Construction is a thriving industry that depends on accurate and efficient work.
Construction is a thriving industry that depends on accurate and efficient work. Companies with a reputation for safety, speed and attention to detail are likely to succeed.
With the hustle and bustle involved with RFPs and ensuring that current jobs are completed to specs and on time, accounting can take a backseat. There are a number of issues that make construction accounting particularly challenging and a handful of strategies that can ameliorate those headaches.
Common problems in construction accounting
Below are some of the most common problems that accountants face in the construction industry.
- Bad overhead estimates. Construction projects have significant overhead, including the costs associated with office space, equipment, materials, rental, and, of course, labor. However, because construction requires different things at different times and overhead can fluctuate from season to season and job to job, it’s hard to get a clear picture of your overall overhead costs. Without a solid estimate in place, you’ll be practically unable to determine whether your business is making a true profit – even if all your jobs are, on paper, profitable.
- Cost-accrual problems. Most construction companies declare revenue when it’s collected, often at the end of the job (but take on expenses throughout the project). This can lead to serious confusion when it comes to determining how profitable each job is – and may lead to cash flow problems if you aren’t careful. For example, if you only bill for a project when it’s complete, those stacked costs that accumulate throughout the project could chip away at your cash reserves, and you might end up with a false idea of your overall profitability.
- Scope creep. Even the best-laid plans are subject to last-minute changes. New information, such as material availability or building site conditions, can force your company to change its original plans. Clients asking for add-on changes, otherwise known as scope creep, can also be problematic. You want to keep your clients happy and make sure the job turns out well, but at the same time, you need to carefully control new costs you take on. Project managers and accounting need to work together to determine which new costs are feasible and which are not, and then draw the line when the project starts to lose a disproportionate amount of profitability.
- Inaccurate cost estimates. It’s easy to underestimate costs, especially when you’re dealing with a project that could take months to complete. You may end up needing more materials or different equipment, but the big killer is labor. Going just one month past your budget and estimated time frame can cost thousands in additional labor costs.
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- POC method and losses. The POC (percent of completion) method is common for construction companies to use, due to the long-term nature of most contracts. However, it can cause serious problems when a job has to be reported as a loss. Standard accounting best practices require that you report a loss when it’s recognized, but the POC method makes it difficult to establish a recognition period. When you determine a loss is imminent, you need to record that loss.
- Partnership confusion. Many construction operations specialize in one element of construction and partner with other businesses to complete large-scale or complicated jobs. These joint operations are often profitable for both parties, but you’ll need to be careful how you split and determine both costs and revenue.
Solutions to construction accounting problems
So how can you make construction accounting easier? Here are three recommendations.
- Hire the right people. First, make sure you’re hiring the right people for the job. You want people who have a formal education in accounting and, preferably, experience construction accounting. Even a year or two of experience in this area can make all the difference for your business.
- Use the right software. There are many platforms for construction accounting, but they aren’t all equal. Make sure you’re using a cloud-hosted platform that offers functionality to help you budget expenses, plan for job profitability and split costs between you and a partner business. Read reviews and maximize free trial periods to be sure you’re getting all of the features you need.
- Spend extra time on accurate estimates. Accurate estimates make or break your construction business. Spend extra time and resources ensuring that your cost projections are accurate and up-to-date.
These three strategies can help reduce the complexity of construction accounting and make it much more feasible – even to new or inexperienced construction business owners.
With practice, you’ll get even better at projecting your expenses and revenues, and your business will remain profitable indefinitely.