The construction industry is hectic and complex. No two jobs are the same, and few projects progress according to plan. These volatile conditions make it easy to miss something on the financial side of your business.
Accounting errors can range from minor missteps to oversights so severe that they become legal issues down the road. Here are some of the most common construction accounting mistakes your company will want to avoid.
1. Inaccurate Overhead Allocation
Every business has overhead, including those in the construction industry, and a portion of your overhead needs to be allocated to your various job costs. Examples of overhead include rent, company salaries, taxes, insurance, marketing and advertising, accounting, and legal fees.
If overhead isn’t allocated appropriately, it can create a distorted picture of job profitability. The key is to find the right method of overhead allocation that is an accurate reflection of costs for the job.
2. Completing Undocumented Work
It’s not uncommon for additional or unexpected work to get added to a job once a project gets underway. What was documented in the original plan is usually not an accurate outline of the work that actually gets done. When changes happen, it’s vital that a construction business follows the correct procedures to document changes. If this doesn’t happen, it can result in work getting done on a project for less profit, no profit, or even a loss.
3. Incorrect Cut-Offs in Billing and Job Costs
Most businesses use the accrual basis of account, meaning revenue is recorded at the time it is earned, and costs are recognized when they are incurred. Cut-off errors happen when costs are omitted during a reporting period. This can be addressed by using a voucher system to record costs as liabilities in the period they are incurred.
4. Poor Cost Estimation and Quotes
One of the most important factors in construction accounting is the estimation of job costs. Inaccurate estimates are usually caused by the improper accumulation of actual costs, incorrect change order revisions, and just bad initial estimates. To avoid these common errors, construction businesses should compare actual versus estimated costs monthly to ensure ongoing estimates are an accurate reflection of market conditions and the reality of the project.
5. Misunderstanding Joint Ventures
Joint ventures can be profitable when handled correctly, but they can be disastrous for your business if you don’t understand how the costs and profits are supposed to be shared among the participants. The terms for a joint venture must clearly spell out how these items will be split, and there should be internal procedures in place to record the activity correctly.
6. Failure to Record Losses
When a construction business uses the “percentage-of-completion” method, it’s not uncommon that it will fail to recognize when a job might generate a loss. According to generally accepted accounting principles, a loss contract should be fully recognized at the time the loss is determined. This may not happen if a business doesn’t consistently and accurately update its project budget against its costs.
7. Failure to Include Cost Escalation Clauses in Contracts
Many contractors include fixed costs in their construction bids, which can come back to bite them when the markets for labor, materials, and other expenses, like energy and overhead, fluctuate.
For example, when steel and plywood prices rose over the past several years, some companies saw their material costs soar nearly overnight. If those were listed as fixed costs in construction contracts, the company would not be able to pass on those price increases to customers. You can remedy this issue by including clauses in the contract that address cost escalations.
8. Poor Cash Flow Management
Many businesses face issues with poor cash flow management, and construction businesses are high on the list for having these problems. It’s a matter of timing. Many construction companies are required to cover the cost of a job (or most of it) until completion. This can lead to a negative cash flow situation if proper planning or contract terms aren’t put in place to cover expenses.
9. Not Using the Right Accounting Software
Technology has come a long way in terms of helping construction companies stay organized and in compliance with financial regulations. You no longer need to keep track of everything by hand or even struggle with cumbersome spreadsheets.
There are some fantastic project management and accounting software packages available for construction companies that ease the burden of accounting and financial management. You’ll simply need to find the best accounting software that best suits your needs and goals.
10. Not Asking for Professional Help
Accounting for a construction business is much more complex than what you’d find in many other industries. Making decisions without consulting a construction accounting professional could be the wrong choice if you want to grow your business. An experienced construction financial professional can get you organized and ensure your records remain compliant and accurate. This is one part of your business you don’t want to handle on your own.
The last thing you want is to make any of these costly construction accounting mistakes. You already have enough on your plate as a busy construction business, especially when one of your goals is growing your business. Outsourcing the financial side of your business is the best way to ensure you get things right the first time.
At New Lyfe Accounting (NLA), we offer customized financial services to clients in the commercial construction industry. With our deep backgrounds in the industry, we’ve dedicated our business entirely to construction accounting.
Construction CFO services are our primary offering, which provides clients with a high-level strategic partnership to help foster growth. Our supplementary services include project accounting, bookkeeping, and construction software solutions. Contact us today to learn more about how partners with NLA can benefit your business.