Pitfalls in Construction Project Accounting

Q: Why is a bookkeeper like an undertaker?

A: Because when their work is done, all you can do is view the remains.

The sentiment expressed in the old joke above can hit home with contractors, who can take on a job after decent planning and enthusiasm, only to wonder what happened when they see a tiny profit or worse at the end of the project. Sometimes the reasons are elusive, but several of them show up in the post mortem time and time again. Below are some issues not immediately obvious which can impact contractors bottom lines,  and what people can do to address them.

Inaccurate Cost Estimates

Inaccurate cost estimates rank near the top, a situation which may be less obvious than it sounds. If the end of a job comes fairly soon, line item estimates are relatively easily estimated and met. However, if the job runs on for months, materials can increase in both cost and quantity. The project may require more equipment, and labor costs a few months in could be higher than at the beginning.

Contractors can mitigate this concern with contract language allowing for added and/or increased costs. But they also must monitor unanticipated changes to an original estimate, which can be difficult when working long hours and trying to keep a job running smoothly.

Changing the Scope of Work

Perhaps related to inaccurate cost estimates is the problem of the scope of work changing in small ways as the job progresses. Kick out that wall after all? No problem. Install eight lighting cans instead of six? Sure, we can do that for you. Clients ask for changes, and it’s in most contractors’ DNA to accommodate clients as best as they can. That said, contractors need to work with their accountants to decide what changes are reasonable. Consider writing a change order for every change no matter how small, and if it turns out to be not that big of a deal, credit the client at the end.

Further Reading

What Is a Schedule of Values?

When a construction company gets paid at the end of a job, it’s easy to book the transaction. Collect the money and post it. What’s less simple to book are the accrual expenses a company takes on during the course of construction. These expenses might be interest charges, restocking fees, payroll costs, equipment rental increases, and the like. While these kinds of charges may be small or one-offs, they tend to fly under the contractor’s radar, only to make themselves known at the end of the job. They can nick cash reserves and affect cash flow. At the very least, be aware of these kinds of expenses at the outset to avoid overestimating the job’s profit. Bill them to the job where possible.

Overhead (that’s unaccounted for)

Finally, contractors and their accountants need to pay near-constant attention to overhead, both fixed and variable. Fixed costs such as rent, taxes, utilities, insurance, key people salaries, back office staff, and so on run 24 hours a day, seven days a week. These fixed costs are what constitute overhead for all jobs.

Variable costs for particular jobs, such as added staffing, staging, unique governmental fees, job trailers, as well as softer costs such as advertising and signage, are also part of overhead. It may be simple enough to account for variable overhead for a particular job, but what if they’re for more than one? What if the variable costs are seasonal in nature, or unique to a geographical location new to the construction company?

The point here isn’t to provide education on overhead so much as it is to encourage contractors to identify it and its components and track it as necessary. Without a solid understanding of overhead, determining profitability is problematic, and the contractor won’t know until the end, when it’s time to view the remains.

Free Resources to Help

With all of this money going out the door on a typical construction project, it’s extremely important for contractors to do everything they can to make sure that the money they’re owed is coming in the door, in full and on-time.

Sending preliminary notice is one of the best things that can be done to help prevent payment issues before they can take root. Not only does sending notice protect your payments by securing lien rights, it also helps contractors get paid faster. (Much faster!)

One of the worst outcomes that can happen on a project is to get burned on a payment. In the article above, we’ve described some of the items that make up the costs and expenses on a typical project. But what is the true cost of bad debt when a non-payment issue causes a write-off to be inevitable? The unfortunate answer is that bad debt is probably much more expensive than you realize.

Download our bad debt calculator to see the true cost of a write-off for yourself. The download is an excel spreadsheet — just enter in a few variables based on the financial information from your business, and you’ll see how much bad debt costs you.

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Common Pitfalls in Construction Project Accounting
The importance of good construction project accounting | There are many pitfalls on a construction project that cause accounting problems and discrepancies
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