Construction accounting is different from the accounting practices of businesses that use only a general ledger. Because construction companies perform contract work and take on invoice-based jobs of varying sizes and durations, they must treat each project as a profit center.
You can help keep your business healthy in 2021 and beyond by adopting or refining a few key accounting practices. The following eight examples boast a proven track record of success when implemented at the project level:
Account for indirect costs in estimates and bids: Don't leave out or miscalculate indirect costs! These may include fees for real estate appraisals, consulting services, and legal and accounting needs. Indirect costs may also take the form of taxes, title transfers, general permits and some types of insurance. By accurately identifying these items, you can make sure indirect costs are properly accounted for, and, in turn see how profitable (or risky) projects really are.
Apply job costing: Balancing a variety of projects and jobs that vary in length and size can make it challenging to match expenses to their respective revenue sources. To measure their profitability and productivity, tie indirect costs — as well as costs for overhead, materials and labor — to specific jobs and activities (such as foundations). Job costing is an incredibly efficient tool for tracking income and expenses across each task and project. It helps provide more accurate estimates and bids and simplifies tax preparation. Plus, by comparing actual to estimated job costs, you can identify which projects are making money and which aren't.
Standardize processes: Your employees should be following the same set of procedures that guide and reinforce their roles in financial reporting. For example, estimators should review estimates with project managers. Then, project managers should use detailed estimates to build job budgets broken down by phase or task so that weekly budgets can be compared against actual reports. Bringing the process full circle, share actual results with estimators so they can create more accurate bids in the future. Also, consider investing in construction-specific business management or accounting software, to help standardize and automate job costing and estimating processes.
Buy out projects ASAP: So that you can lock in pricing for materials and subcontractors, buy out projects as soon as feasible. During project buyout, purchase orders and subcontracts are issued to ensure timely delivery and on-schedule performance by subcontractors. The buyout process isn't complete until the purchase orders have been acknowledged and signed subcontracts have been returned.
Include "pay when paid" clauses in subcontracts and vendor agreements: To maintain cash flow and protect yourself when owners are slow to pay, stipulate in your contracts that you'll pay subs and vendors only after you've received payments from an owner.
Follow the percentage of completion (PoC) method, as appropriate: The PoC method provides a realistic view of your company's financial status and tax liability, especially on long-term or multiyear projects. It shows revenues, expenses and gross profit incrementally on a period-by-period basis based on the percentage of the project that has been fulfilled. Contrast this with the completed contract method, which reports revenues and expenses in a lump sum once a project is complete. We can help you determine which accounting method to use for each job.
Keep current work-in-progress (WIP) schedules: A WIP report is a component of your balance sheet and is an essential financial tool in construction accounting. Keeping an updated WIP schedule for each project will allow you to monitor progress and costs — and how much of those costs remain. With this information, you can measure a project's PoC and review your billing to determine whether you're over- or underbilled on the project and cash positive or negative. When individual project WIP reports are reviewed together, you can assess where your entire business stands financially. It's also good practice to use a WIP report as the starting point for a cash flow projection.
Monitor cash flows: Keeping a close eye on cash flow at the job level allows you to know where dollars are going and when they're coming in — and how much cash your company has on hand at any given moment. With strong financial reporting and forecasting, you can better understand how cash moves through your construction company throughout the year and plan accordingly to ensure you have enough operating capital to mobilize on projects, make payroll and finish jobs on time.
You may already use some or all of these strategies. Contact us to learn more about how to execute them more effectively and other ways to strengthen your construction company's financial position.