Contracting company accounting, which helps contractors track, manage, and report financial data more accurately, differs significantly from standard accounting practices. Construction projects have distinct financial management challenges, making a robust and specific construction accounting approach essential for success. Let's look at the intricacies of construction accounting and how this can significantly impact your bottom line. But first, let's address an uncomfortable truth.
We all know running a successful contracting company isn’t just about doing good work; it's also about solid finances. Construction businesses deal with several key issues that make traditional accounting insufficient, such as:
- Per-project profitability
- Contract revenue recognition
- Varying sales and cost of goods sold
- Long-term contracts
- A decentralized and mobile workforce
- Complex payroll and frequent regulatory requirements
- Retainage and potential losses
Unfortunately, a startling number of construction businesses fail. According to the Bureau of Labor Statistics, Only 35.8% of construction businesses that started since March 2011 were still operating by March 2022. Construction companies often fail due to a combination of poor financial management, inadequate project planning, and lack of effective communication. Without robust construction accounting practices, these businesses struggle to track expenses, manage cash flow, and ensure profitability. Additionally, insufficient project planning can lead to cost overruns, missed deadlines, and dissatisfied clients. Communication breakdowns among team members, subcontractors, and clients further exacerbate these issues, leading to project delays and increased costs. By addressing these critical areas, construction companies can enhance their operational efficiency and improve their chances of long-term success.
Key Aspects of Contracting Company Accounting
Job Costing
One of the cornerstones of contracting company accounting is job costing. In construction accounting, this practice tracks both indirect costs and direct costs to individual projects.
Why? Because construction projects are more unpredictable and have unique cost variations. Think about materials and labor costs—these can significantly fluctuate between bidding on a project and completing it.
Think also of factors like building code changes, bad weather, unforeseen issues, or maybe even disruption to your supply chain—like the lumber surge in 2021. Any one of these events can dramatically increase project costs, especially compared to a controlled, repeatable manufacturing process. Accurate job costing ensures you're making a profit on each project by keeping your costs and estimated budgets in check. You don't just want a general picture of your company’s finances; you also need detailed breakdowns by project.
Revenue Recognition in Long-Term Contracts
Revenue recognition in construction accounting adds a layer of complexity due to long-term contracts. This means payments for work done aren't always received right away. It’s different than selling a product immediately and receiving payment right there.
There's the cash method, where you record revenue when you receive cash and report expenses as you pay them. And then there’s the accrual method, which records revenue when earned and expenses when incurred, regardless of cash flow.
Construction companies can only use the cash basis method if their average gross receipts for the three preceding tax years do not exceed $25 million. This $25 million threshold is also adjusted for inflation. This stipulation comes from the IRS’s Tax Cuts and Jobs Act ("TCJA") 2018. If revenues exceed the IRS’s limit, they'll need to adopt an accrual method like the percentage of completion method. Under the percentage of completion method, revenues and expenses are recognized proportionally based on project completion. In essence, you acknowledge a portion of the revenue as certain milestones are reached.
The completed contract method in construction accounting is a strategic approach where revenue and expenses are recognized only when a project is fully completed. This method offers a clear and definitive financial picture, as it eliminates the need for periodic estimates and adjustments. By deferring revenue recognition until the project's conclusion, contracting companies can avoid the complexities of fluctuating income statements, ensuring a more straightforward and accurate reflection of financial performance. The completed contract method is particularly beneficial for long-term projects, providing a stable financial outlook and aiding in precise tax planning and compliance.
A contractor may choose their revenue recognition method on a per-project basis. They may base this choice on the project's size, expected duration, or other considerations, like accounting for joint ventures. Factors like the company’s investment level and its control over the combined entity may influence this construction accounting decision.
The Challenges of a Decentralized Mobile Workforce
Unlike a manufacturer, where production occurs in a single fixed location, construction happens at job sites. Workers and equipment frequently move around, leading to mobilization costs, decentralized operations, and diverse accounting requirements. Construction is also often seasonal and highly dependent on contract awards.
This highly mobile and project-based workforce adds complexity to contracting company accounting. For example, you must contend with local wage requirements, varying state taxation, and maybe even union-related matters. Not to mention, you must also constantly track worker time and allocate labor costs across various ongoing projects. Additionally, prevailing wage stipulations add another complexity when working on federally funded construction projects. For these jobs, the Davis-Bacon Act defines allowable wages. This means a contractor needs to track prevailing wage rates and often submits specific forms to the government agency to ensure compliance.
Dealing with Retainage
Retainage is a practice often used in the construction industry. Clients withhold a portion of payment from contractors—usually between 5 and 10 percent—until the project is finished.
While this secures clients against incomplete work or potential defects, it creates cash flow hurdles for contractors. Let’s think about what this means. In a world with notoriously tight profit margins, retainage can significantly impact your earnings—it's like that 5 or 10 percent just vanishes for a period. Smart contractors treat it seriously and carefully account for it in their bidding, planning, and financial projections. Effective construction accounting involves tracking retainage separately from regular receivables, ensuring accurate financial reporting and compliance with contractual terms. By maintaining detailed records and regularly communicating with clients about the status of retainage, contractors can mitigate potential disputes and ensure the timely release of funds.
Construction Accounting Reports
Construction accounting reports are indispensable tools for contracting companies, providing a comprehensive overview of financial health and project performance. These reports encompass various elements such as job cost reports, work-in-progress schedules, and profit and loss statements, each offering critical insights into different facets of the business. By meticulously tracking expenses, revenues, and project timelines, construction accounting reports enable contractors to make informed decisions, optimize resource allocation, and ensure projects stay within budget. Furthermore, these reports facilitate transparency and accountability, fostering trust with stakeholders and enhancing the overall efficiency of the contracting company accounting process.
Here are some common accounting reports that construction businesses use:
|
Report Type |
Explanation |
|
Job Cost Report |
Provides a snapshot of estimated versus actual costs for each job. |
|
Profit and Loss by Job Report |
Provides an overview of revenues and costs related to individual construction projects, broken down by activity. |
|
General Ledger Report |
Tracks every transaction at the company level—similar to what a manufacturing company or service business might use. |
|
Work-in-Progress Schedule Report |
Offers a detailed view of how much money is currently tied up in unfinished construction jobs, using the accrual accounting methodology. |
Using Technology for Efficient Construction Accounting
Construction accounting requires the use of specialized accounting tools. These tools should manage job costing, retainage, complex payroll calculations, and unique revenue recognition practices. Many options exist, and a firm should consider its budget and the level of technical knowledge of its people.
If contracting company accounting seems overwhelming to handle manually, a good solution may be construction accounting software. These software programs can vary, so make sure that whatever option you choose meets your particular needs. Many offer robust features like online invoicing, tracking expenses and income, automated reports, and other helpful tools.
Of course, many small business owners choose to handle their finances without accounting software. While there’s nothing inherently wrong with doing things manually, choosing the wrong method can be costly, both in compliance issues and lost opportunities. Today’s contracting companies should seriously consider moving away from things like old-fashioned spreadsheet job costing, especially with complex government projects. Modern construction accounting software options not only offer a comprehensive suite of features but also integrate seamlessly with other project management systems, ensuring that all financial data is up-to-date and easily accessible.
FAQs About Contracting Company Accounting
What is contracting company accounting?
It’s a way to track, manage, and report a contractor’s finances. It focuses on how much each job is earning or costing the business. This differs from a retailer that primarily focuses on a profit and loss report based on items sold in their shop(s). Effective construction accounting ensures that contractors can make informed decisions based on precise financial information.
What are the financial statements of a contracting company?
Some essential financial reports for construction firms include the job cost report, the profit and loss by job report, the general ledger report, and the work-in-progress schedule report. A construction business might also use cash flow statements, balance sheets, aging reports, and statements of owner equity.
What is the role of an accountant in a contracting company?
Accountants do more than just bookkeeping. They ensure a company's compliance with rules, regulations, and specific accounting methodologies that differ from a service-oriented business or a retailer. Their goal is to ensure each contract is as profitable as possible. At the same time, they work to avoid overpayment of taxes and lost time dealing with complex reporting, especially when a company takes on federally funded public works contracts that may apply special prevailing wage requirements. A company may choose to manage their accounting in-house. However, an increasing number rely on fractional CFOs for financial advice and expertise.
Conclusion
Contracting company accounting can be demanding and sometimes frustrating. However, it is essential for successful project bidding, estimating, and profit tracking in today's volatile construction landscape.
Partnering with a Fractional CFO can significantly promote the growth of a construction company. By providing expert financial oversight without the full-time cost, these seasoned professionals bring a wealth of experience in construction accounting, including financial strategy, budgeting, and cost management. By leveraging their expertise, contracting companies can optimize their financial operations, ensure compliance with industry regulations, and make informed decisions that drive growth and profitability. Additionally, fractional CFOs offer the flexibility to scale their services according to the company's evolving needs, making them an invaluable asset for both small and large contracting firms.
