Small Construction Accounting–How to Get a Handle on Your Finances
You are in business to make a profit. However, for smaller construction companies especially, visibility of your financial health can be murky when you may not have staff with expertise in construction accounting.
To maximize your profitability, you need to be able to take control of your day-to-day finances. This comes from establishing effective accounting and project management procedures to help control and understand costs and revenue.
Common Finance Problems in Small Construction Firms
As the owner of your company, you are involved in managing every aspect of the firm. Chances are you don’t have a CFO or controller on your team to ensure that your finances are maintained in accordance with generally accepted accounting principles (GAAP).
This may not be a problem when times are good, but when money is coming in at a strong enough clip to cover costs, it can mask future problems. Things get even more serious when conditions become unpredictable. For example, if material prices are rising faster or more frequently than usual, the risk of financial problems becomes much greater if your projects don’t achieve expected margins.
Protect Your Business with Better Accounting and Operational Practices
So what is your risk level? These questions will help you determine whether or not you have a handle on your construction finances—and the steps you need to take to mitigate risk.
Do your profits swing significantly from month to month?
- If you use cash basis for accounting, switch to accrual basis. Cash accounting seems simpler, but the accrual method accurately matches revenue and cost. It also makes progress billing easier based on percent of completion. When you are matching revenue and expenses per month, you automatically know the completion status at any given time.
- Your project cost estimates may be too conservative (or not conservative enough).
- Management/Ownership should review expected profit margin for project bids.
- Ensure your project planning includes revenue estimates for each month over the term of your projects.
Do you understand each project’s profitability status?
- Ongoing project tracking including monthly Work in Progress reports.
- Regular meetings with project managers to review job statuses.
- Using purchase orders to track committed costs.
- Using full costing that accounts for variable, fixed project costs, and overhead.
Do you get caught short on cash when you do not expect to?
- Accurate cash forecasting is essential.
- Regular collections efforts help cash flow and can prevent later disputes.
- A line of credit can be a valuable cash management tool because funds are available quickly when needed. You can smooth seasonal cash flow or fill gaps created by fluctuating payables and receivables. You also have ready cash to cover an unforeseen expense or take advantage if an opportunity arises to make an unbudgeted purchase.
Do your contracts leave you with little wiggle room?
- Deposit and payment terms and advance billings can give you greater flexibility.
- Ensure your contracts make allowances for increased supply costs. If your contracts do not allow you to increase the job price when your costs rise above a certain threshold, project profitability could drop or go negative. If you are a general contractor, you might consider open-book pricing, sometimes called a cost-plus contract. Customers pay all of the actual costs associated with the project plus a percentage or flat fee above materials costs, which pays for your overhead and profit. Subcontractors do not have this option, so contractual protection against rising prices is even more imperative for such companies.
- Out-of-scope work can be a direct hit on your project’s bottom line if not addressed promptly. Scope changes need to be agreed upon and documented to become change orders to your contract.
Do you have backup staff identified for key accounting tasks?
- Payroll, billing, and accounts payable processes should never be dependent on just one person.
- All of these processes should be documented in writing as well so details won’t be overlooked if a new or backup person performs the work.
The Right Finance Leader Can Strengthen Your Firm
Having a knowledgeable finance leader on your team enables your firm to establish contract and accounting best practices and ensure those policies and procedures are followed. But not every construction firm has a full-time CFO, and your firm may not even need a full-time finance leader. In that case, an industry-savvy fractional CFO can help assure your firm’s financial health.
Even for small companies, a fractional CFO can advise on best practices (including financial protections in contracts), help your bookkeeper set up and follow more suitable accounting processes, and help you develop procedures project managers can follow to ensure accurate project costing and tracking.
Think of hiring a fractional CFO as practicing good financial hygiene. Investing in a sound construction finance process now sets you up for successful growth.
Gregory R. Smith
Greg Smith is a director and practice lead of the Accounting and Management Outsourcing (AMO) group at Redpath and Company. He provides oversight and direction to each of the accounting, payroll consulting and Fractional CFO/Controller areas within AMO as well as directly providing Fractional CFO services. Greg began his career in the entrepreneurial services group at EY in audit and has been a Controller and CFO in public and private companies for over 20 years. Over that time, he has gained experience in a wide range of industries including manufacturing, services, software/internet/high tech, med tech, and real estate. Greg joined Redpath and Company in 2021.
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