Effective construction cost accounting is vital to managing your construction business finances. Because of the many specialized processes in construction accounting, construction companies must pay close attention to construction specific practices, such as revenue recognition, purchase order management, and job costing to keep their finances on track.
Because of the unique nature of construction accounting, there’s the potential for accounting mistakes that could cost your company.
In this blog, we will outline the six most common construction cost accounting risks and show you how to avoid them so you can maintain financial stability and maximize profitability.
The Foundation of Effective Construction Cost Accounting
It’s essential to keep accurate records to effectively manage construction cost accounting. Tight budgeting on your projects means you need to track your costs closely, and without accurate records your accounts could be incomplete.
For example, if your business has had trouble accurately tracking expenses because of unreliable record keeping, your financial accounts could be inconsistent or incomplete. This error could be due to too many manual processes, or because different departments keep records in multiple different systems. Inaccurate record keeping could make it even more difficult to track your project expenses, and it can also lead to potential negative legal and tax implications.
However, if you use accounting software that’s made for construction companies, you’ll be able to track job costs more closely, handle WIP claims, and keep your records straight for tax season.
Categorizing Costs Correctly for Better Financial Insights
There are many expenses in construction budgeting, and every cost must be carefully tracked and assigned to the correct project. Misclassifying costs can lead to misleading construction financial data, such as distorted profit margins, inaccurate project estimates, and potential over or under payment of taxes.
To organize expenses into common categories, most construction companies use construction cost codes. These are standardized values. Often construction companies use the cost codes from the Construction Specifications Institute (CSI) so that they are using a common classification system that other contractors would recognize. Still other construction companies create their own standard cost codes if the above list does not suit their needs.
Cost codes are intended to aid you in managing your projects effectively. The best way to ensure you’re correctly categorizing costs and efficiently managing your projects is to standardize cost codes.
Your company should also regularly review data generated by each project. Correctly assigned cost codes can provide valuable information about when your projects faced bottlenecks and what parts of the project were more productive. You should make it a regular practice to review these costs using your construction accounting software.
Why Project-Specific Accounting Matters
Construction cost accounting is unique because each project undertaken by a construction company is tracked and managed individually with its own budget and job cost accounting. Project specific accounting enables you to track variance between planned and actual costs.
Project accounting tracks tasks and projects, which makes it different from traditional accounting, which tracks departments and cost centers. Project accounting also recognizes revenue differently – by percentage of completion milestones.
Failing to track project expenses separately can result in inaccurate financial reporting, make it more difficult to assess whether a project was profitable, and prevent a helpful audit for identifying future cost savings opportunities.
It’s necessary for construction companies to carefully manage project accounting to invoice correctly. The other benefits of project-specific accounting include:
- Collecting data about costs, estimates and scope which you can use for future projects.
- Staying up to date on progress and profits.
- Identifying project issues so you can easily and quickly change course.
- Managing resources more efficiently, and
- Better overall financial management of your company.
Mastering Cash Flow for Construction Success
Cash flow is a unique benchmark of how successful a construction company is. Construction companies need steady cash flow to fund their new projects while maintaining projects that are already underway.
Without excellent cash flow management, you may have to delay payments to vendors or subcontractors you rely on to help you complete your projects or have trouble covering expenses like office or equipment leases. Poor cash flow may force you to make difficult or costly financing decisions.
Here are some suggestions to help you master your cash flow:
- Use cash flow forecasting to ensure you have cash on hand for slower periods.
- Indicate payment terms on your contracts so that your customers know when to submit payment.
- Consider adding incentives for early payment. Some construction companies provide a 2% to 5% discount for early payment of invoices.
- Implement multiple payment methods so it’s easy for your vendors to pay.
- Make your billing process more efficient. Consider an accounting system that issues invoices and reminders automatically for recurring costs.
Construction cost accounting can be complex and so are the tax regulations for construction companies. It goes without saying that tax calculations are complex in construction. If you’re a business that operates in multiple states, there are different taxation regulations.
Some common tax compliance mistakes include failing to properly handle sales tax, misunderstanding tax deductions and credits that are specific to the construction industry, and inadequate record-keeping for tax purposes.
Consider implementing construction specific accounting software so that your accounting records can be easily exported to your tax accountant. Construction specific accounting software will provide regular updates to manage new tax regulations.
Streamlining Construction Accounting with Technology
As we mentioned above, software that is specifically designed to handle construction cost accounting can benefit your company in numerous ways.
With software, you may be able to automate certain manual processes, reduce errors from rekeying, track job costs and work in progress claims more accurately, and provide real time financial reporting that can help you run your projects more productively.
Construction accounting software can help reduce the risk of rework, errors, and lack of clarity into your project accounting, financial accounting, and tax accounting.
Avoiding the most common construction cost accounting risks will help your company achieve financial stability and success.
To ensure your company remains financially secure, you should consider implementing best practices for keeping complete and accurate accounting records, managing and accessing easy to understand cost controls, and keeping a close handle on project accounting and tax record preparation. You’ll also want to ensure that you track and manage your cash flow closely. Consider using construction accounting software for efficient and accurate financial management.
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