Essentials of Construction Accounting: A Contractor’s Guide

What makes construction accounting different?

All businesses rely on good accounting to lay the groundwork for profitability and success. This is especially true in construction, thanks to the industry’s unique financial challenges and bookkeeping methods. Unlike other businesses, construction companies are project-based, which means you’re more likely to experience irregular cash flow. Add in factors like managing retainage, dealing with complicated cost structures, long pay cycles and tracking change orders, there’s a lot for contractors to keep up with. That’s why good accounting practices are so critical – they’re the ‘glue’ that holds all of your financial information together and ensures your profits don’t slip through the cracks.

In this guide to construction accounting, we’ll walk you through the basics, from setting up an accurate accounting system to controlling cash flow and more. If you want to continue to scale your business and remain profitable while doing so, keep reading.

Setting up a successful construction accounting system

Setting up a successful construction accounting system

When all’s said and done, your construction accounting system should be able to address all of your business’s most critical processes, including:

• Job costing – Job costing is the process of setting a budget for a job, tracking expenses (like labor, materials, and equipment) against that job’s budget and then using the information gained once the job is complete to make better bids in the future. This is a vital part of your construction accounting process, and will be something you keep track of with every new project you take on.
• Change order management – Change orders…you might hate them, but they’re pretty much unavoidable. And because of that, properly capturing, tracking, and managing them is necessary to avoid losing money.
• Labor costs – Understanding your fully-burdened labor costs is incredibly important, and contractors often underestimate them. If you want to avoid throttling your bottom line here, you’ll need to calculate any and all associated expenditures like insurance, benefits, taxes, and payroll processing on top of your base payroll amounts.
• Bookkeeping – Another component of good construction accounting is your bookkeeping, particularly how you handle invoicing and cash flow management. You’ll want to consistently track accounts receivable and monitor invoices to ensure you’re paid on time. In our experience, cash flow problems due to late or missing payments are one of the most common reasons construction businesses fail.
• Revenue recognition – Lastly, don’t overlook proper revenue recognition if you want to accurately record project income. There are four methods you can use to go about this, including recording income and expenses after contract completion, the percentage of completion method, accrual accounting method recording revenue and expenses by transactions, and cash-basis accounting, where payments are recorded only upon receipt.

While you could keep track of all of these things on a set of spreadsheets, this kind of DIY management of your financial data isn’t something that’s easy to scale with your business. That’s why experienced contractors often rely on purpose-built construction accounting software to manage their finances. The right software applications can automate much of these accounting processes and provide accurate real-time information so you can know where you stand on every project.

The importance of cost tracking and job costing

Ongoing cost tracking and consistent allocation of your estimated expenses are fundamental to completing profitable projects and increasing your overall profit margin. Remember, job costing helps account for expenses associated with labor, materials, subcontractors, equipment, and other direct costs tied to each specific project you undertake. Over time, the data you gather here can help you make better decisions and keep future projects on budget.

Tracking your labor and materials spending is particularly important here, because as you well know, these expenses often represent a significant portion of a job’s overall cost. As discussed before, don’t forget to account for all related expenses like overtime, insurance, and payroll processing to get the full picture behind your labor costs. With accurate data, you can experiment with different labor mixes – and ultimately tighten your future cost estimates based on what you learn. Proper job costing also provides insight into resource allocation on projects, allowing contractors to test and measure different labor mixes and tighten future estimates based on what they learn.

A few more job costing best practices include:

• Providing detailed breakout pricing and allocation of all project tasks
• Making accurate cost estimates
• Scheduling regular data reviews to identify any discrepancies

These best practices can help empower you and your leadership team to take action and make any adjustments needed to keep your jobs on schedule and on budget. For a more detailed guide on how to do job costing, check out this resource.

Budgeting and forecasting

As the name implies, forecasts are estimates of a specific project’s projected expenses. Ideally, you’ll make these forecasts based on data from previous projects. These forecasts play an essential part in helping you build out accurate project budgets. Here are a few factors to consider when making these forecasts:

• Historic data from similar projects in the past
• The size and scope of the project you’re estimating for
• Project timeline/duration
• Your fully-burdened labor costs

As you incorporate forecasting into your construction accounting process, you’ll be able to develop tighter budgets over time. One thing that can be helpful here is revisiting your forecasted numbers often throughout a project’s lifecycle – making adjustments where necessary to align estimates with the actual costs you’re incurring. Lastly, we can’t overstate the importance of consistently communicating with your employees, subcontractors, and suppliers. The more you can communicate, the more likely everyone will be on the same page – and sharing the same information.

Accounts payable and receivable

Let’s talk about tracking and managing your accounts payable and receivable. For many contractors, it can take an average of two and a half months just to get paid. If you’ve got an efficient method for managing your invoices, receivables, and follow-ups though, you can potentially cut down on that waiting time.

If you want to be smart about improving your accounts receivable, we’d recommend implementing and following a solid credit policy, as well as incorporating an effective follow-up process for invoices. Of course, no one wants it to get this far, but we’d also recommend staying up to date on your options in the event of delayed receivables, including reserving your right to file a mechanics lien, or at the last resort, file a lawsuit.

On the flip side, managing your accounts payable is just as important to maintaining good cash flow. Put simply, accounts payable are the amounts you owe to suppliers and subcontractors for expenses associated with a specific project. If you want to effectively control these payments, you’ll need to maintain a designated receiver for all incoming invoices to a) simplify tracking and b) facilitate immediate and consistent entry into your construction accounting software or system. 

One last note here: Accurately monitoring retainage (the withholding of a portion of the funds that are due to a contractor or subcontractor until a job is finished) is also essential, as is sticking to an established payment schedule whenever possible to ensure your accounts payable are managed regularly.

Cash flow management

Construction projects are a cash-intensive undertaking, and you’ll often find that they require significant upfront spending for materials and supplies, along with ongoing expenses like labor. One of the big challenges this brings is matching your constant cash outlay against the delays you might experience with incoming payments. Basically, avoiding significant financial problems means building a solid cash flow despitethese consistent differences between receivables and payables. This means you have to have a daily understanding of what revenue has been earned vs. made and how long you are likely to wait before receiving payment for jobs done.

If you want to get even more strategic, you can try a couple things like negotiating more favorable payment terms with your suppliers, and creating a consistent system for billing and follow-ups.

Lastly, if you don’t have a sufficient line of credit and a good relationship with your bank, a lot of this hard work can go to waste. Don’t wait to take care of these. If you experience a late payment or other challenge, having a solid line of credit in place will ensure you have enough cash reserves to keep your business going.

Maximizing success with financial reporting

Construction accounting is an ongoing process, and it pays to regularly review your progress to make sure you’re staying on track with your financial goals. For example, consistently reviewing your forecasts vs. actual project performance can help you identify potential problem areas and course correct before your cash flow becomes negatively impacted.

The larger the project, the more important it is to have a good review and analysis process in place, simply because bigger jobs generally carry more financial risk, particularly in terms of labor and material expenses. Taking the time to review your accounting data from time to time will help you improve your estimates and create more accurate budgets for all of your future projects.

Integrating payroll and project management

A good construction accounting system doesn’t stand alone. Instead, we recommend integrating your accounting system and software with your other business systems, like payroll and project management. This way, you can eliminate the need for multiple entries of the same data, and reduce the amount of time you and your team have to spend working with these systems.

What’s more, integrating all of your systems into one place provides better overall visibility into your financial health, and makes collaboration between your team members much easier. More eyes on every project means less time spent managing miscommunication – and more time doing what you do best.

How construction accounting software can help

At the end of the day, while the construction industry follows a lot of general accounting principles, there are plenty of particular challenges contractors face that require specialized strategies to ensure your financials are managed effectively.

To help reduce some of the burden on themselves and their teams, many contractors turn to purpose-built construction accounting software like CrewCost. CrewCost is an all-in-one solution that goes beyond what generic account software can offer. With CrewCost’s contractor-designed platform, you can manage job costing, service management, and enjoy automated accounting processes all in one place.

Want to take CrewCost for a spin? Sign up for early access here.