Construction Accounting for Contractors: Building Better Business

Aug 10, 2022

In construction projects, contractors must understand the complexity of budgeting, timing, cash flow, purchasing, delivery, labor allocation, and accounting for their projects. In this article, we’re breaking down a few aspects of these realities and exploring some characteristics that, when better understood and managed, can help assure profits and reduce the risks of losing money. Plus, learn some best practices for approaching projects from the business and financial side and how a fractional CFO might be just the partner you need to build a better business.

Characteristics of Revenue in Construction Accounting

Let’s start with some broad discussion on how construction companies function where revenue is concerned.

Project-Based

Project-based construction is a business model focusing on the project instead of the building. The project-based construction model is based on the idea that each project should be treated as an individual entity, not part of a larger whole.

The main advantage of this type of revenue model is that it allows contractors to take on more jobs at once, which in turn increases their chances of making a profit. If the house isn’t finished being built but your project wrapped up, you can move on to a new project.

The main disadvantage of this type of revenue model is that it does not provide contractors with a steady income stream, as they can’t always predict how much money they will make from one job to the next.

Contract Timing

Contracts range from short-term to long-term with extended payments. Each has its nuances that create opportunity or friction. With short-term contracts, contractors can generally have a clear sense of the resources required, cost of goods, timing, and therefore invoicing and payment schedules. Short-term contracts also allow contractors to move quickly from one job to the next.

This can also be a disadvantage – you must have that next job lined up, especially for small teams or sole proprietorships. On the other hand, it can be easy to over-schedule with over-confidence that a job can be completed quickly and the next job picked up. When contractors are juggling multiple jobs with little staff, problems arise that potentially impact long-term prospects.

Long-term contracts provide stability, and extended payments can create predictable cash flow. But time is often an enemy in construction. Will you have the skilled staff to sustain a job? Will the cost of goods increase beyond expectations (thus crushing profitability)? Estimates and scope can dramatically change as a project goes on. Furthermore, construction delays are all in a day’s work. If you have teams and resources dedicated to a site only to have them sitting for hours (or days or weeks), that’s time that could be better spent elsewhere.

Which is best for you? That depends, of course, on the projects ahead, the contractors you work with or subcontract for, the size of your company, the availability of resources, and more. Our guidance in any case includes:

Get it in writing. Your estimates and scope of work should be well understood by all stakeholders going into a project. Change orders should be rigorously updated.
Have contingency and mitigation plans. What if the weather is bad? What if it’s bad for a week? What if there’s a mechanical breakdown? Executing against unknowns is always hard, but be ready for them from a planning and cash flow perspective.
Don’t trust your instincts. Great carpenters aren’t necessarily great business people. Skilled plumbers aren’t always great forecasters. Know your inventory. Understand what your labor costs. Know the implications of lost time on the job. Only by measuring what matters can you make intelligent decisions. This takes data. Let’s take this idea further with job costing.

Job Costing

Job costing is a process of assigning costs to specific jobs. It is done to track and control costs for profitability. Costs can be broken down by expenses such as labor, materials and equipment.

Smart job costing strategies include:

Estimate and track transactions per job
Manage each project as an individual profit and loss. This is key for staying ahead of issues or avoiding them altogether. Trying to make up for lost revenue with a job is difficult and can lead to deceptive decisions.
Itemize costs by each transaction to manage a project as it is underway. Know in real-time what’s happening with a project. It can be helpful, conceptually, to think of each project as its own small business. Your job is to make your business profitable.
Focus on controlling specific costs of labor, materials, equipment, etc. Detail as much of these costs as possible, calculating them into estimates. Leave room for profit!
Include time allocations for shared overhead, like equipment usage

You (Yes, You) Need a CFO

Everybody wants healthy finances, but few of us are financial people. Many start a business around what we love or are interested in or skilled at, only to find the critical financial aspect to be intimidating or too complex. It’s wise to put somebody on your team who’s as talented with finances as you or your team might be on the job site.

Additionally, as your business grows more successful, so will the jobs and the complexity of financial functions and construction accounting. A fractional CFO can be a crucial teammate, managing essentials.

Cash flow: Your CFO can help you develop positive cash flow and structure future contracts to maximize cash and profitability. They can also help manage and mitigate the timing of jobs and the timing of getting paid. For instance, complex mechanisms like retainage mean contractors can’t get paid until an architect gives approval, which could be months after a job’s completion. Your CFO can help you be prepared.
Forecasting: Develop a budget with your CFO aligned to where you’re headed and where you’d like to be headed. Your CFO can help you match what you think is going on to what’s actually going on. With insights like that, you can plan more efficiently.
Trust your instincts: Okay okay, we just said not to trust your instincts. But your CFO can help validate what you think you know or shed light, so you know more. When specific, accurate data complements your instincts, you’re empowered at the moment, on the site or when proposing a project. However, if you’re missing segments of costs you’ve never considered, your instincts might not be bad, just inaccurate. Inaccurate instincts create inaccurate results.

The role of the CFO is to help you, the owner or leader, make better, smarter decisions. In construction, this means also accounting for rules and regulations, outside influence, uncontrollable factors, increasing costs and more. With the guidance we’ve shared in this article and a conversation with an expert CFO, your construction company will be in a strong position.