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Why construction accounting is like a car

Dec 06, 2019

Construction projects are challenging, both financially and logistically. From long project runs, to change orders, staff shortages and seasonal/cyclical volatility, contractors must manage productivity and quality while staring down any number of business risks. 

In such an uncertain climate, effective accounting practices can be the difference between businesses that run smoothly and those that stutter out. Your profits are based on your ability to deliver the job on time and under budget. But meeting those goals requires more than good project management. You need the right financial process.

Think of your accounting practices like the on-board diagnostic system in your car. Having engine trouble? The right diagnostic tools can help you get to the bottom of what’s wrong. 

Struggling with cash flow? Surprised that year-end profits are lower than expected? Effective accounting practices shine a spotlight on problem areas so you can make informed decisions about your business. 

Your construction company’s budget

In order to make your construction company run efficiently, follow a budget. Beyond individual project budgets, an overall company budget will help you manage monthly costs and expenses. A budget is like a GPS system — it’s the roadmap that helps you know where your business is going. 

Break your budget down into two categories: an operating plan and a capital plan. One is a short-term budget for the immediate future, the other is a long-term budget for growth and sustainability. 

The operating budget, or recurring budget, typically covers a one-year period. This is where you forecast sales trends, direct costs, labor expenses, overhead and expected gross margin for the year ahead. 

If you can, base the operating budget on trends over your last three years in business, adjusting each budget line up for down against a three-year average, as you believe appropriate. If you expect the market to shrink or costs to increase, shift your projections accordingly. 

Next, consider your capital budget. Capital budgets focus on expansion and replacement and usually look out five to seven years in the future. You might include a budget cycle to replace computers every three years, for example, or plan to replace equipment and vehicles. 

Operating budgets and capital budgets are interrelated. If your company is projecting better profits, you’ll have resources for capital expenditures. But capital expenditures can also impact the operational budget, such as when maintenance expenses increase for a new facility or piece of equipment. 

Decide how often you and your leadership team will sit down to review performance in terms of expected revenue and expenses. Revisit the budget monthly, ideally, and take corrective action as necessary. If spending exceeds the budget or sales fall short, review with your management team and decide how you’ll adjust your route to get back on track. 

Cash flow for contractors

If a budget is the GPS, the cash flow is the gas. Do you have enough in your tank to get where you need to go? 

Review your cash flow just like you review your budget. You know what you have to spend each month. Labor costs are due every two weeks. Vendor payments are due in 30 days. And overhead payments are generally predictable.  

You know what’s going out, and you need a handle on what’s coming in. Failing to keep tabs on payments may cost more than you realize. If you have to borrow money to cover day-to-day operations, you’re paying for it in terms of interest fees, stress, lost opportunity and perhaps even declining lender confidence. 

If cash flow is a problem, it may be due to slow-paying clients. Or, it may be a function of your own slow billing practices. You need to know what’s causing the hiccup so you can get the funds owed to you. 

Before you accept a project, understand the kind of credit you’ll be extending. Call references if you can. You need to know your customer has the finances to support the project, but you also need to know how fast they pay their bills. If they routinely pay 120 days out, you need to adjust your price (or your payment terms) accordingly. 

Look at your own payment practices, too. Some business owners like to pay their bills quickly. But sending out a check the moment a bill hits your desk is not a smart use of your cash flow. A “pay fast” habit has a big impact on your cash-on-hand, and it’s even worse when you compound it with “bill slowly.” 

Companies that have constant cash flow problems may find themselves stranded with significant debt. The more you know about your cash flow, the better you can manage working capital to ensure your business stays running, and every obligation is covered with ease.

How Wipfli can help

Solid accounting practices are essential to keep your business and jobs running smoothly. Professional assistance from Wipfli can help you make the most of your construction business. We can alleviate some of the administrative burdens while helping you get a handle on money management. Contact us to learn more.

Or keep reading on in these accounting articles:

Busy but broke? Use standard costing to profit in construction

7 habits of a highly effective accounting department

Top 10 accounting tips to make life easier

Author(s)

Keith Koszarek
Keith Koszarek, CPA
Partner
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