As a builder or construction company owner, managing your finances properly is crucial for business success. Construction accounting requires specialized knowledge of fluctuating project expenses, complex tax regulations, and clients demanding financial transparency. This guide will explore the methods, tools, and best practices vital for tracking costs, maximizing profits, maintaining accurate records, and communicating clearly with clients.
Accounting Methods for Construction Projects
Choosing the right accounting method is the foundation for effective financial management. Construction accounting differs from standard small business accounting due to the unique nature of building projects. Let’s examine the most common accounting approaches for builders:
Cash vs. Accrual Accounting
Cash-based accounting recognizes income and expenses when cash changes hands rather than when transactions occur on paper. This simpler method benefits small projects, but accrual accounting better captures financial health over time.
Accrual accounting records revenue when billed and expenses when incurred, even if money has not actually been exchanged yet. This helps match revenues with related expenses for improved insights. Accrual accounting is typically the wiser choice for builders handling multiple projects simultaneously.
Job Costing Principles
Job costing tracks direct costs like materials and labor to specific projects. Builders can accurately calculate each project’s profitability by compiling all associated income and expenses per job. Careful job costing enables you to budget smarter for future projects and identify issues with current ones.
As projects progress, diligently log all related expenditures, including subcontractor invoices, equipment rentals, permits, etc. Job costing integration within accounting software can automate this process for simplified tracking.
Percentage of Completion Approach
Builders can utilize the percentage of completion method (POC) for long-term construction projects spanning months or years. As portions of the project are completed, you incrementally recognize matching revenues and expenses. This prevents artificially inflated earnings or losses from showing on financial statements during the building phase.
Key Financial Tasks and Best Practices
With the foundations of construction accounting established, implementing consistent workflows for key financial tasks is vital for staying organized. Follow these practical steps and best practices:
Creating Accurate Project Budgets
- Gather extensive details on project scope, local regulations, material and labor costs, etc.
- Pad estimates for unexpected expenses average 5-10% of total costs.
- Continuously update the budget with change orders as projects evolve.
Tracking Expenses and Cost Estimates
- Input expenses immediately, including subcontractor invoices and supply purchases.
- Run job cost reports frequently to monitor if actual spending aligns with estimates.
- Carefully log details like vendors, purchase purpose, and job cost codes for expenses.
Managing Payroll Effectively
- Classify employee hours into indirect or job-specific activities for accurate cost data.
- Ensure timely payment of wages and tax withholdings to avoid penalties
- Consider outsourcing payroll processing to reduce administrative headaches
Generating Clear Invoices and Reports
- Use job costing data to create detailed invoices covering labor, materials, sub-costs
- Attach POC percentages and progress details to invoices for transparency
- Present executives with consolidated financial reports and cash flow projections
By making these accounting workflows second nature, builders reap benefits such as predictable budgets, controlled spending, tax savings, and forecast insights. The right accounting tools are key enablers.
Financial Tools and Software for Builders
While generic small business accounting software works initially, growth-focused construction firms need specialized technology to address their unique needs.
Features to Look for in Accounting Software
Core functionalities like job costing, payroll, POC revenue recognition, and reporting are essential. Also, prioritize:
- Change order tracking: Link change orders to associated projects and quickly assess profitability impacts
- Document management: Organize project drawings, permits, warranties, and more in one system
- Mobility: Access financial data and approvals on the go through mobile functionality
Top Software Tools for Construction Accounting
Viewpoint, Procore, Sage 300 CRE, Jonas Premier, and CMiC rank among the top solutions with tailored features for builders. Weigh their pros, cons, and costs to determine the best fit. Integrating add-ons like estimating or bid management tools expands capabilities further.
Integrations for Improved Workflows
Using open API interfaces, leading construction accounting platforms integrate with complementary solutions for complete business management:
- Payroll tools like Gusto automatically transfer employee data
- Routing schedules sync field staff timesheets into the accounting
- Inventory management apps update materials costs and quantities
Tax Considerations and Compliance
Tax regulations vary significantly across states, counties, and cities – presenting headaches for multi-location builders. Staying compliant involves navigating a complex maze of forms, deductions, credits, and deadlines.
Common Tax Deductions and Credits
Cost of goods sold (COGS) deductions significantly lower taxable contractor income. Track raw materials, equipment rentals, subcontractor payments, and other project expenses within COGS.
Claiming depreciation on vehicles, heavy machinery, and office assets also reduces tax burdens. Section 179 and bonus depreciation provide added deductions for new equipment purchases.
Research applicable credits within state and federal tax codes – from small business health insurance credits to enterprise zone credits supporting local growth.
Filing as a Construction Business
Classifying your construction firm’s legal structure is critical when filing business tax returns:
- Sole proprietorships and partnerships utilize Schedule C Form 1040
- S corporations file with Form 1120-S
- C corporations file Form 1120
Estimated quarterly payments hedge against underpayment penalties. Paying 30-50% of projected annual taxes quarterly avoids lump sum balances due.
Avoiding Penalties and Audits
Maintaining accurate documentation enables you to justify figures and pass audits if questioned by tax authorities. In case of errors, voluntarily disclosing past returns and displaying good faith reduces penalties.
Additionally, ensure punctual tax payments and filing to sidestep stiff noncompliance fees. Consider authorizing CPAs or enrolled agents for expert tax preparation services, minimizing audit risk.
Maintaining Financial Health
With strong financial controls and analysis, builders create transparency, ensuring profits, liquidity, and business stability for the long term:
Forecasting Cash Flow
Regularly develop 12-month cash flow projections accounting for outstanding owner payments, loan balances, payroll, fixed assets purchases, and other cash inflows/outflows. This helps manage credit lines to handle fluctuating project demands.
Implementing Internal Controls
Segregate financial role duties across accounting, bank reconciliations, expense approvals, and payroll processing for checks and balances. Conduct inventory counts and audits, ensuring accurate data and preventing misuse of assets.
Monitoring Key Financial Ratios
A current ratio of over 1.25 signifies good short-term liquidity. A debt-to-equity ratio below 2 indicates reasonable leverage and borrowing capacity. Analyze monthly trends in your firm’s ratios – acting quickly if metrics decline.
Communication and Transparency with Clients
Construction projects often foster tense client relationships due to mismatched expectations on budgets or timelines. Prioritizing financial transparency is key for builders aiming to showcase reliability and build trust.
Structuring Understandable Invoices
- Clearly present payment breakdowns across labor, materials, sub-costs, etc.
- Attach POC percentages displaying project progress
- Summarize line items if detailing hundreds of transactions
Explaining Project Cost Breakdowns
Walk clients through detailed cost projections before breaking ground. Justify higher-than-expected invoices by communicating expanded project scopes or change orders triggering increased spending.
Managing Change Orders and Timelines
Collide disputes over deadline changes or cost overruns through open dialogue on their root causes – backed by documentation. Set expectations upfront regarding review and approval processes for change orders.
With this financial playbook for simplified construction accounting, cost management, and client communication, builders amplify their stability and profitability. Understanding key methods, tools, and best practices transforms financial data from indecipherable to actionable.
Understanding Builder Accounting as a Client
On the client side of construction projects, interpreting the complex finances powering your builder’s work is no simple task. This section provides pointers for making sense of job costing, asking the right financial questions, and avoiding misaligned expectations.
Interpreting Job Costing and Expenses
In the job costing approach, builders use records of all costs tied to your project. The resulting cost reports and invoices likely baffle most clients, though. Here are tips for better comprehension:
- Ask for transaction summaries collating hundreds of line items into digestible categories like permitting, materials, site prep, subcontractor payments, etc.
- Request comparisons against the original cost estimates quoted during bidding to identify budget overruns and their drivers.
Having builders walk through a few sample line items also provides education on deciphering these line-by-line project costs.
Identifying Potential Red Flags
While small changes in orders and budget variances are commonplace in construction, several scenarios should raise client concerns:
- Repeated billing delays or purposely opaque invoices could signal cash flow issues
- Avoiding questions about escalating costs or providing vague explanations
- Requests to change payment terms, like asking for upfront payments
In these cases, request documentation supporting invoice amounts or costs before providing payments. Consistent delays likely necessitate legal consultation and reviewing lien rights.
Payment Terms and Retainage
Learn typical builder payment terms and structures before signing contracts. Understand plans for retainage – funds withheld until final project completion to cover any last-minute expenses or delays beyond the builder’s control.
Also, clarify approval processes for change orders and the associated payment timelines in case of scope additions mid-project. Avoid potential misunderstandings by aligning these expectations upfront through open builder-client communication.
With some fundamental accounting knowledge and active financial dialog, clients can better comprehend builder costs, timetables, and invoices – enabling smoother project journeys for both parties.
Conclusion
Construction accounting done right presents builders with accurate financial reporting, fueling smart business decisions while providing clarity and transparency for clients. Mastering job costing fundamentals, exemplary record-keeping, tax compliance, cash flow controls, and open client communication represents the financial blueprint for construction success. This guide outlines best practices for managing finances as a builder or understanding them better as a builder’s client.
