Accounting is a process used to record and measure financial information.
- For most businesses, accounting is one of the most important factors there is as it is used to track profitability and ensure transparency.
- Businesses are valued and regulated based on their financial reporting, so in most industries it is critical to have accurate accounting methods in place to ensure the long-term health of the business.
There are several types of accounting including:
Just to name a few…
Accounting methods vary depending on the industry.
This article will cover the basics of Construction Accounting. You will get an overview of what you will want to be aware of when looking for a bookkeeper, starting a construction business or hiring an accounting firm.
Construction Accounting Basics
To make a profit, you have to charge enough to cover your expenses, so there is money left over.
In accounting, there are three main methods of reporting a company’s financial profit and loss. They are the:
- Balance Sheet
- Income Statement
- Cash Flow Statement
A balance sheet is a detailed snapshot overview of a company’s financials at a given moment. The three aspects of a balance sheet are:
1. Assets - Things that you own
2. Liabilities – What You Owe
3. Equity – What is left over
An income statement focuses only on income produced by the business. The time period covered on an income statement can range from Quarterly to Annually. The key factors that particular statement records are
1. Revenue – Overall income produced
2. Expenses – Overall Costs of operation
3. Losses and Gains – Overall profit and loss
Cash Flow Statement
The Cashflow statement primarily records the flow of cash into a business. This statement will give critical information as to how much a company can produce from its assets as well as its ability to pay its bills.
In some industries, business produce income from investments or holdings which can also be recorded on a cash flow statement.
Most businesses will track financial information using these three statements; however this can vary depending on the industry. Accounting is a complex topic that goes a lot deeper than this.
However, for someone unfamiliar with the subject. Understanding the three essential components of financial reporting is a good starting point.
What makes Accounting for Contractors different?
Most companies utilize relatively simple methods of accounting, due to the nature of their business. Perhaps they have a fixed location and know each month how much their overhead will be.
This makes it pretty simple to track the cost of items and then how much they sold. Construction accounting can be slightly more complicated.
Money flows differently through a construction business.
Contractors often operate in different locations all the time and may require an array of material based on the customer’s needs.
Also, construction accounting must factor in travel, costs of transporting equipment and the time it takes to set up and break down a job site. Some of the most notable differences include:
Often a regular business will offer a few different categories of products and services, which are easy to track when accounting for sales.
A construction business may offer a variety of services which may include:
- Physical Labor
- Physical Products
Regular businesses often do not render services until payment is made. Income is very transactional which make accounting much simpler.
Construction businesses may render services before a complete payment is received.
What a restaurant may consider an “overhead expense,” a construction business could consider “cost of goods sold” as it is directly connected to a client’s project.
Regular businesses often have recurring expenses that they can easily project, while for a construction business this is continually changing.
Most business can determine whether they have broken even quite easily. However, There are several factors to take into account a construction project before one can determine whether or not they have broken even.
Some custom projects may have a specific requirement and several associated costs that can alter these numbers significantly.
Construction Accounting Methods
As a business taxpayer, the IRS gives you a few ways you can record your revenue and expenses for tax reporting purposes. There are a few basic methods which construction business use exclusively. They are:
The Cash Method:
Revenue is booked when money enters and leaves the company. A common and simple way of accounting for cashed based businesses.
Anytime money is received it is reported, anytime money is paid out, it is reported.
The Accrual Method:
Revenue is booked when an invoice is issued. This may not necessarily mean that money has actually entered your bank account, it just means that it will be recorded based on the invoice.
All revenue entering the business is tracked by billing.
Completed Contract Method
Revenue is only recognized when a contract is considered complete. This method is typically used for long-term contracts where costs are difficult to estimate.
For contracts that may last 2 years or more, Revenue reported to the IRS should be done using the completed contract method.
Percentage of Completion Method
Revenue is recognized by estimating the completion of the project. This is a variation on the completed contract method.
It is mainly used when collections are assured. The Percentage of completion method can be used to estimate profitability and measure progress of a project.
Advantages and Disadvantages to each method
Every accounting method has its advantages and disadvantages.
The most important thing for you is to hire an accountant or bookkeeper that understands the construction business and more importantly how you charge for your services.
Based on the information you give them about how you receive and pay money, they should be able to identify the best method for you.
When should a Contractor hire a Bookkeeper?
The simple answer is:
If you can’t do it yourself accurately, then hire a bookkeeper. A book keeper’s job is to record and maintain all of the day to day financial information associated with your business this can include:
If you are receiving money for services, you should have a bookkeeper.
- Maintaining clear and accurate accounting records is a requirement for contractor licensing and bonding in the state of California.
- As a business owner, it is important to delegate tasks as soon as you can so that your focus can be on growing your business.
- Ideally, you would want a bookkeeper to have your information organized throughout the year so that all you need to do is hand it over to your accountant come tax time.
The role of an Accountant in your Construction Business
The primary role of an accountant is to examine your financial records and ensure that everything is accurate and filed correctly with the IRS.
Depending on your relationship, an accountant can help you keep track of your financial information however this is generally the role of a bookkeeper.
Your day to day business financial records should be organized well before you hand them off to your accountant.
Accounting firms will in some cases have you sign a contract agreement that does not hold them legally liable if you are sued by the IRS for any tax-related crime.
Accountants can also consult you on the different types of business structures available to you and which ones can save you on your tax bill.
Learn more about business structures such as LLC and S-Corps!
Construction Accounting Software
These days most bookkeepers will use some type of accounting/bookkeeping software to enter in your financial information throughout the year so that it is organized and accurate come tax time.
In addition to accounting software, there are also programs available that can help you make accurate estimations and bids.
Accurately calculating the costs, you may incur from a project, how much you should bid and how it will affect your accounting is critical.