Construction accounting is an essential area for every company, especially because it tracks costs across projects and avoids mistakes that can compromise profit. With so many different methods and key elements, contractors can face difficulties in the financial process.
With this guide, we ease your doubts and show that accounting for construction companies is not a nightmare. You just need to follow the main principles and use the method that fits your business best. Keep reading to find out how to do this process properly!
What is construction accounting?
Construction accounting is a specialized branch of accounting that focuses on managing financial transactions, reporting, and analysis specifically for construction companies or projects. It involves tracking the financial aspects of construction projects, managing costs, and ensuring proper financial management throughout the construction process.
When executed correctly, this process empowers confident daily decision-making aimed at optimizing profitability. Among routine tasks, a pivotal one involves wisely choosing alternative suppliers for materials and equipment whenever market fluctuations trigger price changes.
This proactive approach prevents excessive charges and ensures prudent resource allocation. Additionally, skillful management of cash flow transactions remains integral. This entails navigating the irregularities inherent to construction projects’ financial rhythms, fostering stability and enabling seamless operations.
These measures leverage market shifts as strategic openings to maintain a robust financial stance. While errors are common in the construction industry, much like in any other, swift analysis and rectification are crucial to avert enduring financial challenges and prevent project timeline extensions.
Why is construction accounting different compared to other industries?
Construction accounting requires specialized knowledge and tools to handle the intricacies unique to the industry. It demands a keen understanding of project management, contract terms, and financial intricacies to ensure accurate financial reporting and successful project outcomes.
Construction work is project-based
Construction companies are used to dealing with more than one project at a time. Every job can have unique inputs but they need to be tracked. While a typical manufacturer has repeated processes with identifiable costs, construction has different materials, processes, and equipment.
Production is decentralized
Production happens at different job sites, not necessarily in fixed and controlled locations. Usually, each project takes place in a district location, and the site conditions are unique, reflecting in future change orders because the production cycles are not that predictable.
Sometimes projects are in the same city, and the prices of the materials are the same, but if another job site is in a different state, the resources may be incompatible. With construction accounting, that is not a problem because contractors can track and manage expenses separately or merge them to have a big picture.
Contracts are long-term
With long production cycles, contracts are longer than in retail industries, where the contract is completed when the consumer gets its order, such as a new collection at a department store. In construction, the contract can take months (or years) since it’s been signed.
Payments can be extended as well, with 30 to 90 days to pay invoices. Sometimes a portion of the payment is held until the construction company finishes its work according to the contract.
Costs are volatile
Labor costs are one of the biggest expenses on the project. However, supplies and equipment can extend the original budget because the market changes quickly. This is exactly why our dedicated accounting software for construction contractors excels – it effectively manages fluctuating costs and maintains impeccable cash flow organization.
Elements of construction accounting
As general accounting has its concepts, construction has others used daily to keep the books in order with detailed reports. By following these key elements, you can track all the expenses in a project.
Job costing is a method to track the costs of different aspects of the project: materials, labor, and overhead. It gives a picture of the finances, predicting change orders and overbilling. The result is better decisions to make the most of the profit.
Also called income recognition, it is the accounting principle that determines when and how a contractor records the payment on the books. It can be based on a cash method (the amount is recorded only when they are completely paid) or an accrual method (recorded before the money is received or dispensed).
Reintanage is when a portion, agreed on in the contract, is withheld until the job is completed within a defined period. It is a practice to encourage contractors to finish tasks on time and resolve problems quickly to stick to the budget.
Billing is the process of receiving invoices. In other industries, it occurs on a fixed schedule or after sales. However, in construction, it is different because of the long-term schedules. It can be divided by time and material, unit price, and other specifications easily created on our contractor accounting software.
This step of construction accounting focuses on employee expenses based on labor laws and tax regimes, such as minimum wages and payroll taxes (federal income tax, social security, and medicare taxes). Contractors must pay attention to multi-state payroll because most projects occur in different cities with distinct taxes.
Methods of accounting
There is no right approach to construction accounting, as each company can choose a specific method or combine them to meet its needs. The cash method is the simplest to manage because expenses are only recorded when the payment is received or the income is spent. Other options include:
- Fixed price method: construction projects create a complete plan with fixed costs expected for the job. It lets the client evaluate different options and pick the best according to the available budget;
- Time and material method: while the project progresses, the contractor must record expenses and submit invoices on construction accounting software, such as our. The client receives a list of labor, equipment, and material costs to avoid unexpected costs.
How to optimize accounting methods
It is easy to optimize construction accounting with our software. Our all-in-one cloud-based system has different features that allow you to update your books automatically and keep all data safe. Financial reports, billing reports, and accounts payable processes can all be monitored in one place.
Let us improve construction accounting on your project!
With Premier, you don’t have to worry about construction accounting or any other step of project management. Request a demo to see how the features can save you time and maximize your profit!