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Top 5 Accounting Risks for Contractors

07/23/2021 Andrew Donohoe

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.

A common pitfall of poor estimates is major fluctuations on interim financial statements.  If a company continues to show a job at an estimated profit much higher than the actual final gross profit, it will lead to a significant decrease in the profit of the company as the job is completed and closed out.  These major fluctuations give the users of the financial statements pause as to whether there are other surprises that may be lurking in the future. To combat this, it is recommended that you have monthly meetings with project managers to discuss status of jobs.  Out of these meetings, adjust estimated costs proactively so that surprises don’t arise at the end of jobs.

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, repairs, and maintenance, 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, attempt to include in your contracts a price acceleration provision that allows you to adjust 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

Times to collect accounts receivable and the release of retainage have continued to increase.  This leads to a strain on the cash-flow of most construction company.  While it may take longer to collect receivables, expenses — including payroll, interest, and rental fees — add up and come due to be paid. 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.

It is always advised to understand cash-flow by job and how it will affect the overall cash-flow of the company.  This will help you plan payments to vendors, subcontractors, etc. and understand where you may need access to your line of credit.

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 are a step towards great profitability. However, those companies which have accounting and operations working in unison to provide proactive and timely job information always take the next step towards greatness.

If you do not have in-house accounting expertise or you are having trouble finding talented employees in the current market, one of the largest growing segments of public accounting is client accounting and advisory services (CAAS).  Many companies have seen the benefit in outsourcing certain aspects of their accounting function while also maintaining the communication noted above.  Because of the nuances of construction accounting, it is advised that you look for a CPA firm that has construction expertise in accounting and tax.  VonLehman’s construction and real estate services and CAAS groups would be happy to assist in any accounting needs you may have.

For additional information on these issues and how to manage them, or any other accounting topic your entity is facing, contact us today at adonohoe@vlcpa.com or 800.887.0437.

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