statutes and regulations directly.

Government references for this section

These official guides and laws supplement the original study note. Check each source's scope and current version; statutes and regulations control California legal duties.

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Sources behind this section

Official documents cited by practice questions in this section, ranked by how many questions cite each one, from the September 27, 2026 law snapshot.

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Statutes (16)

Official guides (1)

Law snapshot date: September 27, 2026