Improve your construction business's financial management with Bookkeeping For Construction. This comprehensive guide covers essential bookkeeping principles and practical strategies tailored to the unique needs of the construction industry. Start maximizing profits and minimizing errors today.
Whether a business is big or small, just starting out, or already established, there is one thing that it needs to succeed: a streamlined accounting system that makes managing finances easy and prevents the headaches that come with inaccurate bookkeeping.
Construction businesses are no exception to the need for efficient accounting systems, and in fact, such systems are even more critical in this complex industry. To effectively manage finances in construction, it's essential to understand the intricacies of construction accounting and to implement best practices. In this article, we will explore the complexities of construction bookkeeping and provide you with the principles and practices you need to know.
How bookkeeping for construction is different?
Before delving into construction accounting procedures, it's important to recognize how this industry differs from others. In contrast to a traditional brick-and-mortar business, construction companies operate at various locations, adding complexity to their accounting processes. Those managing financial records must account for a variety of expenses, including travel, labor, equipment delivery, debris removal, and more, all of which can vary significantly from project to project, making cost prediction a challenge.
However, other factors also come into play, including:
Unique Service Categories
Construction accounting is a unique field that requires specialized knowledge and expertise. One significant difference between construction accounting and other types of accounting is the wide range of service categories involved. Unlike businesses that offer a limited range of products or services, construction firms provide everything from consulting and design to engineering and labor. Therefore, keeping track of expenses and profits in each service category is critical.
Complex Cost of Goods Sold
Another significant difference in construction accounting is the complexity of the Cost of Goods Sold (COGS). In the construction industry, COGS is not just about tracking the cost of products. Instead, there are numerous direct and indirect expenses across various service categories that need to be accurately tracked. Failure to track these expenses correctly can lead to inaccurate job costing and financial statements.
Project-based Work and Overhead
Moreover, overhead expenses in construction are often linked to specific construction projects. Thus, items that other businesses consider overhead expenses often fall into the COGS category for construction companies. This makes construction accounting more complicated than other types of accounting.
Hence, accurate bookkeeping and project accounting are essential, especially since construction companies typically work on multiple projects simultaneously. Therefore, having separate profit and loss statements for each project is necessary to determine whether the company will break even or generate profits. This information is crucial for accurate job costing and long-term financial health.
Does all of this seem too complex for you to handle due to a lack of time, energy, or accounting expertise? If that's the case, don't worry! Here we define a process for the construction business that can simplify accounting and bookkeeping management.
Easy-To-Follow 7-Step Process for Construction Accounting
If you opt not to delegate your accounting tasks to industry experts, this process can assist you in effectively managing your construction accounting on your own.
Step 1: Choose an accounting method
To ensure accuracy and avoid confusion in your construction accounting, it is important to select and stick to a consistent way of recording your income and expenses. Two methods are commonly used: cash accounting and accrual accounting.
Under the cash accounting method, income is recorded when it is received, and expenses are recorded when they are paid. Meanwhile, accrual accounting recognizes income when it is earned, regardless of when the payment is actually made.
For example, let’s say your construction company sent a net 30 invoice to a customer for a $18,000 job. With accrual accounting, the $18,000 is recorded as accounts receivable (A/R) once the invoice is sent. However, with cash basis accounting, the $18,000 is not recorded until the customer pays their invoice.
Although cash accounting is simpler, accrual accounting provides a more accurate view of your monthly revenue and expenses, which can be advantageous for construction businesses given the typical delay between invoicing and payment. For a more comprehensive understanding of the difference between cash and accrual accounting, you can refer to resources such as:
- Cash Basis Accounting vs. Accrual Accounting
- Understanding Accounts Receivable (Definition and Examples).
Step 2: Get a business bank and credit card account
For new or small construction businesses that do not yet have a business bank account or credit card, it is crucial to set up both. Separating personal and business finances is essential for accurate accounting and reconciliation of transactions.
Having a business bank account and credit card will make it easier and quicker to reconcile transactions, as all business income and expenses will be in one place. Mixing personal and business finances can lead to confusion and inaccuracies in record-keeping. Therefore, it is best to run all business-related transactions through a dedicated business bank account and credit card. This will keep your records clean and your accounting process streamlined.
Step 3: Choose your accounting software
After setting up your business bank account and credit card, the next step is to connect them to reliable construction accounting software. There are many options available in the market, so you need to do some research to choose the one that suits your business needs.
Opting for reputable accounting software can bring numerous benefits. For instance, it can significantly reduce the time you spend on accounting tasks, thanks to features like automated expense categorization. Furthermore, it can provide you with a better understanding of your business's financial status, allowing you to make informed decisions. You can read more about the selection of the best accounting software for construction:
Step 4: Record all business transactions
To keep track of your business transactions, you should maintain records of accounts payable, including invoices from your suppliers, as well as accounts receivable, which are the invoices you send to your customers. Accounting software and apps can simplify this process by keeping track of transaction dates, amounts, descriptions, payees or recipients, and receipts.
For expenses, it is essential to categorize them by service and contract so that you can determine how much money you have spent versus how much you have earned per project. You can use an expense tracker app to make this process more efficient.
In the construction industry, most expenses fall into the following categories:
- Business registration and licensing
- Membership fees (unions and associations)
- Tools and equipment (including safety equipment)
- Labor costs, including subcontractors and employee payroll
- Travel expenses (including fuel) and lodging
- Mileage when traveling to and from job sites
- Vehicle maintenance
Maintaining thorough records and categorizing business transactions appropriately will help you make informed financial decisions. Additionally, this can be beneficial in case you are ever audited by the IRS or another tax authority.
Step 5: Record adjusting journal entries
As the accounting period ends, it is necessary to make adjusting journal entries to ensure that the transactions are recorded under the correct accounting period.
If you have opted for the accrual accounting method, the journal entries should indicate all the earned revenue and expenses billed during that particular period. Additionally, if you receive payment in advance for a project that belongs to a future accounting period, a deferred journal entry should be prepared, and the revenue is recorded as deferred until the service is complete.
In case you encounter errors in a previously recorded transaction or use a personal credit card for a business expense, adjustments need to be made. Furthermore, if you need to record depreciation expenses, which include the loss of an asset's value over time and how the original cost is spread across the asset's usage period, you will need to make adjustments.
This stage of the process ensures the precision of financial data. While you can prepare to adjust journal entries yourself, it is recommended to work with an accountant or CPA to ensure the accuracy and completeness of your books.
Step 6: Create financial statements
After thoroughly checking your information, you can generate precise financial statements. Some of the most common ones include:
Balance sheets that summarize your construction business's assets, liabilities, and owner's equity. This sheet offers a clear view of the financial status of your business and indicates when cost-cutting measures are necessary.
Income statements, also known as profit and loss statements, summarize revenue and expenses.
Cash flow statements help with forecasting and ensure that you have sufficient funds to cover your expenses. These statements show how much cash has entered the business and how much has been spent during a given period.
While most accounting solutions, such as QuickBooks, offer at least these three types of financial reports, some may provide additional financial reporting options. It's important to compare various construction accounting software solutions to determine which financial statements you require.
In addition to generating statements, it's important to regularly check the dashboards within your accounting software. These dashboards provide real-time financial information at a glance.
Step 7: Managing Your Tax Obligations
Lastly, it's important to highlight the significance of comprehending and fulfilling your tax responsibilities. For instance, you may be required to make estimated tax payments each quarter, but the amount you owe will depend on the approach you use. Two of the most popular methods used in the construction industry are the percentage of completion method and the completed contract method, which base estimated tax payments on income and expenses or completed construction projects, respectively.
If you're unsure which method to use for your construction business. A tax professional can guide you in the right direction and assist you with other tax obligations. You may have, such as federal income taxes, and self-employment taxes. State and local taxes, payroll taxes, sales taxes, excise taxes, and property taxes. By keeping track of your revenue and expenses regularly, you can reduce the stress of filing and paying taxes.