Originally published in On-Site, ARB’s Construction Industry newsletter.
Managing the financial performance of any business can be complicated. But it’s especially complex for construction companies, which routinely juggle multiple projects at different stages of completion — all while estimating and bidding on other jobs.
That’s why proper financial reporting is so important for contractors. Relevant data can easily become fragmented or corrupted, leading to costly financial statement errors, operational inefficiencies and lack of information for strategic planning.
Like many small to midsize construction companies, yours likely keeps a chart of accounts as part of its bookkeeping function. Let’s review why this chart is such an important tool for contractors and how you might get more out of it.
The Basics
A chart of accounts is a structured list of general ledger accounts used to record and organize financial transactions. Essentially, the chart mirrors a business’s financial statements, including major balance sheet and income statement accounts. Here are five commonly used general ledger accounts, including common subcategories for construction companies:
- Assets: cash on hand, undeposited funds, accounts receivable, equipment, machinery, vehicles, real estate and inventory,
- Liabilities: accounts payable, taxes payable, outstanding loans, accrued expenses and credit card balances,
- Equity: retained earnings and capital,
- Revenue: contract revenue, change order revenue, reimbursements and retainage, and
- Expenses: direct costs (for instance, materials, labor, equipment and subcontractors) and operating costs (for example, payroll and benefits, facilities, utilities, equipment leasing, accounting, marketing, insurance, depreciation, and other indirect and administrative costs).
Each account is assigned a unique identification number. Customarily, the range of account numbers is 1000 to 1999 for the different types of assets, 2000 to 2999 for the different liabilities and so forth. Each number is accompanied by an account name (for instance, “cash on hand” under assets) and a short description (for example, “operating cash on hand”).
Considerable Benefits
A well-thought-out chart of accounts is critical for construction companies. Without one — or with a chart that lumps transactions into overly broad, undefined “buckets” of data — you’re operating in the dark.
An organized chart of accounts simplifies the preparation of tax returns and financial statements that comply with formal accounting standards, such as U.S. Generally Accepted Accounting Principles. Each account that appears on your balance sheet (assets, liabilities and equity) and income statement (revenue and expenses) is clearly broken out and totaled. So, whether your financial statements are generated internally or externally, the task becomes easier and less error prone.
Additionally, a detailed chart provides insight into project and asset management, allowing you to catch problems such as cost overruns and missing equipment before they spiral out of control. It can also help you better monitor key performance indicators, such as net profit margin and working capital.
How a Chart of Accounts Can Help with Cash Flow Management
A chart of accounts (see main article) organizes the information that’s reported on your construction business’s financial statements, including its balance sheet, income statement and statement of cash flows. That last one is especially important because it shows your company’s sources and uses of cash, and the net change each period. More specifically, it focuses on:
Daily operations,
Investments (which, for contractors, is typically the purchase or sale of equipment), and
Financing that provides or requires cash.
The statement of cash flows generally gives you a more accurate assessment of your construction business’s current financial performance than the other two major parts of financial statements. For example, your income statement can show a profit even though you’re experiencing negative cash flow. And, unlike the balance sheet, the statement of cash flows can help you better understand changes in working capital accounts (such as accounts receivable, accounts payable and inventory).
Armed with this information, you should be able to identify financial and operational areas in need of improvement and make better strategic decisions. These insights can also help you communicate more effectively with stakeholders such as lenders and potential investors.
Customized Approach
There’s no one-size-fits-all format for a chart of accounts. The appropriate structure will depend on the number, nature and complexity of your construction company’s financial transactions.
Although most businesses use the five main general ledger accounts described above, you’ll need to identify the optimal subcategories to track. You could, for example, have subaccounts for different specialties (such as concrete, roofing and asphalt) or types of work (commercial vs. residential).
Like most construction companies, yours probably manages multiple projects simultaneously. If so, assign project codes to individual jobs. This extra layer of coding in the chart helps allocate direct costs and overhead to get a clearer picture of which jobs are profitable.
For more granular tracking, some contractors even create subcodes for activities within each phase of a project, such as excavation, framing, plumbing and so on. Task-specific codes can help management evaluate job progress and apply the percentage-of-completion or completed-contract accounting methods. Construction-specific accounting software is usually helpful for automating code assignment and ensuring a consistent chart structure.
Don’t feel obligated to go overboard, though. Start-ups and small businesses may be able to use a simplified chart of accounts, adding more layers of detail as they grow. Focus on areas that will shed the most light on your construction company’s financial performance.
Best It Can Be
Consistency in a chart of accounts is important for comparing financial results from one reporting period to the next. But don’t hesitate to continuously improve yours to capture the most relevant information. Ask your CPA for help making it the best it can be.
This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters, and, accordingly, assume no liability whatsoever in connection with its use. ©2024
Construction and Real Estate Team Spotlight
David Jean is the Practice Leader of the Construction & Real Estate, Business Advisory, and Succession Planning Services Teams. He focuses primarily on financial accounting and consulting for construction, real estate, and manufacturing companies. He is a Certified Construction Industry Financial Professional (CCIFP) and board member and past chairman of the Associated Builders and Contractors of Maine.
