5 Common Construction Accounting Risks — and How to Address Them
The primary focus of most contractors is to complete projects according to specifications, on time and on budget. For some construction businesses, accounting tasks that support jobs can take a backseat. Unfortunately, without accurate and efficient accounting practices, you may be signing contracts that hurt, rather than boost, your bottom line. Here are five issues commonly confronted by contractors and how you can prevent them from hurting your bottom line.
1. Inaccurate Cost Estimates
Bad estimates can lead to bidding jobs too low and, when projects go forward, to faulty budgets with cost overruns. Line-item estimates are relatively simple to make for smaller jobs. But with larger, more complex projects you can easily underestimate costs.
Good estimates are detailed and account for all expected costs associated with a project. Although they take time to put together, it’s time well spent. Start at the task level and estimate from the bottom up. Determine what it takes to complete each jobsite activity, including materials used, equipment hours and labor hours. Use those jobsite tasks as line items that can be added or deleted if the scope of the job changes.
Regularly tracking job task costs is central to creating solid estimates. Compare your estimated costs against actual costs from past projects to determine where adjustments should be made in future estimates.
2. Overlooked Overhead
To develop a realistic picture of your job costs, you must accurately factor overhead. Fixed overhead costs include your office’s rent or mortgage, office equipment and supplies, licenses and fees, taxes, utilities, insurance and salaries. Because your company probably follows a regular payment schedule for these costs, they’re easy to calculate. However, there are variable costs that fluctuate by job, location and even season. These can include additional staffing, staging, transportation costs and equipment rentals, as well as “softer” costs such as advertising and signage.
Pay close attention to both fixed and variable overhead costs by regularly reviewing your income statement. Are expenses being properly allocated to the associated jobs? Are there any costs that aren’t accounted for? Are you factoring in equipment depreciation, administrative expenses and property rentals? Can you allocate variable costs to specific categories, such as soil conditions, geographic regions or climates?
3. Increased Market Prices
It’s no secret that construction supply chains and labor pools have been disrupted by the pandemic. For the foreseeable future, expect costs for materials, equipment and labor to increase. To help ensure you don’t have to eat the rising costs, ask for a deposit to buy and store materials prior to the start of construction.
Also, include in your contracts a price acceleration provision that allows you to make adjustments if market prices increase. To maintain a good relationship with the project’s owner, set a percentage threshold so if market prices change by an agreed-upon percentage, the extra cost will be invoiced to the owner.
4. Cash-Flow Crunches
Sometimes contractors only get paid when a construction job is completed. In the meantime, expenses — including payroll, interest and rental fees — usually add up. To prevent cash-flow problems, include in your project proposal a payment schedule based on agreed-upon dates or milestones. You also may want to consider asking for a deposit before the job begins.
5. Out-of-Scope Work
Even well-planned projects are subject to last-minute changes. Unforeseen site issues, bad weather, worker shortages and unavailable materials can force project teams to revise their plans. And owners may request add-ons or other changes that increase the job’s scope.
You and your project managers should work with your accounting staffers to compare real-time, actual costs against estimated costs throughout the project. If costs start to creep up, quickly make decisions to control them. Project managers and accounting workers also need to work together to determine whether new costs are feasible. If a project is headed toward unprofitability, you may decide to refuse extra requests.
Note that you should submit change orders and receive written authorization before executing new work. Be sure to bill for approved change orders immediately.
Pay Attention to the Numbers
Whether you own a small or large construction company, make sure you prioritize accounting and financial matters. Great sales skills and hard work on jobsites aren’t enough to maintain profitability. If you don’t have in-house accounting expertise, contact Kirsch CPA Group to help.
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