For growing firms trying to manage hectic schedules, it’s all too easy to make construction accounting mistakes, from inaccurately estimating jobs to signing contracts without adequate scrutiny. Here are six of the most common construction accounting errors.
- Disorganization: It’s not easy to run a well-organized construction accounting department, especially for small contractors. When you’re trying to grow a business while staying on top of fluid project schedules and an ever-changing labor pool, careful accounting may not be your top priority. But failing to build an organized construction accounting process can have serious consequences. Among them: failing to keep tabs on project costs and running up against tax problems. Hiring an experienced construction accounting professional can help. So can implementing capable construction accounting software that will help you determine job costs, track finances in real time and comply with tax requirements.
- Poor job cost estimates: Inaccurate estimates lie at the heart of many contractors’ business problems. A too-low estimate can result in a loss-making project or awkward renegotiations with clients. Estimates that are too high can mean losing work to competitors. For companies using the percentage of completion method, poor estimates can cause problems with revenue recognition. To create accurate job cost estimates, it’s essential to develop a good understanding of all the components of job costs — which include overhead, labor and materials.
- Inaccurate recognition of joint ventures: Joint ventures are common on large construction projects, in which companies often come together to pool resources and share risk. Each company contributes capital in the form of funds or equipment. But companies involved in joint ventures are required to use one of several specialized accounting methods to reflect their participation, so it’s critical to set up the correct accounting structure at the outset to ensure each company’s investment, revenue and profit is accurately reported. The choice of accounting methods for joint ventures typically depends on the company’s level of investment in and control of the combined joint venture company, but construction companies sometimes don’t realize this until it’s too late.
- Incorrect overhead calculations: Contractors typically allocate their overhead costs to projects as a percentage of overall project costs. So if they incorrectly calculate their overhead, the result can be inaccurate job costing and reduced profits. That’s unfortunately not uncommon: Contractors tend to have high overhead costs that change frequently, and it’s a challenge to make sure every item is included and up to date. It’s important to regularly review all costs and ensure they’re included in overhead calculations. Overhead may include office costs, insurance, maintenance and training.
- Mismanaged change orders: If managed well, change orders can add to a project’s profits while helping to keep clients happy. But contractors often take on change orders based on quick on-site conversations, resulting in extra work that isn’t adequately documented, accurately priced or correctly accounted for in the project’s finances. This can increase costs and create a distorted picture of profitability. Even though it can be time-consuming, it’s important to perform a thorough estimate of costs and get each change order documented and approved before starting work.
- Accepting unreasonable contract terms: Growing businesses often find it tough to quibble about the terms of a contract, especially if it’s a big job that will significantly boost the company’s revenue or stature in its community or industry. But accepting unreasonable contract terms can lead to huge problems later. Unacceptable penalties and conditions, especially if they’re linked to circumstances outside your control, such as the weather or the actions of third parties, can lead to losses and customer disputes. To avoid problems, ensure you carefully review contracts, with the help of an attorney if necessary, and ask clients to address any unreasonable terms. You may find they’re willing to accommodate your requests.