We’re all about the details in the construction industry. Mess one thing up and a whole project could fall apart, right? Unfortunately, that dedicated level of attention on the job site doesn’t always translate to the back office. Take accounts payable, for example. From incorrect data entry to mismanaged cash flow, a few seemingly small mistakes here and there can lead to big problems.
To help make sure your accounts payable system is as air-tight as possible, we’ve compiled this quick guide on how to streamline the payable process.
Key Takeaways
- Your accounts payable encompasses all the money your construction business owes to subcontractors and vendors. Also known as “current payable”, this sub-ledger includes bills, along with all types of costs associated with the day-to-day operations of your company.
- Standardizing your accounts payable system with a step-by-step process doc can go a long way in improving your bookkeeping and cash flow.
- Going paperless with construction accounting software will give you a bird’s eye view of your company’s financials in real-time, so you can stay proactive.
What is Accounts Payable in Construction?
In construction, accounts payable (AP, for short), refers to the money you owe to subcontractors, vendors, and other suppliers for things you’ve purchased on credit. Put simply, it’s the money going out. Also known as “current payable”, AP can include invoices from vendors and bills for day-to-day expenses like on-site trailer rental, monthly copier service, or rent. These are all recorded as a sub-ledger on your company’s general ledger, which keeps track of all of the accounts in your accounting software or Excel spreadsheet.
🔍 Dive Deeper: Essentials of Construction Accounting: A Contractor's Guide
Accounts Payable vs. Accounts Receivable
You can think of accounts payable as the opposite of accounts receivable. Instead of money owed to subcontractors or vendors, accounts receivable is the money you’re owed from clients. Simply put, accounts payable is money going out of your organization, while accounts receivable is money flowing in.
Because construction companies often need to receive payment from their clients before they’re able to pay their bills, keeping an accurate accounts payable total is vital to maintaining a healthy cash flow. In this next section, we’ll take a look at the pitfalls that can happen when AP isn’t managed well (and how to avoid them).
Handling Subcontractor Payments & Retainage in AP
While some construction companies might include subcontractor payables amounts in their standard accounts payable account, we recommend breaking them out separately. This way, you’ll be able to track everything more accurately and make sure all releases are a) collected correctly and b) paid as needed. This is particularly important for general contractors because subcontractor payments often make up the majority of their AP. These subcontractor payments often follow a paid-when-paid basis.
How Retainage is Handled
Under your general accounts payable, you can also have a specific account recording retainage, sometimes called “retention payable”, or simply “accounts payable: retention” (or subcontractor payable retainage for your subcontractor payable account). The reason you’ll want to track this separately is because of how retainage is paid out. Since retainage is paid out at the end of construction jobs, you’ll need to be able to accurately track its amounts to manage your overall cash flow situation.
What Happens When Accounts Payable is Poorly Managed?
A lot of things can go wrong with accounts payable, from duplicate payments to matching errors. Arguably one of the most important things to keep an eye on though, is the payment terms you’re getting for what you owe (either net terms or pay-when-paid). If you’re paying someone who is a material supplier, you want to make sure your terms aren’t worse than any of the other people in the same space as you. If there are competitors you’re on friendly terms with, you can ask them about their typical terms to help you validate this information. Or, if you belong to a trade organization, you can ask your peers there.
Good Payment Terms Are a Delicate Balance
If you’re a millwork subcontractor buying a lot of wood, for example, you want to negotiate the most lenient terms possible with your suppliers. From a cash flow perspective, these are the bills you’ll have to pay whether you’re paid on the job or not, so it’s in your best interest to negotiate as much as possible.
Net 30 is going to be the typical payment terms you’ll encounter, but if you can negotiate Net 45, you’ll be in a much better place compared to your competitors. If you manage to get more lenient terms like these, make sure you’re committed to maintaining a high-level relationship with those suppliers. Because you’re considered a “slow payer”, any miscommunication or late payments can turn a good working relationship sour.
Why You Can’t Ignore Your Cash Conversion Cycle
The payment process for construction projects is notoriously slow, and that means it can take a long time to collect money once it’s been billed. If you’re not careful about managing your cash flow, you can end up having to fund projects out of your own pocket. This is why the longer you can get your average days of accounts payable, the better position you’ll be in. This metric is called the cash conversion cycle. If you can extend the average amount of time you’re paying other people, the less likely you’ll have to rob Peter to pay Paul the next time a new project rolls around.
In theory, you want your average days to collect accounts receivable to mirror the average days you pay your accounts payable. This gives you a zero cash conversion cycle number, which means you don’t have to bankroll any of the work you are doing.
TL;DR: Make sure you’re paying close attention to the average number of days you’re paying people. If that number becomes larger, that’s generally a good sign for you - and you should be working to keep that consistent over time.
The Proof is in the Process
Accounts payable isn’t something to treat lightly. The problem though, is that a lot of construction companies don’t follow a consistent AP process, and end up indiscriminately moving money around without much thought. Inconsistency can kill your cash flow, so it’s crucial to set up a process you can follow each week, even if it’s just a few simple steps.
For example, you need to be able to enter bills correctly into your construction accounting system every time. If possible, separate the duties of opening and entering bills between two people to reduce the potential for fraud. On the payments side, you’ll need to schedule payments to vendors on a regular basis to avoid paying late fees or interest.
It’s also a good idea to set up a process to make sure the streams between your standard accounts payable and subcontractor payables don’t cross. Standard accounts payable follow Net 30, etc terms, while subcontractor payables are normally on a pay-when-paid. If these accounts overlap, you run the risk of paying people before they’re supposed to be paid, which will quickly drain your cash flow and throw your whole AP off. The easiest way to avoid this is by setting up an approval process. Even if it’s simply between a bookkeeper and owner, having a standardized approval process in place will help you maintain visibility on all payments, so you can catch potential issues before they affect your account.
7 Ways to Make Your Accounts Payable Process Better
Simple changes/fixes can go a long way in making sure your accounts payable work for you, not against you. Based on all of our collective experience at CrewCost, here’s the best advice we can give:
1. Take the time to create a repeatable process: We said it once but it bears repeating - take the time to sit down and build a simple, standardized process for your accounts payable (for entering and billing). No matter who’s working with your AP, they should be able to repeat and follow this process to a T. Having a standardized process will save you thousands of hours over the years.
2. Build an approvals hierarchy: This process will help your business operate efficiently and will ensure there’s more than one set of eyes on your AP.
3. Create a checklist: If you’re set up to pay bills every week, what are all of the steps that need to be followed? Get as detailed as possible. A lot of construction companies build processes and don’t follow them. Don’t be like them.
4. Set up a dedicated email address: Once you’ve got your process outlined, set up an email address specifically for AP. This is where all invoices should be sent. To save time and boost security, make sure this email isn’t tied to any specific person.
5. Know your cash situation: Whether you have a dedicated Chief Financial Officer, or are taking care of financials as the owner, whoever is responsible for money within your organization needs to know the amount of cash that is going out every time accounts payable are paid. Don’t get complacent and trust your bookkeeper to take care of everything. Make sure you have eyes on all funds going out.
6. Take the 2% discount if you can: Sometimes, suppliers will offer 2% Net 10/Net 30 payment terms. This means if you pay within 10 days, you’ll receive a 2% discount on your bill. Taking this discount is one of the most profitable things you can do in your business, and compounded on an annual rate, this discount often surpasses the amount most construction companies make. To be able to execute this consistently though requires careful management of your cash position.
7. Invest in AP automation: Many smaller contracting companies are heavy on paper (to their detriment). The problem is, construction accounts payable isn’t something you want to leave up to pen and paper. By automating your workflows in a construction accounting software, you can get a real-time view of your company’s financials all in one place.
Last Thoughts
Staying on top of your accounts payable goes well beyond being able to pay people on time. It ultimately comes down to your ability to stay profitable and keep your cash flow healthy. By accurately tracking and managing project costs, vendor payments, and all of the financial data in your construction accounts payable, you’ll protect your cash flow, reduce your operating costs, and maintain great business relationships.
Want to go above and beyond? Save your accounting teams unnecessary stress by investing in an accounts payable software. A user-friendly platform with purpose-built automation will cut down on time-consuming manual processes and reduce costly mistakes, so you can spend more time running your business with confidence.