Managing finances effectively is crucial for subcontractors in the construction industry. Accurate accounting helps track expenses and manage cash flow, while also playing a significant role in ensuring compliance and profitability. With the increasing complexity of construction projects, relying on robust accounting tools has become more important than ever.
In this blog post, we’ll dive into some construction accounting fundamentals and then explain how to evaluate construction accounting software to find the best fit for your needs. We’ll cover essential features, key considerations, and provide insights into choosing software that will streamline your financial processes and enhance your operational efficiency.
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What Subs Need to Know About Construction Accounting
In the construction industry, accounting isn’t just about tracking income and expenses—it’s about closely monitoring each project’s unique financial flow. For subcontractors, this means understanding how to properly allocate revenue and costs to each project, managing cash flow, and knowing the ins and outs of billing practices. Here’s a breakdown of key accounting principles and how they apply to subcontractors.
Revenue Recognition
Recognizing revenue accurately is fundamental in construction accounting. There are two primary methods subcontractors use:
- Completed Contract Method: This method recognizes revenue only when a project is fully completed. It’s suitable for projects where it’s challenging to determine the percentage of completion or for short-term jobs. This approach helps avoid premature revenue recognition, reducing the risk of any financial discrepancies.
- Percentage of Completion Method: This method is more commonly used and recognizes revenue and expenses based on the project’s progress. For this method to be effective, an accurate assessment of the project’s completion percentage is required. This ensures ongoing visibility into project profitability and helps in managing cash flow more effectively.
Accounting for Retainage
Retainage, a portion of payment withheld until a project is substantially complete, is a common practice in construction. In accounting terms, retainage needs to be handled carefully as it affects both the income statement and balance sheet. Subcontractors should record retainage as revenue on the income statement while also noting it as a receivable on the balance sheet. If retainage is expected to be held for more than a year, it should be recorded as a long-term asset. Proper management of retainage can significantly impact cash flow and tax liabilities.
Cash Flow and Financing
Effective cash flow management is crucial for construction subcontractors, given the extended timelines and payment schedules typical in this industry. Monitoring the inflow and outflow of cash helps avoid liquidity issues that could hinder operations or prevent you from taking on new projects. Subcontractors often face cash flow challenges when they need to purchase materials upfront before receiving payment from existing projects. Solutions like material financing can help manage these challenges by allowing payments for materials to be spread over terms that more closely align with payment cycles in construction.
Billing for Construction Projects
Billing in construction is distinct because projects are typically long-term and multifaceted. Subcontractors need to choose the appropriate billing method based on the project’s scope, duration, and contract terms:
- Progress Billing: Invoices are sent periodically, based on the percentage of work completed. This method is beneficial for large projects with defined stages or milestones.
- Fixed-Price Billing: Involves a lump sum contract price based on a detailed estimate. This method works best for projects with a clear scope and defined schedule.
- Unit-Price Billing: Charges are based on the quantity of work performed, making it suitable for projects where unit production is uncertain.
- Time-and-Material Billing: This method charges for labor and materials used, with the contract price based on actual time spent and materials consumed. It’s ideal for projects where the scope or duration cannot be accurately predicted.
Project Payments: Triggers, Restrictions, and Delays
Understanding what triggers or delays payments is crucial for effective cash flow management. Here are some common factors that can affect payment timing:
Substantial Completion Can Trigger Payment
Substantial completion is when a project can be used for its intended purpose, even if some minor work remains. This milestone often triggers payment from the project owner to the contractor and subsequently to the subcontractors.
Retainage Can Restrict Payment
A certain percentage of payment is often withheld as retainage until a project is fully completed. This practice ensures the work’s quality and completion, and can restrict cash flow until the retainage is released.
Change Orders Can Delay Payment
Change orders are modifications to the original project scope or schedule. Delays in processing these changes can result in payment delays, affecting cash flow and project schedules.
Payment Chain Issues May Cause Payment Delays
Delays in payments from the top of the payment chain (e.g., project owner or general contractor) can trickle down, causing delays for subcontractors and suppliers. This makes it essential for subcontractors to monitor their accounts receivable closely and maintain good communication with all parties involved.
Key Features to Look for in Construction Accounting Tools
When selecting construction accounting software, consider the following features to ensure it meets your business needs:
- Job Costing: Job Costing is essential for tracking project cash flow and comparing estimated versus actual costs
- Revenue Recognition: Tools should allow for flexible methods of recognizing revenue based on project completion
- Billing Flexibility: The software should support multiple billing methods to accommodate different types of projects
- Retainage Management: Given the specific nature of retainage in construction, ensure the software can handle this separately from regular receivables
- Payroll Integration: If you have employees or subcontractors, payroll capabilities can help streamline wage tracking and tax management
- Software Integrations: Look for tools that can integrate with other construction management software, such as project management, estimating tools, or CRM systems
Popular Construction Accounting Tools
There are numerous accounting tools made for the construction industry, each with its own special features:
- CMiC: A comprehensive solution with modules for budgeting, project forecasting, and robust reporting
- Foundation: Suitable for businesses of all sizes, it includes job costing, payroll, and purchase order management
- Sage: End-to-end construction management software that supports from bidding to estimating to contract management
- QuickBooks: While not construction-specific, it is widely used by small contractors for tracking project profitability and handling payroll
Conclusion
For subcontractors, having a firm grasp of construction accounting practices and the right tools in place is essential for financial stability and growth. By understanding how to evaluate and implement the best construction accounting software, you can ensure accurate financial tracking, improve cash flow management, and set your business up for long-term success.
