The Complete Guide to Contractor Accounting

Running a profitable construction business requires more than just landing clients and managing projects. You also need to have an intimate understanding of your company’s financial position.

Many contractors fail because they struggle to track income and expenses across multiple jobs while keeping up with tax obligations. Without clear visibility into the numbers, profitability suffers.

Mastering contractor accounting takes work but is absolutely essential for growth and stability. This comprehensive guide will teach you the fundamental concepts and best practices you need to know.

Let’s get started!

Core Accounting Concepts for Construction Companies

Before diving into industry-specific methods, you need a foundational grasp of general accounting basics. These universal concepts apply to construction businesses as much as any other industry.

What is Accounting Anyway?

At its core, accounting is simply quantifying financial transactions into meaningful data that provides insights into a business’s performance.

You can break accounting down into a few key focal points:

• • Capturing incomes and expenses

• • Assessing asset and liability balances

• • Calculating profits and losses

• • Reporting via financial statements

Getting a handle on these areas is paramount for construction companies.

Key Accounting Elements

Drilling down further, your accounting approach tracks five key elements:

Assets

Tangible or intangible possessions that hold value like equipment, property, materials inventory, and cash balances. Tracking changes in total assets over time offers insights into business growth and reinvestment strategies.

Liabilities

Debts and financial obligations owed like loans, unpaid vendor bills, credit accounts, mortgages, bonds, and taxes due. Monitoring liabilities indicates risk levels and informs capital decisions.

Equity

Also called owner’s equity. This represents your ownership stake in the company’s value after liabilities are paid. Increasing equity reflects profit accumulation and business health.

Income

Revenue streams flowing into your business from all sources, such as client project billings, investment returns, property rents, etc. Measuring income patterns over time enables realistic growth forecasting.

Expenses

Outflows from business operations like payroll, materials, admin costs, financing charges, etc. Controlling expenses is key to profitability. Analyzing expense trends exposes cost drivers.

Mastering the relationships between these five cornerstones provides tremendous financial clarity.

Grasping Accounting Mechanics

You also need to understand the overall flow of money through widely accepted “double entry” accounting, a standardized system where every transaction is recorded twice to demonstrate both the allocation impact and net effect on your books.

For example, buying a new company truck would be logged as:

Debit (Increase) to Vehicles Asset Account

Credit (Decrease) to Cash Account

In contrast, paying your power bill would be captured as:

Debit (Increase) to Utilities Expense

Credit (Decrease) to Cash

While admittedly intricate at first glance, wrapping your mind around double-entry logging and how amounts shuffle between general ledger accounts is crucial.

This data fuels dynamic reporting via financial statements.

Financial Statements 101

Common financial statements provide periodic snapshots of your company’s fiscal performance and position.

While reams of specific transactions lay hidden behind the scenes, financial statements condense everything into key metrics for quick insights.

Some examples include:

Income Statement – Summarizes incomes and expenses over a defined period. Also called a profit and loss statement. Allows assessing operational profitability.

Balance Sheet – Reports asset, liability, and equity balances at a given point in time. Indicates overall company financial strength.

Cash Flow Statement – Details cash inflows and outflows over a period. Helps forecast future cash positions.

Now that we’ve covered the big picture accounting landscape let’s explore concepts tailored specifically to contractors…

Accounting Methods for Construction Companies

One of the biggest decisions you’ll make is which accounting methodology to adopt for your construction business:

Cash Basis Accounting

Simple cash-based accounting logs income when cash is received and expenses when cash payments occur.

This approach provides basic tracking but fails to match revenues directly with corresponding project expenses incurred. It also does not record accounts receivable or accounts payable.

It is best used by smaller contractors and subcontractors with lower complexity.

Accrual Basis Accounting

Accrual basis accounting records income when invoices are generated and expenses when vendor bills are formally approved. This better reflects project profitability by linking revenues to associated job costs regardless of actual cash flow timings.

The method recognizes accounts receivable and accounts payable balances. It is more complex but provides in-depth financial visibility. Well-suited to large and mid-sized contractors.

Percentage of Completion

Under this method, revenues and job expenses tied to long-term construction projects are incrementally recognized over the life of the project based on percent completed milestones rather than lump sums when jobs wrap up.

Aligns income realization with project progress. Requires careful progress tracking and complex reporting. Best for multi-year public works and commercial construction projects.

Completed Contract

All revenues, job costs, and gross profit are fully recognized only when construction projects reach 100% completion per contracted milestones.

Can severely obscure financial transparency for companies juggling dozens of jobs at varying stages of progress. I do not recommend it except for very short-term projects.

Evaluate your business’ size, complexity, cash flow needs, and reporting requirements to determine the optimal approach.

A tax advisor can provide further guidance on the pros and cons of accounting methods.

The key is picking one system and applying it consistently across every project. Avoid mixing multiple approaches.

Advanced Construction Accounting Concepts

Now that you grasp the big picture of accounting approaches let’s drill down into more advanced concepts critical for construction operations…

Job Costing = Profit Visibility

In construction, profit lives and dies on the accuracy of your cost estimates versus actual expenses. This is where job costing comes in.

Job costing involves closely monitoring ALL associated costs tied to a specific project during completion, including:

• • Labor (incl. subcontractors)

• • Materials and equipment

• • Job site overhead, like temporary utilities

• • Admin costs for permitting, etc.

Meticulously capturing indirect costs like mobilization, temporary utilities, supervisor salaries, Punch work, warranty expenses, demobilization, and site cleanup is imperative.

Advanced job costing breaks total expense monitoring down further across perhaps 100+ detailed cost codes under categories like:

• • Committed Costs

• • Cost of Goods Sold Entries

• • Uncommitted Costs

• • Under/Over Applied Costs

Getting to this micro level of cost visibility is extremely challenging without technology. We’ll explore software options later.

For now, understand that proper job costing is indispensable for accurately forecasting, bidding, budgeting, and measuring profitability per project and for your company overall.

Mastering Job Estimating

Speaking of bid estimates, the lifeblood of any contracting business is landing new jobs. And owners award most contracts based predominantly on bid accuracy.

Underestimate – bleed cash. Overestimate – lose the job.

This estimating tightrope act requires intimate knowledge of your true costs and acceptable profit margin needs across materials, labor, sub-charges, projected overheads, and more for each type of project.

Become an expert at analyzing data from past job cost performance to build future estimating models that precisely predict complete project expense totals.

Advanced estimating techniques like regression analysis can leverage historical data to forecast costs as a function of key factors like:

• • Square footage

• • Location

• • Number of floors

• • Material grades

• • Labor wages

• • Project duration

The future of job cost estimating indeed looks more data-driven than intuitive. Employ software tools to help compile data and run analytical reporting.

Strategic Invoicing = Healthy Cash Flow

You likely work hard to estimate and control job costs accurately. But profitability still suffers profoundly if clients drag their feet paying invoices.

Don’t let your business bankroll customers! Approach billing strategically by systemizing prompt invoice generation integrated with various payment reminder triggers based on aging thresholds and customized client profiles.

For example, setup processes to automatically print and email job invoices timed with certain project milestones or based on work progress percentages.

Then, schedule automatic payment reminder emails on days 7, 14, and 21 days overdue if a payment is still outstanding.

Escalate matters for chronic late payers by integrating directly with collection agencies within your accounting platform.

Yes – accounting systems easily handle all of this heavy lifting! Just remember to maintain a spirit of win-win collaboration with contractor partners who might also face occasional cash hiccups. We’re all in this together!

Tax Rules and Regulations for Contractors

Staying tax-compliant is mission-critical yet agonizingly complex for most construction business owners. Why?

You juggle significant overlapping tax obligations spanning multiple government agencies:

Federal Taxes:

• • Income Taxes

• • Self-Employment Taxes

State Taxes:

• • Income Taxes

• • Sales and Use Taxes

Local Taxes:

• • Business Licenses

• • Property Taxes

• • Special Assessments

Failing to stay current on taxes threatens your very business viability if faced with fines for noncompliance. Delinquent filings also tank important credit ratings needed to access affordable insurance and bonding rates which are vital in this industry.

Thankfully, construction-focused accounting firms and savvy software solutions help create compliant processes for timely tax filings and payments.

The key is proactively planning to maximize legitimate write-offs while keeping all government stakeholders satisfied. Consider automating reminder alerts for key filing due dates to avoid getting behind.

Explore Assigning PO Financing

Managing cash flow fluctuations represents a perpetual construction business balancing act. As jobs ramp up, equipment purchases and labor demands drive increased upfront costs well before first invoice payments arrive.

Carefully evaluate each new project’s financial plan and cash trajectory. For cash-intensive jobs, consider collaborating with new breed lenders offering unique purchase order (PO) financing options at competitive rates tied directly to specific job invoices.

This innovative approach unlocks working capital to handle project and growth expenses by essentially monetizing your accounts receivable balance. Payments due from outstanding PO invoices get bundled as collateral for loans as projects progress.

Because loans are derived directly from active accounts receivable, the total available financing scales smoothly alongside your business, and there are no traditional credit checks or age minimums for companies involved.

When client payments hit for those invoices, you immediately pay back principal loan amounts. Interest rates typically run around 1-2% monthly.

While not the cheapest form of financing, PO lending provides important cash flow flexibility between invoice cycles.

Construction Accounting Technology

If your brain is still spinning trying to mentally manage the intricate accounting intricacies we’ve covered so far across taxes, job costing, cash flow, and more… you desperately need software support!

Thankfully, today’s cloud-based accounting platforms automate myriad complex tasks for you:

• • Custom reporting

• • Automated workflows

• • Notifications and alerts

• • Instant access across devices

• • Data integrations

This technology liberation allows you to redirect your precious mental focus toward more strategic initiatives to grow your business.

When assessing construction accounting software for your organization, prioritize these key capabilities:

Robust Job Costing – Break projects into distinct cost codes and phases for detailed expense tracking and analysis reporting. Assign multiple cost types like materials, labor, equipment, admin fees, etc.

Flexible Invoicing – Easily generate professional invoices and lien waivers. Allow for progress and milestone billing. Schedule recurring reminders.

Tax Planning Tools – Get guidance managing tax obligations across federal, state, and local agencies. Includes automated payment reminders powered by compliance calendars.

Mobile Functionality – Manage finances on the go with tablet and smartphone access. Scan receipts, upload pics of supplier invoices, and review reports.

Customer Payment Processing – Directly accept invoice payments via check, credit card, or ACH. Sync with bank account. SendPayment reminders.

Popular all-in-one platforms like QuickBooks Online and Xero provide surprisingly robust construction accounting functionality at affordable rates, including tiered pricing to match needs and budgets as your business scales.

Leverage Integrations

Managing project details involves collaboration between potentially hundreds of people and systems – from office staff to job supervisors, subcontractors, suppliers, design consultants, investors, and oversight agencies.

Thankfully, today’s construction software platforms talk to each other freely via open APIs to centralize data and unify workflows.

For example, intelligent tools like Honest Buildings, Procore, and PlanGrid capture and integrate actual job cost data across the field while syncing budget versus actual reporting figures with your core accounting system automatically. Attach photos of time cards and suppliers’ invoices visually anywhere conversations happen.

This data fluidity minimizes manual processes, allowing your accounting team to focus on high-value controller duties to optimize cash, maximize profit, ensure compliance, and advise management with key insights KPls.

Other valuable platform integrations to consider:

• • Estimating tools

• • Bidding platforms

• • ERP systems

• • Payroll processors

• • Document management

• • Business intelligence

• • Custom reporting

The innovation possibilities are truly impressive, thanks to open API ecosystems and the rise of the construction technology stack.

Frequently Asked Questions About Contractor Accounting