Accounting is an essential and often complicated process for every business, especially when it comes to construction. Overhead costs are more complex than with your average business, and creating an accurate budget is a challenge since the cost of construction projects can change in response to a variety of factors.
All of this is to say construction accounting can be difficult, but it doesn’t have to be. The right construction software can help you manage budgets and expenses with ease to keep your next project on track.
Read on to learn more about construction project accounting and how to choose the best software for your needs.
The importance of construction accounting
Construction accounting is quite different from other industries due to the special considerations it requires. The complexity, long-term nature and multi-stakeholder involvement of construction projects make them unique and explain their distinct characteristics. Construction accounting has some specific features, such as:
1. Being project-based
Accounting for construction companies focuses on individual projects rather than the entire business operations. Job costing and project profitability are essential for successful financial management. It requires rigorous cost management for the financial viability of a project. Cost management in construction accounting will include planning, monitoring, controlling and reporting costs.
2. Having a decentralized production
Construction projects don’t involve one on-site location. Logistics often needs to cater to moving materials and supplies from one place to the next. Production can occur on different job sites, and requirements for equipment and personnel on each jobsite will vary. This complex setup means you must have a system that keeps track of everything.
3. Having long-term contracts
Construction projects often run for long periods of time. Many construction projects take years to complete, and payments are made continuously over that period. These payments can easily be delayed by retainage and contract terms with extended payment periods.
These special terms make it even more difficult to keep track of expenses and recognize revenue. A solid cash flow management strategy and reporting mechanism to ease the burden of sorting through years of invoices and bills is needed.
Construction accounting best practices
If you want to have a successful construction project, construction accounting should be built on solid principles. These construction accounting best practices and accounting methods can help you save time and money:
1. Create sound job-costing practices
A job costing system can be implemented to allocate direct and indirect costs to individual projects accurately. Direct costs include labor, materials and equipment. Indirect costs include overhead, insurance and permits.
Reviewing and revising cost allocations regularly is essential to ensure accuracy and relevancy. Monitoring costs compared to the budget and assessing variances is vital to discover potential opportunities for improvement with real-time tracking and updated information.
2. Cash-basis accounting
Smaller construction companies may favor the cash-basis method because of its flexibility. The IRS will however, require another method if your company generates revenue over a specific threshold. The cash method allows you to simply record revenue when payments are made.
3. Accrual-basis accounting
Accrual-based accounting is more suited for larger companies, but it’s more complex. This is because it recognizes revenue when work is completed and expenses when they are incurred. It provides a more accurate representation of your construction accounting, but it could lead to cash flow issues.
4. Percentage-of-completion method
The percentage-of-completion method for construction accounting is widely used and allows you to recognize revenue and what’s earned over a period. Contractors will bill you in stages as a construction project progresses for the work they do along with the expenses and earned revenue at each stage.
5. Completed-contract method
The completed-contract method is a revenue recognition approach used in the construction industry, particularly for short-term projects. Here, you’ll recognize revenue and expenses associated with a construction project when the project is fully completed. Rather than being recognized incrementally over the project’s life cycle.
Challenges of construction accounting
Construction accounting certainly has its challenges because of all the various moving parts. The accounting process in the construction industry is hardly straightforward. Therefore, you need to be organized or you could end up losing money.
Some common challenges in construction accounting include:
- Cash flow issues: Working on long-term construction projects can cause cash flow issues and create challenges in accurately recognizing revenue and allocating costs correctly.
- Poor revenue recognition: Construction accounting requires careful implementation of either the percentage-of-completion method or the completed-contract method to recognize revenue properly. Both ways are complex and require accurate definitions of costs and project progress.
- Inability to manage job-costing: Job-costing is essential to determine if your project will be profitable. However, it can become complex quickly due to factors like change orders, additional costs and variations in material and labor costs.
- Poor cost allocation: Accurately attributing direct and indirect costs to various projects is a tricky task for construction firms. Primarily because of their shared resources, changing material prices and differing labor rates.
- Change order issues: Variations in project targets, technical details or timelines can affect both expenditures and income. Therefore, making financial record-keeping and predicting job results quite tricky.
- Delayed payments: Retainage is a part of the contract price withheld until you complete certain milestones of a project. This practice can complicate accounting and cash flow management when milestones change or if delays occur due to disputes.
How to use accounting software for construction
Accounting software for construction can make your construction project more efficient. Picking the best construction accounting software, ideally one with the integrations you need, is only the first step. You need to know how to make the most of your construction software to manage your financials.
- Create detailed budgets and project financial estimates during the planning phase. Thereby, stakeholders can see what financial constraints they are working with. Investigate any discrepancies and take corrective measures to control costs when needed.
- Track your expenses in real time with your construction software. Daily expenses should be recorded with on-site activity to avoid delays and inaccuracies during reporting. Job-costing features allow you to accurately monitor the expenses associated with each project, including labor costs, materials, equipment and overhead fees.
- When construction software supports or integrates with your accounting system, you can track your team’s hours worked, calculate accurate pay rates and generate compliant tax documents for reliable payroll processing. This allows you to manage your work against contractual agreements, easily track commitments and changes and trigger invoices to vendors and subcontractors directly to avoid payment disputes.
- Use document management features to keep track of change orders. Cloud-based document management improves the workflow for changes in project scope, specifications, budget or schedules.
- Leveraging automated billing and invoicing features will allow you to produce accurate and timely pay applications. Construction software that supports progress billing, time and materials billing and retainage tracking helps manage cash flow.
Benefits of using construction accounting software
Construction software that supports accounting needs can bring numerous benefits to your business, some of which include:
- Improve job-costing accuracy in cost allocation, revenue recognition and other financial processes, expense reports, income reports and more.
- Save time by automating various accounting processes. Those can include invoicing, payroll and job-costing.
- Manage the finances by simplifying the process of budgeting, cost monitoring and profitability tracking.
- Integrate with other tools for project or document management, creating a streamlined workflow.
- Scale your business with effective and consistent financial management strategies.
- Access your financial data securely anywhere at any time with a cloud-based solution.
- Integrated information helps you and your stakeholders to make informed financial decisions. Resulting in more effectively managed projects.
Investing in construction software with accounting functionality is a smart move for any construction business looking to improve their financial management and overall performance. It can help you with job costing, revenue recognition, change order management and financial reporting. Learn how RedTeam’s construction management solutions support complex financial processes for better decision-making.
Frequently Asked Questions
Q: What is construction accounting, and why is it important?
Construction accounting is a specialized form of accounting tailored to the complexities of construction projects. It’s crucial because it helps manage project-based finances, ensuring accurate cost management, profitability analysis and compliance with financial regulations.
Q: What makes construction accounting different from other types of accounting?
Construction accounting differs from other types because it focuses on individual projects rather than overall business operations. It involves job costing, decentralized production tracking and handling long-term contracts with complex payment schedules.
Q: What are the key components of a construction budget?
A construction budget includes direct costs (e.g., labor, materials and equipment), indirect costs (e.g., overhead, insurance and permits) and contingency funds. It outlines the financial plan for the entire project lifecycle, from initiation to completion.
Q: What are some best practices for construction accounting?
Best practices for construction accounting include implementing sound job-costing systems. Use cash-basis or accrual-basis accounting as appropriate for your business. Adopt the percentage-of-completion or completed-contract methods for revenue recognition. Regularly review and revise cost allocations to ensure accuracy.
Q: How can construction companies effectively manage job costing?
Effective job costing involves accurately allocating both direct and indirect costs to individual projects. It also includes monitoring costs against the budget in real-time. Using software tools to track expenses, labor and materials for each job site is essential for effective management.
Q: What are the common challenges faced in construction accounting?
Common challenges include managing cash flow issues, ensuring accurate revenue recognition, handling complex job-costing processes, dealing with poor cost allocation, navigating change order issues and coping with delayed payments due to retainage.
Q: How can construction accounting software help manage budgets and expenses?
Construction accounting software helps create detailed budgets, track expenses in real-time, manage payroll, handle change orders and automate billing and invoicing. It integrates with other project management tools to streamline financial processes.
Q: What is the percentage-of-completion method in construction accounting?
The percentage-of-completion method allows revenue and expenses to be recognized based on the project’s progress. Contractors bill in stages, reflecting the work completed and associated costs, providing a more accurate financial picture over the project’s duration.
Q: Why is cash flow management critical in construction projects?
Cash flow management is essential because construction projects often have long payment cycles and retainage clauses. Proper cash flow management ensures that the business can meet its financial obligations, pay suppliers and workers and avoid project delays.
Q: What are the benefits of using construction accounting software?
Benefits include improved job-costing accuracy, time savings through automation, better financial management, integration with other tools, scalability, secure access to financial data and informed decision-making for more effectively managed projects.
