As you grow your construction firm, you'll find that construction accounting presents distinct challenges. The biggest hurdle is that construction industry costs aren't straightforward. Each project incurs both indirect and direct costs. There are unique charges such as travel time, cleanup hours, and equipment rentals. Revenue is also normally calculated based on the percentage of the job completed.
The construction industry depends on accurate and efficient work. Companies with a reputation for safety, speed and attention to detail will likely succeed. With the hustle and bustle involved with requests for proposals and ensuring that current jobs are completed accurately and on time, accounting sometimes takes a back seat.
While construction accounting can be challenging, the right strategies can alleviate the headaches.
Common construction accounting problems
Though many small businesses grapple with common accounting mistakes, construction companies face unique issues. Here are some of the most common accounting problems in the construction industry.
- Bad overhead estimates: Construction projects come with significant overhead, including the costs associated with office space, equipment, materials, rental and labor. Because construction requires different things at different times – and overhead can fluctuate from season to season and from job to job – it's hard to get a clear picture of your overhead costs. Without a solid estimate in place, it's difficult to determine if your business is making a true profit – even if your jobs are profitable on paper.
- Cost-accrual problems: Most construction companies declare revenue when money is collected, often at the end of the job. However, these companies take on expenses throughout the project. This can lead to serious confusion about how profitable each job is, leading to cash flow management problems if you aren't careful. For example, if you only bill for a project when it's complete, stacked costs that accumulate throughout the project could chip away at your cash reserves, and you might end up with a false idea of your overall profitability.
- Scope creep: Even the best-laid plans are subject to last-minute changes. New information, such as material availability or building site conditions, can force your company to change its original plans. Clients who ask for add-on changes, otherwise known as scope creep, can also be an issue. You want to keep your clients happy and make sure the job turns out well, but at the same time, you must control new costs. Project managers and accounting personnel should work together to determine which new costs are feasible and which are not, and draw the line when the project starts to lose a disproportionate amount of profitability.
- Inaccurate cost estimates: It's easy to underestimate costs, especially when dealing with a project that could take months to complete. You might end up needing more materials or different equipment, but labor is the killer. Going even one month past your estimated timeframe could cost thousands in additional labor.
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- POC method and losses: The POC (percentage of completion) accounting method is standard for construction companies because most contracts are long-term. However, this method can cause serious problems when a job has to be reported as a loss. Standard accounting best practices require that you report a loss at the time it's recognized, but the POC method makes it difficult to establish a recognition period. When you determine that a loss is imminent, you need to record that loss right away.
- Partnership confusion: Many construction operations specialize in one element of construction and partner with other businesses to complete large-scale or complicated jobs. These joint operations are often profitable for both parties, but you'll need to be careful how you split and determine your costs and revenue.
Solutions to construction accounting problems
So, how can you make construction accounting easier? Here are four recommendations.
1. Hire the right people.
First, make sure you're hiring the right people for the job. You want people who have formal education in accounting, and preferably experience in construction accounting. Here are a few tips for hiring the right people:
- Explore your options. Do this during the hiring process. Is it best to hire someone with intermediate accounting knowledge, or do you need a professional bookkeeper? Even a year or two of experience in this area can make all the difference for your business.
- Consider soft skills. In any challenging situations your business may encounter, you'll need someone who can maintain a positive attitude under pressure.
- Factor in construction knowledge. You'll also want an employee who understands the construction industry. One great way to gauge a candidate's skills is through administering a short test.
Onboarding can be tedious, but in the end, a thorough hiring process can save time and money.
2. Use the right accounting software.
Most construction firms are aware that accounting software's features and benefits are necessary to keep operations running smoothly. There are many platforms designed specifically for construction accounting, but they aren't all equal.
Here are some tips for selecting the best accounting software for your construction business:
- Ensure it has key features beneficial to the construction industry. Use a cloud-hosted platform that can help you budget expenses, plan for job profitability, and split costs between you and a partner business. Look for software that offers remote access as well.
- Look for advanced capabilities. You'll need a software package capable of handling more than just running payroll. Seek out construction accounting software that can handle change orders, customer deposits, retention and more.
- Ensure comprehensive reporting capabilities. Billing in the construction industry can become complex due to outstanding payments and long-term contracts. Software that can maintain a detailed record of accounts receivable aging reports is vital.
- Research potential software packages. Read reviews and maximize free trial periods to ensure you're getting the features you need.
3. Spend extra time on accurate estimates.
Estimates make or break your construction business. Spend extra time and resources ensuring that your cost projections are accurate and up to date.
A good rule of thumb is to keep detailed estimates versus reports of actual costs. Your reports should include a breakdown of each project phase and an analysis of how close your estimates were to actual costs. As you take on additional projects, these reports can guide you in creating more accurate estimates.
4. Conduct job costing.
Job costing is an accounting method that tracks costs and revenue per project. This method is how you'll generate detailed estimates for materials, labor and overhead on each project and charge your client an accurate price.
A job cost report keeps track of customer billing amounts, the progress of each construction project, and incurred costs over the lifetime of each project. A job cost report is a must for any construction company. If you skip this step, you'll risk going over budget.
To ensure accuracy, include as many details as possible for each project you take on, pay close attention to labor costs, and always have clear insight about your project goals before you begin. Never underestimate the value of communication with both your client and your team.
Reducing the complexity of construction accounting
These four strategies can reduce the complexity of construction accounting and make it much more feasible, even to new or inexperienced construction business owners. In the long run, it's important to use all four strategies equally and resist the urge to gloss over minor details.
With practice, you'll get even better at projecting your expenses and revenues, and your business will remain profitable indefinitely.
Larry Alton contributed to the writing and research in this article.