Construction accounting is complex and mistakes are inevitable. That’s because construction accounting, compared to regular accounting, has unique requirements, processes, documents, and procedures, such as AIA billing, change orders, submittals, and Requests for Information (RFIs). In addition, a contractor’s payroll can become complicated when work extends to multiple states, requires prevailing wages, or involves unions.
How Can Contractors Improve Their Construction Accounting?
Through decades of servicing the construction industry, we have identified 10 best practices in construction accounting that will help increase job profitability, manage cash flow, and successfully grow your business.
#1 USE JOB COSTING
At the end of each day, a contractor needs to use job costing to allocate the cost of equipment, tools, and other assets used on a job (e.g., the cost of owning, operating, and maintaining that asset) to keep score of their jobs and business overall. Any easy way to do this is through a robust construction accounting software solution, such as Deltek + ComputerEase.
#2 TRACK COMMITTED COSTS DAILY
Costs already committed for subcontractors and materials should be tracked in real-time to maintain control over a job and keep it profitable. You will know, with certainty, the budget you have available for future expenses and/or additional costs. Some examples of committed costs include an open subcontractor agreement, purchase orders, time from the field, and expenses from the field.
#3 UNDERSTAND THE DIFFERENCE BETWEEN MARGIN AND MARKUP
Markup is the difference between the cost of materials or services and the price charged. Margin is the gross profit on a job and is a percentage of the sales price. Mistaking the two terms may cause you to set a price too high or too low, which can result in losing profits and potentially, business.
#4 DISTINGUISH BETWEEN PERCENTAGE SPENT AND PERCENTAGE OF COMPLETION
If you’ve spent half your budget that does not necessarily mean you have done half the work. You may have done only 40% of the work, or maybe 60% of the work. Understanding and tracking percentage spent and percentage of completion through your WIP reports allows you to come in under budget.
#5 RUN FREQUENT WORK IN PROGRESS (WIP) REPORTS
WIP reports are one of the most important reports for a contractor because they provide a detailed schedule on completed work and in-progress work for a certain period of time. With frequent WIP reports, you can manage work and profit proactively using actual job data as opposed to being reactive to problems that arise. This helps you stay ahead of the game and grow your bottom-line profits. The commonly used WIP methods include units complete, percent complete, and cost-to-finish. WIP reports also identify underbilling and overbilling amounts. The accounting staff must enter these amounts on the P&L Statement and Balance Sheet to get an accurate financial picture.
#6 IDENTIFY OVERBILLINGS VS PROFIT
Overbilling occurs when a contractor bills ahead of work completed. If managed properly, overbilling can positively affect cash flow. If unmanaged, it can be problematic because contractors will not have the available cash to fund the remaining work. For example, if you overbill by $10,000, that is not a cash profit that you can spend. That amount should be recognized as payment for work that has not yet been completed.
#7 MANAGE YOUR CHANGE ORDERS SUCCESSFULLY
Change orders are a product of changing the scope of the initial contract. To successfully manage your change orders, it is important to provide contracts that are detailed and easy-to-understand, introduce the change order process in the initial contract (and negotiate pricing and markups for change orders), and establish the structured process for change requests, both with the client and your internal team. Since change orders occur so often in the construction industry, creating change order templates for customers and exploring construction accounting software tools will save you time, rather than manually creating change orders at the time they are needed.
#8 MONITOR UNPOSTED PAYROLL
Standard accounting software lacks the ability to track unposted construction payroll. However, monitoring these costs in real-time with a project management software allows you to manage costs proactively by seeing the effect of employee hours on the budget without actually processing payroll.
#9 TRACK LABOR HOURS EACH DAY
You want workers to turn in their time at the end of each day, not the next day, not a week later. Tracking things as they happen with remote field-to-office tools, like the Deltek + ComputerEase mobile app, makes them more accurate and you don’t have to return to the office to do this.
#10 CHOOSE THE RIGHT CONSTRUCTION ACCOUNTANT
The unique accounting requirements a contractor is faced with almost always call for a CPA that specializes in construction. Choosing the right Certified Public Accountant (CPA) is a critical step to building out your trusted advisor team and can be a major contribution to business growth. Locate a CICPAC member firm near you.