We are excited to begin a special, 3-part series focused on the construction industry! Today, our focus is on the basics of construction accounting, as well as construction industry accounting best practices for construction contractors. More specifically, we discuss what you can do to find efficiencies and transparency in your business. We will also talk about what you should discuss with your CFO to get better information and make better decisions to help your business grow.
Katina Peters, vCFO and Partner at PJS & Co. CPAs, has a wealth of knowledge on this topic and is an expert in working with business owners in the construction industry for over 17 years. If you would like to learn more about her, please visit Our Team page.
What we cover in this episode:
- 02:57 – When should you speak with a CFO?
- 06:04 – Job costing is key in construction accounting
- 13:04 – Direct vs. indirect costs
- 19:55 – Work in process (WIP)
- 22:20 – Profitability and cash flow
- 25:59 – Specialized software
When should you speak with a CFO?
At what point should construction business owners consider partnering with a CFO? If you’re interested in a deep dive into the topic of understanding when you should consider bringing in a CFO or financial expert, check out episode #72 – How to Hire a CFO. Katina stated, “You have to be on top of that a little bit sooner as a construction business. You can’t just fly by the seat of your pants for maybe as long as you could in another business, because there’s just a lot of structure that has to be in place around the type of accounting and job costing, etc. that you will have to do.”
The bottom line is that bringing a CFO onboard may need to happen a bit sooner than in other industries. A CFO with experience in construction accounting can help you establish the structure needed. Proper systems will set you up for future growth and give you the ability to handle business decisions in a more profitable, knowledgeable, and efficient manner.
Job costing is key in construction accounting
In the construction industry, you are typically operating on the basis of percentage of completion. It is crucial that you have the ability to track your accounting on a granular level. You are likely aware that you need to track your costs and what jobs those costs are associated with so you know which jobs are profitable and which jobs may be losing money. That’s the basic idea of job costing. We’ll talk about some of the methodologies used, the direct versus indirect, as well as general administrative costs and how some allocations will help you in your business work in process. This is where the percentage of completion comes into play.
So why is it important for construction companies to do job costing? If you are in the industry you probably know this, but there are certain regulatory issues, bonding requirements, and the occasional need for reviewed financials. Establishing proper procedures to ensure proper recording upfront for regulatory purposes can seem like a chore for most construction business owners, but why not also look at it as a way to leverage all of that information you are gathering to really build a better business?
As you are paying people, using materials, using equipment, etc., you will want to identify and assign those costs to the associated job in your accounting system, and doing that allows for better reporting. So obviously it gives you the answers you need to the questions on whether this job is costing what I thought it was going to cost throughout all the phases of the job. Are you being as efficient as you could be? There may be other trades that are getting in your way and making things inefficient. The ability to analyze the progress of jobs as you go is very crucial so you can make necessary changes. It’s not helpful for you to get to the end of the job and realize that you just lost a ton of money, so use job costing as a way to keep a pulse on what is happening.
Direct vs. indirect costs
Direct job costs are easy to identify. Direct costs include things like the person who’s on the job, the piece of equipment that’s been rented for the job, the materials that you bought specifically for that job. These costs are very direct and fairly straightforward to determine.
There are also indirect costs that you need to be monitoring as well. If you are estimating a job, you have to think of all the costs involved, which may not be as glaring. An example would be if you are using your own equipment on a job, then a portion of the usage, say an allocation of a per hour cost, needs to be assigned to that job since it’s not free equipment. Even though you may own it, you need to account for the maintenance and wear and tear on that equipment. There are insurance requirements that must be included in indirect costs as well and can be significant for a construction company, as well as general and administrative costs. You’ll want to be collecting those indirect costs and allocating them back to the jobs you are doing in order to fully understand how profitable each job truly is for your company. Building in all costs (direct and indirect) ties everything to a job and allows owners to make better, more informed decisions, which improves efficiency and profitability.
You will be able to use the information you are gathering to monitor and see very quickly if something doesn’t look right. Things that are off will stick out pretty quickly, and you’ll be able to determine what is happening so you can make adjustments that will prevent you from realizing losses after the fact. You’ll be able to look at the metrics with your CFO and compare the progress of the job, compare the costs to the percentage of completion of that job, and work on solutions to get back on track if needed. Many owners have to rely on the job superintendent for the status of job completion, and if that superintendent says the job is 25% completed when you’ve used 50% of your allocated costs, that may be a problem and a disconnect.
Work in process (WIP)
With the assistance of your CFO and accounting team, owners should be having discussions on a regular basis to ensure costs and billings are being tracked properly for current jobs. Are the billings over or under billed compared to the job status? It’s good to have those meetings, and they can also be used to judge the capacity for what can be done on future jobs. Keeping a pulse on your WIP allows you to plan for the future and keep your business pipeline on track.
Profitability and cash flow
When you are tracking work in process, it’s really like tracking the nitty-gritty details of your profitability. Obviously, the bread and butter of profits in the construction industry is the jobs, and the jobs are what drive the company’s profitability. Looking at the details of the costs associated with each job closely will make sure you are staying profitable and allow you to make any needed adjustments as quickly as possible to get back on track. Using the knowledge and feedback you gain on the profitability of the jobs should also be shared with those completing estimates for future jobs.
It’s also important to stay on top of cash flow since the construction industry typically has ebbs and flows to workload, and can see seasonal changes as well. Planning for those changes can help level and equalize cash flow as much as possible. You’ll want to make sure you are billing appropriately and timely for everything, as well as collecting appropriately and timely so that you’ll ride the ups and downs with more ease.
With all this tracking and gathering of information to better run your construction business, it seems that you could easily be overwhelmed if you are completing each of these tasks manually. For a smaller business manual processes are doable to an extent, but you have to be aware of how much time and effort tracking these things manually can cost you in your efficiencies. There is specialized software for construction companies that will help you graduate to a higher level of efficiency and are designed to do the kinds of things that will allow for expanded growth and profitability.
Specifically, in the construction industry, where you need timely information and detailed tracking of costs, it is a wise investment to use specialized software to run your business well. Specialized software packages can allow you to integrate all the tasks you need to do to run your business. You can gain efficiencies by performing most tasks, like invoicing, estimating and job costing, paying bills, timekeeping and payroll all in one system. Most also have the ability to utilize mobile technologies and can allow staff to enter information from the field. The more integrated your systems, the better your information and reporting capabilities will be.
We kicked off our 3 part construction series with best practices in construction accounting and discussed questions you should ask your CFO. First, we discuss timing and when a CFO should become a part of your team. Then we get into the topics that you should be discussing regularly with your CFO. Job costing, direct and indirect costs, work in process (WIP) and specialized software should all be a part of your growth strategy and have a high focus in order to push your business to the next level.
Helping business owners increase profitability and value in their businesses is always our goal at PJS and Co CPAs. We have professionals with almost 20 years of experience in the construction industry who are able to partner with you to help accomplish your goals. The construction business owner has unique challenges compared to other business owners, but we are here to make your life easier, to help put the tools you need in place for your unique situation, and help you to reduce stress levels.
If you are interested in more information in our construction series, remember that this is our first in our three-part series, and we welcome you to subscribe to our podcasts so you won’t miss anything. If you are looking for a vCFO you can partner with in your construction business, or any business, please reach out to us at PJS & Co CPAs, or call us at 844-475-7272.