Applying best practices for construction accounting can deliver benefits across the entire business. Accurate job costing, for example, can help businesses see where they’re making or losing money and react quickly before profitability is negatively impacted.
- Focus on accurate job costing. Since contractors are project-based businesses, accurately determining the cost of every project is key to managing profitability. Detailed job costing helps businesses estimate projects accurately, and then track actual versus estimated costs.
- Costing isn’t easy, though. To accurately estimate a job, every aspect of its labor, materials and overhead costs must be understood. Tracking labor costs is tough when you have a mobile workforce deployed on many different projects. It can be easier when job costing is made a priority for all employees, so they understand its value to the company. Good accounting software and clear, intuitive coding for each job and each cost category can make it easier.
- Use cash basis accounting. For many smaller businesses, cash basis accounting is an appealing choice. Its simplicity typically means lower bookkeeping costs than when using accrual basis accounting, and it usually provides a clear picture of a company’s actual cash position — which is particularly helpful for smaller businesses with limited funds. Because you only record revenue when you receive payment, you don’t have to pay taxes on sales for which you haven’t yet collected the money. And because you record expenses when you pay them, you may be able to reduce your current year’s tax bill by purchasing additional materials at the end of the year.
- Determine the best tax strategy. Many factors can affect contractors’ income tax liability, including their choice of revenue recognition method, the type of projects they work on and their business structure. The best tax strategy will depend on the business and its needs. Most contractors use the percentage of completion method for recognizing revenue on large contracts. This has the advantage of smoothing out swings in revenue because it records both revenue and associated expenses over the life of a project.
- Contractors working on home construction projects may be able to use the alternative completed contract method, which recognizes revenue and expenses only at the end of a project. This can be advantageous for firms looking to reduce tax liability in the current year because it defers revenue and associated income tax to a later period.
- Owners or partners in construction firms should think carefully about the tax implications of their business structures. For example, those structured as pass-through entities, such as sole proprietorships or many LLCs, can reduce their personal income tax liability by deducting business losses.
- Invest in construction accounting software. Modern accounting software can simplify financial management while helping contractors comply with tax laws. Good construction accounting software should automate much of the otherwise laborious work of job costing. Reporting capabilities enable you to track projects and analyze overall business finances in real time, so you can quickly identify problems and take steps to correct them before it’s too late. By managing accounts receivable and accounts payable, software can help contractors ensure they collect what they’re owed and stay on good terms with suppliers. Construction accounting software should also help to ensure accurate tax filings, with enough flexibility to support the range of revenue recognition methods used by the construction industry.