Construction Accounting – Best Practices
Accounting – it’s a part of the construction business that most don’t pay much attention to until there is an issue or reports and financials are needed. Although often out of mind, the accounting function is a necessary tool needed to properly manage a company. It serves the important purpose of providing key financial reports which are used to understand company performance, cost control opportunities, cash flow management and identify opportunities to enhance profitability. While essential for all companies, it’s especially imperative for construction companies to have robust accounting practices in place because of the nature of the industry and work performed. Multiple jobs with various labor requirements, equipment and materials all present unique accounting challenges. To help clients, prospects and others understand how effective accounting practices can help manage project profitability, JLK Rosenberger has provided a summary of best practices below.
Key Elements of an Effective Accounting Practices
- Cash Basis Accounting – Using the cash basis of accounting is essential for a construction company as it provides greater flexibility in when expenses and revenues are recognized. Under the accrual method revenue is recognized when it is earned (and not when it is received). The cash basis of accounting recognizes revenue when payment is made and when expenses are paid out. This is important because using the cash basis makes it easier to plan for recognition of taxable -income (including when to make payments to vendors) and to reach the desired profit level at the end of a financial period or year.
- Job Costing – This is an essential accounting practice that all construction companies and contractors need to have in place and review regularly. Unlike other industries that offer products with a constant production cost, sales price and profit margin, construction companies operate very differently. One construction company could be working on three very different projects that require different levels of labor, materials and equipment. This means that without proper tracking not only is estimating difficult but so is profit management. As a result, proper job costing ensures that expenses are correctly assigned to projects and profit margins are managed appropriately. Without effective job costing practices, management would not be able to accurately track expenses, manage cash flow or achieve profit goals.
- Change Order Management – Another best practice for construction companies is to have a process for tracking change orders. Since changes to the original project are common in the industry it’s essential to have a method for tracking the expenses related to the change. Expenses need to be properly documented and presented to the client in an additional invoice. Such expenses include labor, material and even additional equipment. Many struggle with change orders due to lack of communication with their customers. As such, it’s important to clearly communicate all changes, why the change was implemented and what the corresponding costs are. A clear process for tracking change orders ensures there are no unexpected surprises when the project is completed (for you and the customer).
- Effective Internal Controls – Implementing an effective series of internal controls is a best practice that companies in all industries should follow. Without a proper series of safeguards a company exposes itself to lose money from schemes and scams perpetrated by employees, vendors and others. Key areas where controls should be implemented include; cash management, accounts receivable, accounts payable and payroll processing. These are the core areas where the largest opportunity for fraud exists and where internal controls can most effectively deter dishonest behavior. It’s much easier and less expensive to proactively manage this risk, then find out considerable sums of money were stolen from the company.
An effective accounting process will ensure that any construction company is properly situated to manage the various challenges that come with working in this industry. If you have questions about construction accounting best practices or other concerns, JLK Rosenberger can help. For additional information, please contact us at 949-860-9880, or click here to contact us. We look forward to speaking with you soon.