Common risks in Construction Accounting
Updated: Aug 14, 2020
After a cheerful and enthusiastic project planning, many contractors are left wondering what happened to the expected enormous profit and only saw little, or worse, negative profit at the end of the project. One time, maybe you were unlucky. But then the third or fourth times it happened, you seriously need to look into identifying and solve the problems. Here are some of the reasons, which are not really obvious at first glance, but definitely affect contractors' bottom lines, and some solutions.
Inaccurate Cost Estimates
Inaccurate Cost Estimates are one of the top problems that contractors face. If the construction project is short-term, estimates are fairly easily estimated and met. However, if a project goes on for months on end, the cost and quantity of materials can be increased out of control. More equipment, labor costs increase, all of which add to the estimate at the beginning.
This concern can be lessened with contract language allowing for adding and/or increase the cost. Unanticipated changes to the original estimate must be monitored, which can be a lot more difficult when working long hours and trying to keep a job running smoothly.
Changing the Scope of Work
It’s in a contractor's blood to put the client’s needs above all. After all, we are doing services, with the mindset that “clients come first”. Perhaps this is the reason for inaccurate cost estimates since the scope of work is constantly changing. The client wants the wall to be fixed this way, not that? No problem. Update the lightning to a slightly different version? Easy-peasy. However, most of the time, contractors forget that they have to work with their accountant to decide which changes are reasonable. Sure, sometimes these changes are small and don’t take up a lot of money, but if those small little things combine, well, you know how it is. And we haven’t mentioned the big changes that may apply.
You should consider writing a change order for every change no matter what, and always let the clients know about this as well so you can credit them at the end.
When a construction company gets paid at the end of the project, it’s easy since every transaction has been recorded in the books. Just collect the money and post it. HOWEVER, the accrual expenses a company takes on through the course of construction are easily forgotten because of how small these charges are, only to make themselves known at the end of the project. They can be interest charges, restocking fees, payroll costs, equipment rental increases, and the like. They can affect cash flow. Billing them to the job if possible. Be aware to not overestimate the job’s profit.
Lastly, let’s talk about overhead. As a contractor, you need to pay near-constant attention to overhead, both fixed and variable.
Fixed costs such as rent, taxes, utilities, insurance, key people's salaries, back-office staff, and so on, run 24/7. These fixed costs are what constitutes overhead of all jobs.
Variable costs, however, are more unpredictable since they based on the project you’re working on: Is it seasonal? Do you have to consider the geographical features? Etc. For particular jobs will have different variable costs, such as staffing, staging, unique environment fees, etc., which are also parts of overhead.
The point is, contractors need to carefully identify and track all these expenses as well. Take your time to review everything, if not, determining profitability is going to be problematic, and contractors won’t know until the end.
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