Construction companies face unique accounting challenges due to the high price of contracts and length of projects. These factors require a different approach to bookkeeping that considers project-centric methods such as job costing.
This process involves allocating costs and revenues to specific jobs to predict profitability accurately. Some best practices for construction books include:
Track Time
Construction companies often have short- and long-term contracts extending for months or even years. Cash flow is a crucial factor when determining upfront payments or paying expenses.
Because of this, bookkeeping for construction companies must track the amount of time spent on each project. This will allow them to measure labor costs and allocate overhead expenses accurately. This will also ensure compliance with local prevailing wage requirements when working on public contracts.
As a result, it’s essential to use payroll software to track and record the project’s daily employee time worked. This helps streamline the bookkeeping process and can help avoid over or under-billing for ongoing projects. It also allows you to accurately calculate the cost of goods sold for each contract and monitor job profitability. Lastly, it will enable you to recognize revenue using the completed contract or percentage of completion method and calculate estimated taxes for tax filings.
Establish a Separate Business Bank Account
In addition to helping you manage cash flow, a separate business bank account leaves a professional impression on clients and suppliers and will help your company build its credit rating. For some small businesses, this can unlock borrowing opportunities with better lending terms.
Construction projects can take years to complete, which creates challenges when it comes to accounting. During that time, it’s common for the costs of labor and materials (including supplies, equipment, and overhead) to fluctuate. It’s essential to have a system in place that tracks these variables so you can accurately estimate future projects.
Many smaller construction companies choose to use the cash method of accounting, which recognizes revenue when cash is received and expenses when money is spent. However, this method is only a good fit for some construction firms and has limitations regarding IRS reporting requirements. Using an accounting software solution or hiring a bookkeeper with experience in the construction industry will help you implement a robust, accurate accounting process.
Track Direct and Indirect Expenses
Whether for labor, equipment, or materials, tracking these direct costs accurately to budget for future projects is essential. Additionally, it’s crucial to account for indirect overhead costs such as insurance and payroll, which vary monthly but don’t directly impact specific project costs.
A double-entry bookkeeping system is the most accurate way to record and categorize revenues and expenses. However, construction companies also need to set up an accounting process that’s robust enough to handle their industry’s unique accounting and reporting needs. For example, construction contracts are long-term and may span several fiscal years.
Accrual-basis accounting is necessary to help contractors properly recognize earnings and expenses based on when they’re earned or spent, not when they’re paid or received. This allows construction firms to manage their cash flow more effectively. It also improves accuracy when estimating project costs and profitability.
Establish Accounts Payable and Accounts Receivable Accounts
While standard bookkeeping principles apply to all businesses, construction accounting requires a more specialized approach. How contractors are paid, expenses are allocated to individual projects, and the revenue recognition method employed all impact financial reporting.
For example, many construction companies must pay their employees a “prevailing wage,” defined by state or local regulations. This is in addition to union rates, travel pay, and taxes. All of these additional costs can have an impact on your bottom line, and it’s critical that you accurately track them.
Another example is overhead costs, which can fluctuate depending on the number of projects you work on or if your business operates across multiple states. These can include insurance, workers’ compensation, transportation, and software. It’s important to categorize these costs and use an accurate calculation method called job costing. This enables you to determine the true profitability of each project and ensures that your service prices cover all overhead costs.
