Accounting for small business owners, with just a few employees on the payroll, select products, and a limited number of transactions is often seen as a herculean administrative task.
Especially for businesses operating in the construction arena, accounting can seem difficult owing to the complexities in the nature of construction work.
However, basic of construction accounting and financial management is a vital part of running a business, and if done correctly, it can be a powerful management tool.
As a construction business owner, you will have to sort through correspondence, paperwork, on-site inspections, manage meetings with engineers, architects, etc. Of all this, the most pivotal factor is: Managing Project Budgets efficiently.
You will need to think about a wide range of financial factors such as billing, cost of labour, and production to reap the rewards. This is why you must understand construction accounting as a construction business owner.
This blog is a helpful guide to understand the concept and offers best practices that work for businesses involved in construction.
What is Construction Accounting?
Accounting is the language of business. It is the practice of recording and summarizing financial transactions as well as business transactions. The importance of accounting for a business is crucial in determining the economic outcomes of the business.
Construction accounting is a distinct type of financial management, bookkeeping, and accounting for contractors. It was designed exclusively to support contractors in keeping records of each project and how it affects organisational performance.
Construction accounting is particularly difficult since projects sometimes span multiple reporting periods, demanding projections of future project revenue and expenditures to determine the amount of revenue earned and related profit in any given accounting period.
Why is Construction Accounting Different?
While construction accounting incorporates all of the fundamental principles of general accounting, it also contains a few unique features.
1. Project-Based
Retailers treat each store as a profit centre. Whereas contractors treat each project as a short-term profit centre, each producing a varied amount of revenue. Therefore, it’s beneficial to consider each project as a unique entity with its profits and losses.
Due to this, the financial focus for the company varies. Most significantly, construction companies must keep costs under control and bid rationally, which requires reliable cost tracking for particular projects.
2. Differing Overhead Costs
The construction industry has different costs than other businesses. Hiring laborer’s, subcontractors, training, insurance, etc., are more relevant and specific to the construction industry than other industries. The overhead costs associated with these are more volatile with changes in laborer’s, subcontractors, etc.
3. Specialized Contracts
Construction contracts usually have a long gestation period and flexible terms than other businesses. Thus, there is scope for many changes in contract terms. Due to this, contractors must have the tools to precisely track costs and make available funds for pay periods.
4. Nature of Production
Production takes place on a variety of sites rather than in a single area. As a result, equipment and workers must be moved from one location to another, resulting in mobilization costs. These expenses must be carefully traced to each location, along with the correct wage rate.
Construction Accounting Best Practices
1. Job Costing
Job costing entails all teams (operations, sales, etc.) keeping track of spending during the project and submitting those charges daily. Expenses must be classified under different buckets in the same way the estimate was drawn up before the project. Using time-tracking software might prove to be useful in keeping track of volatile costs such as labour.
2. Automation
There are many software solutions that offer transaction categorization, bank account reconciliation, financial statement preparation, and management of bills and invoices. This will prove to be time-effective in managing company construction accounts especially when there are multiple ongoing projects.
3. Cash Basis
Cash basis accounting is the most sophisticated way of construction management accounting. It involves the accountants recording money as and when they received or spent. However, this would not be feasible with multi-year contracts where revenue realization and expense allocation are spread out over long periods.
4. Payroll Management and Bank Account Reconciliation
Invest in solutions that help reconcile your bank account with your financial records as well as simplify payroll processes that can calculate, process, and distribute payments to your employees and subcontractors.
5. Tax Reporting Strategies
Construction firms manage multiple projects across multiple locations for various clients. Therefore it is crucial that the firm has tax reporting strategies in place to manage its tax liabilities. The firms will need to have reports created annually and ensure they comply with the tax requirements.
Things to track:
Accounts payable and Accounts receivable
Job costs
Labour costs and wages
Overhead costs
Costs of equipment – maintenance, cost of rental equipment to be included
Insurance
Administrative expenses towards accountants, controllers, etc.
Conclusion
Construction accounting is pivotal to the survival of your projects and business since it provides continuous deep insight and effective communication with internal and external stakeholders. It entails identifying the costs involved in a project and managing the diverse portfolio of contracts.
Construction accounting is a complex process. Analyze the operations of your firm and apply the best practices to maximize profitability. The accounting practices should align with the business model of the company.
Most contractors focus on job costing and change order management as they are crucial to maintaining profitability while keeping the business efficient in its work.
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