Construction businesses are included in this, of course. You might even say that accounting systems are even more essential in the construction industry due to its complexity.
In what way is construction accounting complex? And what construction accounting principles and best practices should you know and use? You’re about to find out.
How is construction accounting different?
Before we get into proper construction accounting processes, it’s worth noting some of the ways in which the industry is different from others.
Unlike a business that sells products from a brick-and-mortar location, a construction company operates across various locations. Plus, whoever’s keeping the books has to account for travel time and expenses, labor costs, delivery of tools and equipment, removal of debris and leftover material from each job site, and more. These costs can be unpredictable because they vary by project.
But that’s not the only difference. The following also play a role:
Numerous service categories. In contrast to businesses that have limited offerings, most construction firms provide a wide range of services—everything from acting as a general contractor to consulting and design to engineering and labor. Having a way to keep track of expenses and profit in each category is crucial.
Cost of Goods Sold (COGS). In construction, COGS is not as simple as noting how much a product costs. There are likely dozens (if not hundreds) of direct and indirect costs across the various service categories mentioned above on any given job. Tracking them accurately can be tricky but getting it right is essential since it helps with job costing for future construction projects.
COGS vs. Overhead. Overhead consists of necessary, ongoing expenses that can’t be attributed to any particular revenue unit and, therefore, don’t directly generate revenue. But since many such expenses in construction are linked to specific construction projects, items that other businesses would consider overhead often fall into the COGS category for construction companies.
Project-based work. Construction companies often work on many projects at once—all of which are in various stages of progress—which means that they often need separate profit and loss statements for each one. The more projects underway, the greater the importance of accurate bookkeeping and project accounting. Knowing when (and if) the company will break even on each job is crucial for accurate job costing in the future and long-term financial health.
Does this all sound more complicated than you have the time, energy, or accounting knowledge to deal with? If so, don’t worry! There’s an accounting process you can use to make financial management much easier.
A simple, 7-step construction accounting process
If you decide not to outsource your accounting to professionals who know the construction industry’s ins and outs, this process can help you DIY successfully.
Step 1: Decide on an accounting method
To limit confusion and inaccuracies, you need to decide on and stick to one set way of recording your income and expenses. You can choose between two methods: cash accounting or accrual accounting.
The first—cash accounting—involves recording income when you receive it and expenses when they’re paid for. Accrual accounting, on the other hand, records income when you earned it, regardless of when the cash actually changes hands.
To illustrate, say that your company just sent a net 30 invoice to a customer for a $10,000 construction job.
With the accrual accounting method, the $10,000 is labeled as accounts receivable (A/R) once the invoice is sent.
With cash basis accounting, the $10,000 is recorded whenever the customer pays their invoice. Your books won’t show any income from the work you’ve done until the customer pays.
While cash accounting is the simpler of the two methods, accrual can give you a more accurate picture of your monthly revenue and expenses. This can be beneficial for construction firms since there’s often a 30 to 90-day delay between invoicing and payment.
Need a little more help understanding the difference between cash and accrual accounting? Check out these helpful resources:
- Cash Basis Accounting vs. Accrual Accounting
- Understanding Accounts Receivable (Definition and Examples)
Step 2: Get a business bank account and credit card
If your construction business is new or on the smaller side, you may not yet have a business bank account or credit card. But when it comes to accounting, it’s important that you have both in order to keep your personal and business finances separate.
Reconciling your transactions will be much easier and faster if you don’t have to sift through income and expenses unrelated to your construction business. So set up a business bank account and run all of your business income and expenses through it to keep your records clean.
Step 3: Choose your accounting software
Once your business bank account and credit card are set up, you’ll want to connect your accounts to reputable construction accounting software. You’ll need to do some research to figure out which accounting software will fit your needs best but, if you choose wisely, you can enjoy many benefits.
For one thing, accounting will take less of your time, especially since many accounting solutions offer automated expense categorization and other time-saving features. Plus, you should have more clarity on the financial health of your business.
Step 4: Track all business transactions
Keep a record of accounts payable, such as invoices from your suppliers. And do the same for accounts receivable—invoices you send to your customers. Accounting software and apps will make it simple to keep track of:
- Transaction dates
- Transaction amounts
- Descriptions of the transactions
- Who was paid or who money was received from
For expenses specifically, you’ll want to categorize them by service and by contract so that you can get a clear picture of how much money you’ve made vs. how much you’ve spent per project. You can use an expense tracker app to make this process even smoother.
You may find that many of your expenses fall into these common categories in the construction industry:
- Business registration and licensing
- Membership fees (unions and associations)
- Tools and equipment (including safety equipment)
- Labor costs including subcontractors and employee payroll
- Travel expenses (including fuel) and lodging
- Mileage when traveling to and from job sites
- Vehicle maintenance
Keeping thorough records and categorizing business transactions properly in this way will help you to make smart financial decisions. Plus, it can be a big help if you’re ever audited by the IRS or another tax authority.
Step 5: Prepare adjusting journal entries
At the end of the accounting period, you’ll need to prepare adjusting journal entries to make sure that the transactions you’ve recorded match up to the right accounting period.
If you’ve chosen the accrual accounting method, your journal entries should reflect all revenues earned and expenses you’ve been billed for during that period.
And, in the event that you receive payment in advance for a project that belongs to a future accounting period, you’ll need to prepare a different kind of journal entry. It’s known as a deferral and any such revenue would be considered deferred until you complete the service you were paid for.
Learn more: What is Deferred Revenue and Why is it a Liability?
You may also need to make other adjustments if, for example, you:
Spot an error in a transaction that’s already been recorded (for example, if a piece of equipment has been improperly categorized)
Pay for a business expense using a personal credit card instead of the company card
Need to record a depreciation expense, which encompasses:
- The value that an asset, such as a machine, loses over time
- How the original cost is allocated across the time when the asset is in use
This step in the process is all about ensuring the accuracy of your financial info. While you can prepare adjusting journal entries yourself if you’re comfortable doing so, we recommend working with an accountant or CPA to make sure your books are accurate and complete.
Step 6: Generate financial statements
With all your info double or even triple-checked, you can then generate accurate financial statements. Some of the most common are:
Balance sheets, which summarize all of your business’s assets, liability, and owner’s equity. Think of your balance sheet as an overview of the financial health of your construction company and a straightforward way to see when you need to cut costs.
Income statements, which are also known as profit and loss statements and summarize revenue and expenses.
Cash flow statements, which can help with forecasting and ensure that you have the money to cover your expenses. These statements break down how much cash entered the business and how much you spent during a given period.
While most accounting solutions,such as QuickBooks, offer at least these three types of financial reports, some offer additional financial reporting options. It’s worth comparing top construction accounting software solutions to see which financial statements you need.
Also, besides generating statements, regularly check the dashboards within your accounting software, which can give you real-time financial info at a glance.
Step 7: Take care of your taxes
Last but not least, we can’t forget to mention the importance of understanding and meeting your tax obligations. For example, you may need to pay estimated taxes each quarter. But how much you’ll need to pay depends on the approach you use. Both of the following are popular in the construction industry:
- The percentage of completion method, which bases estimated tax payments on total income and expenses for each quarter.
- The completed contract method, which involves calculating how much you owe for each construction project completed during each quarter.
If you’re not sure which method would be best for your construction firm, a tax pro will be able to point you in the right direction. And they’ll also be able to assist with other tax obligations you may have including:
- Federal income taxes
- Self-employment taxes
- State and local taxes
- Payroll taxes
- Sales tax
- Excise taxes
- Property taxes
The better you are at keeping track of your revenue and expenses on a regular basis, the less stressful filing and paying taxes will be.