8 Accounting Basics for Contractors and Construction Businesses

Accounting is an essential part of running a successful construction business. However, managing your business finances correctly doesn’t always come naturally—especially if you’re not much of a numbers person. What’s more, accounting for construction company finances has some unique challenges compared to other types of businesses.

In this guide, we address some of those challenges and cover the basics of construction accounting. Follow this resource step-by-step to establish an effective accounting process, avoid costly mistakes, and make more money.

Here’s What We’ll Cover:

• How Is Construction Accounting Different?
• Tips for Handling Your Construction Accounting Processes
• Conclusion

How Is Construction Accounting Different?

Accounting for the construction industry is more complex than it is for most businesses due to the nature of the work, revenue recognition, per-project pricing, job costing, fluctuating operating costs, and other aspects of construction projects.

Construction companies deal with a variety of requirements. So they need to be able to track accurate costs, bid on jobs, manage prevailing wage requirements, and handle a slew of other accounting responsibilities.

Below are the key ways in which construction accounting differs from other types of accounting.

Project-based

Construction companies work from project to project and typically manage multiple projects at one time. Construction projects aren’t necessarily paid for as soon as the project is completed: There may be an upfront deposit required, the project could be paid in full, or it can take months before the final invoice is settled.

For these reasons, construction companies may need to generate separate profit and loss (P&L) statements for each project.

Sales

Regular businesses typically offer 1-5 different types of products or services, whereas construction businesses offer a wide range of services. This may include service work, design services, consulting, engineering, sourcing materials, and more.

This can make it difficult to track expenses and effectively calculate the profit generated from each service category. 

Fluctuating Overhead Costs

Construction companies also experience fluctuating overhead costs. Consider the cost of insurance, travel, workers’ compensation, materials, subcontractors, equipment, and more. You will need to factor this into your construction accounting for each construction project and for the business as a whole. To effectively manage these variable expenses, you can use FreshBooks Project Accounting Software which lets you track project financials and create reports quickly and easily.

Cost of Goods Sold

Most businesses simply record the cost of the products sold, but construction companies are quite different. Each job incurs direct and indirect costs that may fall into a wide range of categories. It’s essential that contractors have an effective method for keeping track of income and expenses, and for reconciling every transaction.

Also Read: Cost of Goods Sold Formula

Long-term Contracts

Your company may manage short- and long-term contracts, often with varying end dates. This means you may not get paid at the same time every month. To stay on top of cash flow and keep your books in check, you will need a flexible yet organized construction accounting system.

Tips for Handling Your Construction Accounting Processes

The following steps can help you get your construction accounting started on the right foot and help you stay on top of your bookkeeping and financial management.

1. Separate Personal and Business Expenses

The first step for all construction firms is to open a separate business bank account that will be used exclusively for your business.

You can go to a bank or credit union to set up a company checking account that suits the needs of your firm. This will make it easier to keep your finances organized. 

To set up a business bank account, you will need:

• Social security number or employer identification number (EIN)
• Personal identification, such as a driver’s license or passport
• A copy of your business license
• Organization documents filed with the state

2. Break Down Project Costs—Job Costing

Since construction accounting is project-centric, you’ll need a way to track, categorize, and report transactions for each job. This is called job costing.

Job costing is a method for allocating expenses and revenue to each specific job. Not only will this help you prepare for tax time, but it provides an accurate accounting of profitability for each contract.

It essentially ensures that your service price covers all overhead expenses and helps ensure you make a profit on all of your construction projects.

Job costing is calculated by determining the cost of labor, materials and overhead on a specific job (Total Job Cost = Direct Materials + Direct Labor + Applied Overhead). 

Read our complete guide on How to Calculate Job Costing

3. Record Day-to-Day Financial Transactions

Use a journal, spreadsheets, or construction accounting software to record day-to-day transactions like accounts payable, accounts receivable, labor costs, and material costs incurred. You’ll want to include a description of each transaction, the date of the transaction, and the revenue received.

You can use construction invoice templates to bill your clients and keep a paper record of all construction projects and revenue generated.

If you use a contractor accounting software, it can usually connect to your business bank account to automatically report expenses that flow through the account, including equipment and labor costs and administrative costs.

4. Select Revenue Recognition Methods

Revenue recognition is how a a business determines when they’ve officially earned revenue from a contract or project.

Under regular business accounting circumstances, revenue recognition is simple because they sell a product or service and collect a fixed price right away. They can choose between the cash method or the accrual accounting methods. However, the nature of construction companies makes how these businesses recognize revenue more complicated.

In construction accounting, there are a few main revenue accounting methods if the company has long-term contracts:

• Completed contract method. Under the completed contract method, contract revenue recognition doesn’t occur until the project is complete.
• Percentage of completion method. Under the percentage of completion method, you recognize revenue according to the percentage of the project completed during the year. You calculate this percentage by comparing expenses incurred and allocated to the contract during the year to the total estimated costs.

In general, a construction business with gross receipts (also known as Business Tax Receipts) over $10 million must use the percentage of completion revenue recognition method for tax purposes. A construction business with gross receipts under $10 million can use the completed contract method on construction projects that last less than two years. They’re only required to use the percentage of completion method for construction contracts that extend over two years.

If your construction business follows generally accepted accounting principles, you should use the percentage of completion method for financial statements as well.

5. Track Business Expenses

You’ll also want to categorize these expenses by service, and by individual job so you can easily track how much money came in as well as how much you spent on expenses. Using an expense tracker and saving your receipts can help you keep track of all of your expenses and project profits on each job.

The most common expenses construction industry businesses have include:

• Business registration and licensing
• Bank fees
• Tools and equipment
• Travel expenses (including fuel)
• Electronics
• Trade school tuition
• Vehicle maintenance
• Phone and internet expenses
• Lodging
• Software subscriptions
• Membership fees (unions and associations)
• Mileage (tax write off)
• Insurance
• Lease payments
• Safety equipment and uniforms
• Subcontractors
• Employee payroll
• Advertising and marketing

6. Reconcile Bank and Supplier Statements

Each month your bank will send you a record of your income and expenses. You can use that bank statement to reconcile your transactions to make sure they match up with your own accounting system, invoices, payments, etc. 

Reconciling your transactions involves:

• Comparing your bank records to your expense receipts
• Looking for any discrepancies between your construction accounting system and your bank account
• Comparing transactions in the bank statement to what you have in your record of financial transactions
• Contacting your bank to discuss any discrepancies

7. Pay Estimated Taxes

To pay estimated quarterly taxes, you have a few options, including:

• Signing up for the Electronic Federal Tax Payment System (EFTPS) online
• Paying online via the IRS website
• Paying using debit or credit card
• Sending a check or money order by mail to the IRS

Many construction companies use a “completion percentage” approach, meaning they calculate estimated taxes based on quarterly income and expense reports. 

However, you can take a “completed contract” approach as well, which involves calculating taxes owed on each contract. A benefit of this approach is that you can track income, operating expenses, profit, and taxes on the micro-level so you gain a better understanding of where you stand on each construction project. 

The important thing is that you adopt a construction accounting strategy that works best for you, and stick with it so there’s no confusion come tax time. If you need extra help, it’s recommended that you seek out an accountant or professional tax preparer.

8. Hire an Accountant (Optional)

While it’s possible to manage your construction accounting on your own, owning a construction company comes with many complexities that may lead to you making costly accounting errors.

Just as you have project managers overseeing each job site, it might make sense to hire a professional accountant to help you reconcile a variety of transactions for various jobs and services. 

An accountant will help you make sense of the numbers, manage your books, generate reports, estimate your quarterly tax payments, maintain a healthy cash flow, and protect narrow profit margins.

Nervous about the cost? The average hourly rate for an accountant in the U.S. is about $35, making it quite affordable for the average owner. However, these rates may vary depending on the size of your company, the number of jobs and employees you manage, and your unique needs. 

9. Leverage Professional Construction Accounting Software

Invoice templates and spreadsheets will only take you so far. If you truly want to master your construction accounting and avoid costly mishaps, you may want to look into the best construction accounting software.

This will make it easy for you to send invoices online, track expenses, monitor payment status, generate financial reports, and more.

Even better, clients are more likely to trust businesses that use construction accounting software over manual methods because accounting software provides a safe, convenient way for them to pay online.

Plus, you’ll have all the tools you need to stay on top of your construction accounting and make smarter financial decisions.

Conclusion

Construction accounting doesn’t have to be a headache. With the right process, you can save time on your invoicing, accounting, bookkeeping, and tax preparation, even without previous construction accounting experience. 

Improving your process starts with understanding how construction accounting is unique, and determining the different types of job costs you can incur on each project.

The best way to stay organized is tracking your day-to-day transactions, reconcile your accounts on a regular basis, and use construction accounting software.

With the steps in this guide, you have everything you need to do construction accounting for your company the right way. For those looking to streamline their operations further, explore our post on the best construction apps to enhance your efficiency.

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