Cracking the code of your company finances shouldn’t be a struggle. If you’re just stepping into the construction world, or looking to improve your financial handling, this straightforward guide has got you covered with all the essentials.
Construction accounting differs from typical bookkeeping; it requires a strong understanding of the construction industry’s unique characteristics. Unlike industries with predictable product lines or fixed locations, construction is project-based and fluid, with unique considerations like change orders. The Ultimate Construction Company Accounting Guide will explore the specifics of managing a mobile workforce, handling project-based construction accounting, and mastering revenue recognition methods like the percentage of completion method.
Table Of Contents:
- Understanding Key Aspects of Construction Accounting
- Job Costing
- Contract Revenue Recognition
- Navigating Contract Retainage
- Mastering the Art of Billing
- Payroll Management and The Mobile Workforce
- The Importance of Specialized Reports
- The Transformative Power of Software
- The Ultimate Construction Company Accounting Guide: Finding an Expert Financial Partner
- The Ultimate Construction Company Accounting Guide: Conclusion
Understanding Key Aspects of Construction Accounting
Understanding the cornerstones of sound financial practices helps contractors better control their business by effectively managing job costs, accurately recognizing revenue, and staying informed about state-specific regulations. By following the guidance outlined here, businesses can create a path to sustainable profitability.
Job Costing
Precise job costing is at the core of construction accounting, ensuring every dollar spent is allocated to its respective project. This process, often detailed in a job cost sheet, allows contractors to closely monitor profitability at a granular level.
Job costing goes beyond simple expense tracking; it delves into individual components such as direct and indirect costs, overhead allocation, and cost codes. This meticulous tracking allows businesses to gain valuable insights into project performance by categorizing expenses according to materials, labor, and overheads.
Analyzing past project data using this meticulous tracking becomes crucial for informing future bids and estimates. Effective job costing within your chosen accounting software allows contractors to bid confidently, control expenses with greater precision, and ultimately increase profit margins. Construction companies are empowered to proactively manage projects, rather than simply react to unfolding costs. For a practical example of how this looks, refer to this Job Cost Sheet example.
Contract Revenue Recognition
Construction companies often grapple with projects spanning multiple months or even years, with revenue coming in at various stages. Determining how and when to acknowledge this income on financial statements depends on the method chosen: cash method, completed contract method (CCM), or percentage of completion method (PCM). These revenue recognition techniques provide clarity for income tax purposes and offer insights into a company’s overall financial standing.
Smaller construction firms may opt for the simplicity of cash-based accounting. This straightforward method records revenue upon receipt of payment and registers expenses only when bills are paid. While this method eliminates the complexities of tracking accounts payable (A/P) or accounts receivable (A/R), it offers a delayed financial picture that may not provide the foresight needed for proactive decision-making. Additionally, the IRS Tax Cuts and Jobs Act (“TCJA”) of 2018 states that only construction firms with an average gross receipts under $25 million (adjusted for inflation) over the previous three tax years are eligible.
The CCM recognizes revenue and expenses at project completion, offering tax benefits by deferring taxable revenue to later periods. This method works best with smaller, shorter projects. For businesses juggling longer projects, PCM presents a more accurate representation of a company’s financial position by recognizing revenue in alignment with project progress.
Each invoice triggers a portion of the revenue recognition, reflecting a clearer picture of earned income, which is crucial when working with projects extending over fiscal years. It’s important to note that these accounting methods fall under the umbrella of the Generally Accepted Accounting Principles (GAAP), offering guidelines and standards for accounting in the U.S. Although compliance with GAAP is generally mandatory for publicly traded companies, it also represents best practices for many privately held companies, fostering transparency, and providing a common accounting language, ultimately aiding in more effective communication between a construction company and stakeholders, lenders, and potential investors.
Navigating Contract Retainage
Retainage, a common practice in the construction world, involves a portion of the payment (usually around 5%-10%) being held back by project owners until the project is complete and deemed satisfactory. As detailed by most state laws such as Wisconsin laws outlining maximum retainage rates, this withheld percentage acts as insurance for the client, protecting them from unfinished tasks or faulty workmanship.
While contractually straightforward, managing retainage within a construction company demands specific accounting practices. Unlike A/R, which reflects the full amount owed, retainage is held in a separate asset account. It is only recognized as A/R once the project meets completion terms and release is approved by the owner.
While retainage is a necessary aspect of construction projects, the long withholding periods can significantly impact cash flow, especially for businesses working with tighter margins. Strategic planning and cash flow management can mitigate these potential bottlenecks.
Mastering the Art of Billing
In the world of construction, there are several common construction-specific billing methods, each with their own nuances and implications for financial management.
The most common method is fixed-price billing, where the price for the whole project is locked in up front. This can either be a firm “hard bid” or negotiated to allow for flexibility in case of unforeseen circumstances. Next, there’s time and materials (T&M) billing. With T&M, it’s all about carefully documenting hours and resources. Transparency is key, as this method involves a per-hour labor charge coupled with a marked-up cost of materials to incorporate overhead and secure profits.
Lastly, there is unit price billing, often seen in large-scale public or commercial projects. Unit price billing revolves around a pre-agreed-upon cost-per-unit. This could be per cubic yard of concrete poured or per square foot of roofing installed. AIA progress billing, favored for commercial and government contracts, involves invoices tied to project milestones. The American Institute of Architects has streamlined the process with its Form G702 summary coversheet and Form G703, a breakdown of work completed, offering a clear picture for clients.
Effectively navigating these various methods, along with selecting appropriate construction accounting software, is vital. Software like Deltek, known for its specialized solutions such as Project Information Management for the AEC (architecture, engineering, and construction) industry, can be instrumental in tracking projects and cash flow, ensuring financial stability, and fostering stronger client relationships.
Payroll Management and The Mobile Workforce
Payroll in construction can be complex. Unlike a typical office setting, construction crews move from one job site to the next, requiring careful tracking of time, location, and project-specific wages.
Adding to the complexity is the Davis-Bacon Act, which dictates prevailing wages on federal projects. Imagine having teams in different states working on state-funded public projects; this means navigating a whole new set of local labor regulations and tax requirements for each project.
Technology like robust accounting software can be used to track and ensure compliance with both federal regulations, like the Davis-Bacon Act, as well as various state laws. Utilizing these tools alongside a consistent review of updated regulations is vital. This ensures businesses are accurately paying their workers based on location and project requirements.
The Importance of Specialized Reports
Contractors should have consistent access to reports that are tailored for the construction industry, going beyond basic income statements and balance sheets.
Report Name | Purpose |
Job Cost Report | Details actual costs vs. budget for each job and cost code. |
Work in Progress (WIP) Report | Provides insight into income earned, expenses, and potential profit on active but unfinished jobs. |
Cash Flow Report | Helps predict incoming and outgoing payments to foresee and manage cash flow issues. |
Projected Income Statement | Creates a forecast of revenue and expenses over time to inform decisions on staffing, budgeting, and bidding new jobs. |
Regularly reviewing these statements, with a focus on key performance indicators, arms construction businesses with the data needed to make proactive, informed choices.
The Transformative Power of Software
In today’s digital age, a construction company accounting guide would be incomplete without addressing the power of industry-specific software solutions. Forget about managing stacks of spreadsheets; these software solutions streamline data management, improve accuracy, and free up valuable time.
Construction-specific software solutions can effortlessly manage job costing, track invoices, forecast cash flow, and provide real-time insights into your financial health. They are tailored to tackle the complexities inherent in managing projects with dispersed workforces and long timelines.
Software like Deltek streamlines data sharing, allowing field teams and back-office staff to work from a unified platform. Similarly, Procore, designed for construction project management, facilitates collaboration and enhances data visibility across projects, ultimately streamlining operations. By embracing these technological advancements, construction companies can enhance efficiency, minimize errors, and focus on what matters most: building successful projects.
The Ultimate Construction Company Accounting Guide: Finding an Expert Financial Partner
In the dynamic world of construction accounting, companies face unique financial challenges that demand specialized expertise. An experienced financial partner can navigate these complexities, and by leveraging their deep understanding of industry-specific financial intricacies, they help construction companies mitigate risks, enhance profitability, and achieve sustainable growth. Their guidance is indispensable in making informed decisions and planning for long-term success, ultimately empowering construction companies to build a solid financial foundation for the future.
What is the best financial partner for construction companies?
A Fractional CFO (Chief Financial Officer) is the ideal financial advisor for a construction company. These seasoned professionals bring a wealth of industry-specific knowledge, creating financial clarity and helping to avoid common pitfalls that contractors face.
What is a Fractional CFO?
A Fractional CFO is a highly experienced financial executive who provides CFO services to businesses on a contract basis. Fractional CFOs offer strategic financial guidance and expertise without the full-time commitment or associated costs. This flexible arrangement is particularly beneficial for small to mid-sized businesses that need high-level financial leadership but cannot justify the expense of a full-time CFO. By leveraging the skills of a fractional CFO, companies can gain valuable insights and drive growth while maintaining financial stability.
A Fractional CFO that specializes in construction, like DAAXIT, can provide the right guidance to build a stronger, more profitable business.
The Ultimate Construction Company Accounting Guide: Conclusion
Understanding the complexities of construction company accounting is not just important—it’s essential for achieving lasting profitability in the construction industry. This involves meticulous attention to detail, selecting the most appropriate accounting method, and, crucially, equipping your business with the right tools and expertise. Whether it’s experienced financial partners or robust accounting software, making informed choices in these areas is key to financial success. By prioritizing financial awareness as outlined in this guide, construction companies can turn potential challenges into opportunities, leading to well-managed projects and maximized profits. By leveraging the tips and techniques detailed throughout this guide, success in construction becomes an achievable target rather than an industry myth.
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