Commercial construction companies face financial challenges unlike other industries. Construction accounting demands a special approach. It’s not just about recording transactions; it’s about carefully managing every dollar on a project, from the initial bid to the final payment.
With slim profit margins and the construction industry’s high failure rate, mastering contractor accounting becomes critical for a company’s survival and growth. It demands more than basic bookkeeping, especially given the prevalence of change orders and complex construction contracts in the industry.
Table Of Contents:
- What Makes Contractor Accounting Unique?
- Benefits of Specialized Contractor Accounting
- Conclusion
- FAQs About Contractor Accounting
What Makes Contractor Accounting Unique?
While all businesses need financial management, construction accounting is different. This is due to factors unique to construction. Long project timelines, complex contracts, and reliance on subcontractors all introduce specialized accounting requirements.
1. Project-Based Accounting and Accurate Job Costing
Commercial construction companies revolve around individual projects. Contractor accounting focuses on monitoring and managing each project’s finances separately.
Think of each project as its own small business with its own income statement, balance sheet, revenue, expenses, and profitability. To understand your overall financial health, you need accurate insights into each project’s cost sheet.
This is where job costing comes in. A well-structured job costing system breaks down the expenses for each stage of a project, such as labor, materials, equipment, and subcontractors.
For instance, your working capital turnover might look healthy at a glance. However, upon deeper review of your job cost sheets, several projects could have negative working capital, indicating potential cash flow problems.
This level of detail helps create more competitive bids. Your historical cost data tells you the actual cost of each phase, so you can bid intelligently and protect your profit margins.
For example, imagine a contractor reviewing their financials. Their job cost sheets show a worrying trend. Even though large commercial projects showed good profits, several smaller renovation jobs, mostly overlooked, are draining the company’s cash flow.
By using job costing software and adjusting bids on these smaller jobs, they regain control and increase overall profits.
2. Complex Contracts and Revenue Recognition Methods
Construction accounting doesn’t involve straightforward transactions like retail sales. Instead, it involves complex, long-term contracts, often with payment milestones spread over months or even years.
The extended timelines associated with construction work make accurate revenue recognition more challenging than in other industries. Determining when to record revenue becomes crucial in painting an accurate picture of the company’s finances.
Choosing the right revenue recognition method depends on factors like your contracting business’s size and the average length of your projects.
Contractors with under $25 million in revenue for the preceding three tax years might use the cash basis method, where income is recognized upon payment.
This method is simple, but it can create an inaccurate financial picture when dealing with projects with staggered payments. For example, you might have hefty expenses logged for a project, while the associated revenue isn’t recorded until the very end. This distorts your financial statements and impacts tax planning.
Many commercial contractors, especially larger businesses, adopt an accrual-based method. Within accrual methods, the most common option for construction businesses is the percentage of completion method. As work is finished on a project, a corresponding percentage of the project’s revenue is recognized. The percentage of completion method gives a smoother, more realistic view of financial progress and cash flow over time.
There’s also the completed contract method. With this method, revenue and expenses are recognized only when a project is finished. This approach can minimize your immediate tax liability, as profit is recorded later. However, it can lead to fluctuating income, which can make cash flow management unpredictable and impact how you see your business’s overall financial health.
It’s important to work closely with a construction accounting specialist or tax advisor. They can help you determine the best revenue recognition method for your specific situation and goals.
3. Mobile Workforces, Payroll, and Union Compliance
Commercial construction happens at various job sites, requiring mobile workforces. Accurately tracking labor costs becomes essential in construction accounting.
Allocate worker hours and wages to each project. Factor in things like travel time, benefits, and other expenses related to having a mobile workforce. Accurately calculating the labor burden is essential for accurate bids and profitability.
In the United States, government-funded construction projects over $2,000 are subject to the Davis-Bacon Act (DBA). This act mandates contractors pay “prevailing wages.” These wages align with regional labor rates for similar work and these rates change frequently.
You are also obligated to report this prevailing wage information to the relevant government agencies. Failing to include these costs in your bid calculations could lead to significant losses on a project.
The DBA ensures fair wages, but it also creates accounting complexities for contractors. They need to forecast these wage changes and manage potential cost increases.
Union involvement adds another layer to contractor accounting. Subcontractors you work with might have varying wage requirements from their collective bargaining agreements with local unions.
This means accounting for different rates and properly deducting any required union dues, which is different from managing a non-union workforce.
4. The Retainage Quandary
It’s common for customers (private and public) to withhold a percentage of the contract value until project completion, known as retainage.
This is typically between 5-10%. While retainage protects the owner from quality issues or delays, it significantly impacts your working capital and cash flow, especially on large projects.
The aim of retention is to safeguard the project owner. However, from the contractor’s viewpoint, it’s a significant portion of your project’s profit that you can’t access for a potentially extended period. This can be years, depending on your state’s laws.
This lack of access to a large part of your earned income requires careful financial planning. It might necessitate finding financing solutions and clear communication with your subcontractors if you use retainage with them.
5. Specialized Billings
Billing in contractor accounting is more complex than in many industries. Construction projects vary in scope and scale, meaning your pricing, contracts, and payment schedules change based on the project.
There are five main types of construction contract billing:
- Lump Sum Contract: You and the client agree to a fixed price before starting, which requires detailed and accurate estimations.
- Time and Materials Contract: Payment depends on labor hours, material costs, and a profit markup, helpful for fluid project scopes subject to changes.
- Unit Price Contracts: The work is split into units, with pricing on a per-unit basis. These are common for large projects with multiple phases or repeating tasks.
- Cost-Plus Contracts: The customer reimburses all project expenses plus a profit percentage, minimizing your financial risk but requiring accurate cost tracking.
- Guaranteed Maximum Price: Like cost-plus, but with a set upper price limit, demanding stringent cost control to ensure profitability.
AIA Progress Billing adds another layer of complexity. Contractors submit regular invoices, usually monthly.
Benefits of Specialized Contractor Accounting
With all these complexities, you might ask: why bother? Strong contractor accounting practices offer major advantages, helping you thrive in a challenging industry.
A good accounting system does more than track spending. It provides tools for cost control and profit margin protection. It identifies when expenses rise or budgets go off track. This early detection allows for course correction and better resource management, which is especially crucial when dealing with fluctuating material costs or indirect costs.
Diligent tracking of all financial aspects empowers you to bid competitively and hit your profit goals. This allows you to use historical data from past projects to inform future bids and pricing strategies.
Choosing the Right Contractor Accounting Software
Contractor accounting software has significantly improved, streamlining processes. These include job costing, bid management, financial reporting, progress billings, and payroll within a centralized system.
With many software options designed for construction, choosing the right one takes some planning. Many are tailored for specific construction sectors.
Software Option | Notes |
NetSuite | Large suite of features, suitable for businesses needing various business solutions (like CRM or inventory) bundled within the software |
QuickBooks Online | Often chosen by small- and medium-sized contracting businesses for its affordability and basic functionality. Many CPAs are experienced in this software. |
Sage 100 Contractor | Robust software known for its specialization in construction, suitable for small to large businesses needing advanced features like estimating or service management. |
Sage 300 CRE | Geared towards large contractors with more complex requirements. Offers integrations with other popular Sage business software. |
Sage Intacct | Cloud-based accounting solution, often considered when a business needs stronger integrations and scalability. |
Jonas Premier | Considered by some to be a strong choice, particularly when a business needs service management, dispatch and scheduling bundled within their software. |
Acumatica | Wide range of features for project and resource management, well suited for companies needing advanced reporting and integrations with other solutions. |
When choosing construction accounting software, consider these factors:
- Ease of use
- Scalability
- Features aligning with your projects (like unit price tracking)
- Accurate job costing capabilities
- Support offered
- Integrations with other systems
- Mobile access for on-site teams and approvals
FAQs About Contractor Accounting
What is contractor accounting?
Contractor accounting is a specialized system used by construction companies to manage the finances of each project separately. It involves tracking job expenses, creating invoices, managing bills, handling payroll for mobile workforces, addressing project-specific taxes, and determining the appropriate revenue recognition method for long-term contracts.
What is the process of construction accounting?
Construction accounting is a multifaceted process that encompasses all financial transactions related to a construction project, often integrated with specialized accounting software.
It starts with pre-bid cost analysis. Then it moves on to meticulous expense tracking throughout the construction phase, timely invoicing, and ensuring tax compliance.
Other important aspects include managing payroll for workers across different job sites with varying pay rates, including union dues considerations, and deciding on the optimal method for revenue recognition from projects, particularly those with extended payment timelines.
What type of accounting is used in construction?
Construction businesses usually use either cash basis accounting or accrual accounting. The best fit depends on factors like the company’s revenue and project durations. Many contractors with larger revenues choose an accrual approach like the percentage of completion method. This gives a more accurate view of a project’s profitability during its life cycle rather than waiting until completion.
Conclusion
Mastering contractor accounting ensures the success of your construction business. By accurately tracking project costs and expenses with a detailed system, you’re better equipped to make informed decisions. Make the most of available tools like accounting software. Work closely with construction accounting experts. By doing these things, you’ll gain a competitive edge and build a more financially stable and profitable future.