- Construction accounting relies on different methodologies to track costs and revenue. Each project has set indirect and direct costs associated with it.
- Common issues in construction accounting include bad overhead estimates, scope creep and cost-accrual issues.
- Software programs and experienced construction accountants can assist with frequent issues that construction companies face.
Why is construction accounting challenging?
Construction accounting presents unique challenges. The biggest hurdle is that costs are less straightforward within the construction industry. Each project incurs both indirect and direct costs. There are unique charges such as travel time, cleanup hours and equipment rentals. Construction companies also normally calculate revenue based on percentage of the job completed.
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 back seat. Various issues make construction accounting particularly challenging, with a handful of strategies that can alleviate those headaches.
Common problems in construction accounting
These 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. 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 profitable on paper.
- 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 as to how profitable each job is – and 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 timeframe can cost thousands in additional labor.
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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 that 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 four recommendations.
- Hire the right people. First, make sure you're hiring the right people for the job. You want people who have formal education in accounting and, preferably, experience in 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 to use a cloud-hosted platform that can 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. Estimates make or break your construction business. Spend extra time and resources ensuring that your cost projections are accurate and up to date.
- Conduct job costing. Job costing is a type of accounting methodology that tracks costs and revenue per project.
These four strategies can 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.