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Strengthen construction project management with internal controls

Mar 17, 2021

Construction projects are complex undertakings, with moving parts that touch many hands between the field and the office. Internal controls for construction projects can streamline these handoffs, improve financial performance and help project teams stay in compliance with rules and regulations.

When well-defined processes and procedures are in place, employees know what they are accountable for. As a result, every invoice, every payment and every decision is documented and filed where it belongs. The benefits have a cascading effect by ensuring everyone has the information they need to make timely — and often consequential — decisions.

Controls should be established at inflection points across all phases of a project, from initial estimate to final acceptance. But it is the period between bidding and closeout when internal controls can really make or break a project. Poorly designed or implemented controls can result in inconsistent processes, uneven cash flow and substandard documentation. Financial red flags can be missed and decisions may be made without proper authorization, opening up the risk for litigation.

Conversely, well-defined processes and procedures that are built on internal controls best practices can strengthen the partnership between project managers and the accounting team. As a result, the two functions can work hand-in-hand to reduce risk, improve financial performance and support overall project success.

Internal controls promote predictable cash flow

Internal controls over billings and collections are critical to prevent fraud and maintain a sustainable cash flow. When properly structured, they also provide project managers with an accurate picture of where the project stands financially.

To create a timely billing cycle, procedures should ensure the following contract terms are documented on the front end:

  • Timing of when to bill
  • Total contract to be billed
  • Whether the contract allows for early billing of materials, bonding costs or other up-front costs
  • Retention provisions
  • Existence of bonus provisions

Additional controls should confirm that billings are completed consistent with the terms of the contract. Prior to the contractual deadline, the project manager should generate and sign off on the bill after ensuring costs reflect the work performed. The invoice and a summary of work performed should be maintained for internal records. In instances when the billed amount exceeds pre-determined thresholds, the billing and related detail should be approved by management.

In other words, contractors need to establish processes for billing and verify that they are being followed at every step. Deficiencies in billing practices and procedures can lead to longer-term issues.

Internal controls keep contractors on financial track

Every contractor wants to complete their projects on or under budget. It’s not just about revenue; it’s a proof point for winning future work. Controls over the revenue recognition enable project managers and the accounting team to keep a close eye financial performance and their budget goals. As such, incurred costs, contract value, estimated margins and project outliers should be updated on a rolling basis. By staying current, over/under billing adjustments can be made in a timely manner. It’s much easier to address potential overruns or financial shortfalls at the outset, rather than months down the road.

In addition, procedures should require that the following items are reviewed on a monthly basis:

  • Bank reconciliations 
  • Accounts receivable aging by job 
  • Accounts payable aging by vendor
  • Job schedule reconciling year-to-date revenues and cost of revenues to the income statement as well as the over/under billings reconciling to the balance sheet
  • Any other significant balance sheet item

Upon review and approval from management, the accounting team should perform a month-end close to make certain that no costs get posted back to the incorrect period.

Internal controls provide greater visibility into project performance

When effective billing and revenue controls are established and followed, project managers have greater visibility into real-time project performance. But it’s not enough to have access to this information. Internal controls can also help set the agenda for better, more informed communications and decision-making within the project team.

At a minimum, the project team should meet monthly to review:

  • Job progress reports showing original contract price, signed change orders, status of unsigned change orders, estimated cost to date, balance over/under billed and percent complete
  • Project manager notes regarding job issues and potential concerns related to estimated completion
  • Outstanding billings, with an emphasis on billings that are greater than 60 days

On a weekly basis, budget-to-actual comparisons should be completed. The sooner that unusual costs or potential overruns are flagged, the more quickly the team can adapt its approach. Review of the budget categories along with the overall job progress will support accurate gross profit estimates and could reveal areas for potential change orders.

How Wipfli can help

Well-structured internal controls are self-reinforcing. Maintaining a regular billing cycle and ensuring revenues are accurately reconciled are critical for generating budget-to-actual comparisons. Likewise, mandating a regular review of the numbers ensures that issues are caught early so that billings, project plans and expectations can be adjusted as needed. 

Wipfli’s team offers decades of experience assisting construction firms of all sizes with designing and implementing strategy-based controls. Contact us or learn more about us on these web pages:

Services for construction firms, contractors

Internal audits

You can also learn more about internal controls in these resources:

Internal controls for contractors

Internal controls can flag fraud

Internal control in virtual office

5 myths about internal controls

Internal controls: Back to basics

Author(s)

Curtis R. Olson, CPA, CCIFP
Partner
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