Good accounting practices are critical for any business. They are especially important in the construction industry.
Construction accounting is more challenging than it is for businesses in other sectors due to the nature of the work, pricing for particular projects, fluctuating operating expenses, and other variables. Additionally, construction companies need to be able to handle a variety of accounting tasks, including managing payroll, submitting project bids, tracking and reporting spending, and more.
Here are five accounting best practices to help your construction business simplify accounting processes and better manage cash flow.
1. Job Costing
A construction company will most likely handle several projects at once. It is essential to accurately allocate expenses to each job in order to manage costs and gauge a project’s profitability. To guarantee that the company's financial records are correct, all direct and indirect expenditures must be appropriately assigned to the corresponding job. This must be done during the project, not after, and daily expense reports must be filed.
Additionally, it is recommended to categorize expenses in the same format as the estimate provided for project managers to determine if the job is going as planned. It is also advisable for the company to have a standard formula by which they measure indirect costs, like administrative time, for each project.
2. Percentage of Completion
One way to account for long-term building projects is the percentage of completion method. This strategy, as the name implies, recognizes revenue as the project nears completion. This is recognized as a more accurate way of recording revenue and expenses and is often preferred by banks and lenders, because contractors bill in stages for work performed to date, recording the earned revenue and expenses at each stage.
3. Completed Contract Method
In contrast to percentage of completion, the Completed Contract Method (CCM) defers reporting all project revenue, expenses, and profit until a contract is completed in full. This method is best used for contracts under two years where it is not possible to calculate the project’s percentage of completion. CCM also allows revenue to be deferred to a future period for income tax purposes; however, to be eligible, contractors must complete their contracts within a set period, and they cannot exceed a certain average annual revenue.
4. Manage Change Orders
It is common for construction projects to undergo changes from the original plan. While this may be expected, these changes can reduce project revenues or even result in customer disputes. Ideally, the initial contract should clearly state how modification orders are to be handled in order to prevent this. Additionally, contractors should set up a consistent change order procedure that includes thorough documentation of the work and costs associated with each request for a change. It is important to record any change orders in your accounting system so that project cost and profitability are tracked accurately.
5. Accounting Software
Accounting software can help automate processes like job costing and estimate comparisons, simplifying bookkeeping efforts and enabling contractors to better track profitability. There are accounting software options specifically designed for the construction industry, with some including broader project management tools and employee time tracking capabilities.
Construction company accounting is challenging and calls for a special strategy, as well as a thorough comprehension of all the components that go into the process. By following these suggestions and best practices, you can make sure that your business is able to maintain accurate records and have a thorough understanding of your financial position.