Many businesses sell their product in a single transaction, and costs are relatively steady inputs. Construction, however, relies on long-term contracts spanning months or even years.
This requires unique standards like revenue recognition and retainage, billing, and payment collection. It also involves tracking project-specific costs and identifying overhead allocation.
Construction companies deal with unique financial challenges that aren’t present in other industries. Profit margins are tight, and payment terms can be extended. Additionally, a construction company’s profitability can depend heavily on external factors like weather, season, and equipment availability.
Contractors must also consider that each project has distinct inputs and requirements. This leads to different pricing for each job and a high risk of underestimating costs and overestimating profits.
The cash method is the most straightforward accounting technique for contractors, but it provides only a partial picture of a company’s financial health. To get an accurate overview of the company’s financial health, a construction business must use an accrual method that recognizes revenue and expenses regularly throughout the year rather than waiting until the end to send an invoice and receive payment. This requires consistent and reliable bookkeeping for construction companies on industry-specific accounting software..
Unlike cash accounting, which only recognizes revenue and expenses when money is paid or received, construction companies use an accrual bookkeeping method that records sales and earnings when they are earned. This gives contractors a more robust picture of their financial position by including all contract sales on their income statement.
Contractors also need a way to track each project’s specific costs, which is why they practice job costing. Since construction is a project-centered, decentralized business, keeping accurate records can often take time. Costs like labor and equipment can move between jobs, which creates mobilization costs that must be accounted for properly.
Other project-related expenses include materials and indirect costs like maintenance, insurance, and transportation. Keeping track of these unique costs can help you develop accurate bids and avoid costly mistakes during the bidding process. This is especially important when working with large project managers who require extensive documentation and approval.
Construction companies often have multiple ongoing projects with nuanced payment processes. Unlike sales-based businesses that may only have one revenue stream and predictable expenses from quarter to quarter, most contractors receive payments over 30-60, even 90 days or longer. In addition, contract retainage or disputes can delay invoices further.
Consequently, a contractor’s income recognition and cash management practices must be adapted to their unique business model. For example, the completed contract method, whereby a client is sent an itemized invoice at project completion, can help speed up cash flow. However, this approach can also hide the proper financial health of your company and lead to costly mistakes.
Separating business banking accounts and dedicating an account to payroll is crucial. This helps you better track the flow of money in and out of your business, which can be essential when tax season rolls around. Keeping accurate records can also help you avoid penalties for non-compliance.
The accounting landscape for construction companies is incredibly complex. Unlike sales-based businesses with predictable revenue streams and expenses, construction businesses often deal with extended payment terms prioritizing cash flow management.
For example, some construction companies use the cash method of accounting, which recognizes revenue when money changes hands. In contrast, others prefer the accrual method that records income and expenses as they are incurred. Other unique elements of construction accounting include using different contracting methods (percentage completion or completed contract) and withholding retainage on some projects.
In addition, construction businesses have to track direct and indirect costs, including labor, materials, equipment, delivery fees, insurance, and software. A reputable bookkeeper can help manage these different cost types and accurately track and record them. Otherwise, you could risk an inaccurate picture of your financial health. For this reason, hiring a professional accountant is essential to your success.