This article is part of a larger series on Accounting Software.
Construction accounting is a unique form of bookkeeping and financial management with many distinctive features, such as job costing and change orders. This can leave many contractors and construction companies struggling to find the right accounting methods to keep up with their different projects, decentralized work, and irregular costs. In this article, we present tips and best practices to help simplify these construction accounting processes.
1. Use Job Costing
Because a construction company can work on many different projects at the same time, it is critical to accurately attribute expenses to each job to control costs and measure a project’s profitability. All direct and indirect expenses must be allocated to the proper job properly to ensure that the company’s financial records are accurate, and this must occur during the project―not after―and expenses must be submitted daily.
Expenses should be categorized the same way as in the estimate you have provided for project managers to determine whether the job is proceeding as planned. The construction company should also have a standard formula for allocating indirect expenses, such as administrative overhead, to each project. You can use job costing features in the software, such as QuickBooks Contractor.
When done correctly, job costing produces actionable data that provide project managers and supervisors with a “scorecard” to review how their crews are performing and potentially make adjustments. It can also help to protect narrow profit margins and target the right projects.
2. Consider Completed Contract Accounting for Taxes
The Completed Contract Method (CCM) involves reporting all project revenue, expenses, and profit only once a contract is completed in full, although payments may be received during the duration of a project. While this approach is often the most preferred method in the construction industry, it’s best suited for short-term contracts under two years.
Contractors will often use this method if it’s not possible to calculate the percentage of completion for a project or if they want to defer revenue to a future period—but it also has particular restrictions from the IRS. To be eligible, contractors can’t exceed a certain average annual revenue and their contracts must be completed within a set timeframe. It’s also important to note that because revenue isn’t properly matched with costs, this method of income recognition isn’t Generally Accepted Accounting Principles (GAAP)-approved.
3. Use Time Tracking Software With Geofencing
A construction company’s labor force can include a combination of salaried employees, union and non-union workers, and independent contractors. Tracking the labor hours and costs on multiple projects can become disorganized easily, which is why it’s important to take advantage of web-based tools and mobile apps available for construction companies of all sizes to automate the process and reduce human error and oversight.
Not only is it essential to use some form of time tracking software, but it’s also a good idea to invest in an app with geofencing that reminds your employees to clock in and out and allows you to track employee location as they travel at work.
4. Manage Change Orders
Construction projects can often undergo changes from the original plan, which can cut into project profits or even result in disputes with customers. To avoid this, the original contract should spell out exactly how to handle change orders. Contractors should also establish a standard change order process with full documentation of the work and cost required for each requested change.
While contractors should ideally hold off on starting work until a signed agreement from the customer is received, that often doesn’t happen in reality. But either way, it’s important to record the change order in your accounting software so that project cost and profitability can be tracked.
5. Leverage Accounting Software
Construction accounting software helps automate standard processes like job costing and estimate comparisons and also enables contractors to better track a project’s profitability. We recommended Sage 100 Contractor as one of the best construction accounting software, specifically because of its enterprise resource planning (ERP) features that include project management, remote time tracking by employees, and equipment management. Sage 100 Contractor is also a full accounting software package, with a job costing capability that allows you to generate cost reports and check job cost journals, labor journals, and billing summaries.
You can review other great choices in our guide to the best small business accounting software.
6. Choose the Right Payroll Provider
With the rigorous reporting requirements in the construction industry, companies may find that payroll can be a complex process. This can apply in instances, such as prevailing wage requirements, certified payroll reporting, multiple pay rates, multiple states, and multiple localities. Construction companies can also face numerous payroll reporting requirements, even if they don’t have to file certified payroll. These can include union reports, worker’s compensation, new hire reporting, and equal employment opportunity (EEO) minority compliance.
Because there are so many variables that factor into processing payroll for a construction company, it’s important to select the right construction payroll provider. The ability to manage multiple pay rates is key for processing payroll as are multistate, union-specific, and job costing tools.
7. Track Business Expenses
Tracking business expenses can be tricky, as it includes tracking materials and labor too. If you’re paying for these expenses with a credit card, it’s imperative that you use one that’s only for business. You’ll need to track payroll, subcontractor fees, equipment, and material purchases, making sure that the date, description, and payment made are indicated for each transaction.
It’s also important to categorize these expenses by service and individual job so that you can track how much money came in as well as how much you spent on expenses easily. You may want to use a digital expense tracker app to automate this process for you.
8. Reconcile Bank and Supplier Statements
Each month, your bank and suppliers will send a statement for each of your accounts, which you’ll need to reconcile to ensure that it matches up with your own accounting system, invoices, and payments. After checking for any discrepancies, you may need to contact your bank to discuss any issues that come up.
While reconciling your accounts, you may also want to review whether you’ve had any unexpected expenses, which will impact a project’s profit forecast by raising the predicted job costing. You’ll want to make sure that this is accounted for, and that you have a plan in place to ensure that you don’t lose profitability and compromise your profit margin. Check out our recommendations for the best bank reconciliation software.
9. Back Up Records Digitally
Maintaining accurate records of receipts, invoices, and other documents is essential when it comes to managing your company’s finances. If you keep hard copies of these records, you’ll need to organize them so that it’s easy to find the documents you’re looking for. But you should also have a backup plan in case your documents are lost or damaged; maintaining a digital record of these files is the best way to ensure their safety.
Cloud-based technology offers nearly unlimited storage capabilities at affordable prices. By keeping backups in the cloud, you’ll make sure that your construction business will have access to the information it needs to function, no matter where you are.
10. Improve Inventory Tracking
Keeping an accurate inventory of materials makes it easier to see where your resources are being used so that you can budget accordingly. It isn’t unusual for a job to require more labor or materials than originally anticipated, and if you’re constantly taking materials from inventory, you can quickly go over budget on a project as well as find yourself in short supply on others.
Automating inventory management is the key to increased efficiency and eliminating time-consuming manual tasks. Since contractors deal with an array of construction materials―from raw materials and consumables to prefabricated products―and are often managing multiple construction sites at any given time, the need to streamline storage locations, work orders, and purchase orders (POs) using an inventory management system is crucial. We suggest reviewing our recommendations for the best inventory management software.
How Construction Accounting Is Unique
Construction accounting differs from regular business accounting in several ways. In addition to the standard accounts receivable (A/R), accounts payable (A/P), and payroll transactions, construction companies also deal with job costing, change orders, progress billings, and customer deposits. Here’s a summary of its three most distinct traits:
- Project-based: Whether related to production, billing, or labor, construction companies operate their business primarily around projects. Therefore, contractors must treat every construction project as a unique, short-term profit center. To control costs and bid successfully, it’s crucial to track accurate costs for each project individually.
- Decentralized production: Construction projects primarily happen on different job sites as opposed to a fixed location. Both equipment use and labor frequently moves from site to site, which can result in mobilization costs. It also means that equipment and labor costs must always be tracked to each job site along with the correct wage rate.
- Long-term contracts: In construction, production contracts can last years and have multiple, extended payments over that time. Contract terms frequently allow 30, 60, or 90 days or more to pay invoices. As a result, revenue recognition and cash management carry special considerations in construction.
Accounting for construction companies comes with its challenges and requires a unique approach as well as a comprehensive understanding of all of the factors that go into the process. By following the suggested tips and best practices, you’ll ensure that your company will be able to maintain accurate records and have a better handle on your financial situation.