Construction Accounting Basics: 6 Questions Contractors Need to Ask When Starting a New Construction Firm

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Construction Accounting Basics: 6 Questions Contractors Need to Ask When Starting a New Construction Firm
Meeting with a business advisor, like this construction business owner, can help you leverage a few accounting basics to minimize tax exposure, reduce costs, and increase profitability.
Meeting with a business advisor, like this construction business owner, can help you leverage a few accounting basics to minimize tax exposure, reduce costs, and increase profitability.

Starting your own construction company without a financial strategy rooted in smart accounting basics is like starting a build without a floor plan. Many of the decisions you make early on can significantly impact your finances and ongoing success. It’s probably safe to say that a desire to join the paper-pushing office hustle wasn’t the driving force behind your decision to start your own construction company. But, if you develop and implement the right strategic financial plan, your administrative duties don’t have to overshadow your relationships with your customers or ability to work hands-on in the field. 

Asking yourself these six questions in the early stages of your company’s set-up can help you leverage a few accounting basics to minimize tax exposure, reduce costs, and increase profitability.

Will my choice of entity type support my personal and business goals and in a tax-efficient manner?

The variables and considerations for choosing the right entity type are vast, and each entity type has its own benefits and drawbacks. Contractors must determine what’s right on a case-by-case basis to comply with applicable laws and meet the owners’ personal and business goals for legal liability, financial responsibility, management structure, and transferability of funds in the most tax-efficient way. 

But understanding the way each entity type is taxed goes a long way in helping you develop your strategic financial and tax compliance plans accordingly. Your entity type selection doesn’t always write your tax fate in stone. Many entities can elect to be taxed differently at the federal level. For instance, an eligible LLC can make an “S” election on Federal Form 2553 and elect to be taxed as an S corporation or file Federal Form 8832 to elect to be taxed as a corporation, partnership, or disregarded entity. 

Am I set up to maximize cash flow, monitor my financial standing, and accurately assess and project my working capital and liquidity needs?

Because many construction costs are paid in advance, monitoring billing and receipt of payment to maximize cash flow takes on a higher level of importance. Build regular A/P and A/R review procedures, such as weekly reviews of aging reports, so you can take corrective or preventive action when necessary. 

Preparing financial statements, cash flow forecasts, and projections and measuring them periodically against your actual cash flow will help you evaluate your financial standing. Contractors can download our cash analysis tool below. We designed this worksheet specifically to target the liquidity needs of start-ups and small businesses and assist them with projecting cash flow, forecasting for deficits, managing shortfalls, assessing working capital and liquidity needs, and determining their ability and need to borrow. 

Download ARB’s 13-Week Cash Flow Analysis Worksheet

Banking and surety bonding relationships are imperative, and maintaining those relationships requires you to be transparent. Be proactive in surety and bank communications and, to the extent you can, approach new financial obligations with a mind to seek flexibility in the terms. 

Do my job costing procedures align with an effective cost management strategy?

While watching sales and revenue numbers climb undoubtedly brings more joy, it’s vital to monitor operating and financial costs just as closely. Your fees need to remain in line with competitor pricing, and your jobs need to generate enough revenue to exceed your costs. And your costs will run the gamut from general overhead, labor, and materials for a specific project to the smallest box of nails in your inventory. 

Your company will need job costing procedures that allow you to break down the labor, materials, and overhead cost allocated on a per-job and even per-project, division, or phase basis. Job costing allows you to compile accurate data on actual costs over time, make estimates with greater accuracy and less risk, and analyze job profitability and performance.

Tracking changes in these costs at the micro-level allows you to make necessary pricing adjustments at the macro-level and make adjustments before taking a loss. Your job costing system should help you account for things like an unexpected increase in the price of supplies, or additional labor and equipment costs and capture scheduling and delay costs promptly to prepare for possible future claims. 

Does my plan appropriately account for risk management?

Now, more than ever, it’s essential to take a step back from the competitive bidding landscape and adequately evaluate risk. You don’t want to let fear encourage a high volume of low-ball proposals. Develop a project rating system based on the type of work, a predetermined minimum profit, bonding requirements, timeframe, and whether you have workers with the appropriate skills available. Prioritize the time and expense estimates associated with jobs that have the potential to provide the highest profit. 

Contractors also take on an expanded level of risk when work is subcontracted. To assist construction companies in properly vetting subcontractors and minimizing their risk exposure, ARB created the downloadable pre-qualification form below.

Download ARB’s Subcontractor Prequalification Form 

Does my strategy consider ways to leverage software, automation, and new technology? 

The cost associated with implementing technology and software can be significant, especially when you’re starting out. But don’t discount the return on investment over time. Advancements in technology have provided new opportunities for vertically integrated services. For example, structuring your operations to include distribution in-house or implementing prefabrication and modular construction can help reduce cost, boost efficiency in use of resources, and maximize job profitability. 

A cost-benefit analysis may prove the projected time savings, increased efficiency, reduction in costs and risk, and revenue increases gained by automating manual processes with software programs worth the initial cost of implementation. For example, job costing software allows for real-time cost tracking, reduces risk, increases accuracy, and allows access to valuable reporting, such as cost-to-complete, budget to actual, and labor productivity reports. Asset management, project management, risk assessment, and customer relationship management programs also often yield a positive ROI.

Do I have the right professional service and advisory resources? 

When starting your own business, you also need the right professional team to advise you on legal, tax, and accounting intricacies that could affect your operations, finances, and overall success. ARB’s Construction & Real Estate Services Group provides industry-specialized accounting, tax, and advisory services for construction start-ups, established firms, and the contractors that own them. 

I help contractors with job costing, overhead cost calculations, profitability analyses, software selection and implementation, and preparing forecasts and projections. I want to help you start your company with a plan that maximizes profitability, minimizes costs, and reduces risk. Contact me today to get started.

by David Jean, CPA, CCIFP, CExP

David Jean

David Jean is a firm principal and the Practice Leader for ARB’s Business Advisory, Construction & Real Estate, and Succession Planning Services Groups. David focuses primarily on financial accounting and consulting for construction, real estate, and manufacturing companies. He is a member of The Certified Public Accountant Advisory Council, an exclusive, 10-member council formed to serve as the resource team for the National Association of Surety Bond Producers (NASBP).

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