Intro to Construction Accounting
Construction accounting is a different form of accounting than for many regular companies. Construction accounting is usually rather project-based instead of doing bookkeeping on the whole company level.
This becomes even more crucial when you are a contractor company and have multiple clients. You probably want to know the P/L (profit/loss) on a project level or ideally even on a job level.
This means that the project management teams (project managers, quantity managers, and site staff) need to work hard to work out the current state and profitability of each job of each project. Either way, this is where the term job costing comes into play.
Job Costing = Construction Accounting
Most companies are fine by just using a normal company-wide general ledger (G/L). They use this to keep track of all transactions the company has been involved in – money in, money out, etc.
For construction companies, it is not really an option due to the fact that construction accounting is project-based. Job costing in construction is tracking the costs of a particular project or a stage (job) in a project.
Job costing provides this insight by attaching additional info to each expense and income. You can be achieve by attaching a project or cost level code to each accounting entry. You can even have codes with the combination of both. With this additional cost code information you can later see what your balance is for each of them.
Often times companies use a standard budget structure. So that jobs between projects become more comparable and easier to estimate. The budget estimate is a structured data with the price and quantity we expect to have our required jobs done.
Find our example template for construction budget categories here.
When we have an initial estimate, we ideally want to get some verification that the prices are realistic. We can do this by either looking at price lists or we can ask for offers/bids from subcontractors.
When we ask for prices from subcontractors, we will then get feedback to set some actual forecasts for the project so that we know what the most up to date project outcome is.
When we finally find a bid that we are happy with then we can either sign the subcontract with the subcontractor or send out a purchase order to receive the materials when we need them.
Subcontracts and Purchase Orders
It is already a good state if you kind of know your job profitability of each project or job after it has ended. However, when your subcontractors or suppliers are sending you invoices for work they did or for the materials you ordered, you need to see if you haven’t already received the materials already. Or that you haven’t paid the subcontractor in the full amount already.
Purchase orders are the tool when you have jobs with materials you need to buy. You just send out an order to the supplier to figure out how much of what materials you need and the supplier will provide them to you. The purchase order itself is a good comparison document to see how much you receive
In jobs where subcontractors will do all of the work and provide their own materials, you will need to sign a contract or at least have a verbal agreement. When you fix the quantities of work that need to be done, then you can more easily track the progress of these jobs against the contracted amounts. The work done by a subcontractor is periodically (bi-weekly or monthly) presented to the project management teams using progress reports.
Progress Reports (or pay applications or claims or valuations)
Subcontractors submit progress reports periodically by the subcontractor for confirmation of the works done. The project manager compares the progress report against the contract, actually done work, and the previously reported work.
Based on the combination of all these three factors, the project manager or quantity surveyor can decide whether the progress report is valid. If it is confirmed, then the project manager gives their confirmation that the done jobs are accepted and the subcontractor can send the invoice to be paid.
But what about unexpected additional work that you missed in the design phase or was added due to client wishes? For this case, the thing to use is change orders.
Change Orders (or variations)
According to Autodesk, a change order is “a bilateral agreement between parties to the contract”. Change orders usually come out in the scope of a subcontract or purchase order when something extra has to be done or ordered. Oftentimes, the need for change orders is provided by either party – the contractor or the subcontractor.
So that the initial estimate (and the budget) does not surprisingly exceed the expectations, there has to be a way to keep track of these as well. For this, it is good to keep track of them in a similar way to the contracts. You can fix the quantities and prices you agreed on and in progress reports see if the agreed-upon amount has been reached.
Cost and Invoice Management
When you have received your materials, then you will also receive the bill from the supplier. The same goes for when you agreed with the subcontractor and his proposed progress report – he will want you to pay him for the work done.
The main challenge is to make sure that you have a systemic way to receive your invoices and have them checked with the people who know about the project and job. When you see the invoices come in, then part of the checking happens again. First, you need to find the contract or purchase order the invoice is. Second, you need to see how much you already paid out in this contract. This is not a trivial job and can eat up a lot of your time. And it is not even providing any added value to your employer.
Finally, after all that, you can tell the accountant what account the item is connected to make the payment. Additionally that, you have to find your spreadsheet and update the state there to make the checking a bit easier. The next month, the same happens again and probably takes even longer.
What if there was an automatic solution that does most of the work for you?
Construction Accounting Software
The scenario which we described in this article is based on using regular Microsoft programs such as Excel and Outlook. The problem with these tools is that most of the data entry and validation is still relatively manual.
There are also standard workflow tools like Procore and Planyard, that do most of the data-heavy work for you and let the subcontractors do the data entry for you. This means that you can just focus on checking the subcontractor’s values and see the previously approved values right there. This can save days of your monthly data crunching and can you love your job again! As an added bonus, both platforms integrate with your accounting software and forward the pre-approved documents automatically. For example, the two industry-standard accounting platforms – Xero and QuickBooks.
Check out our blog post on the comparison of accounting software and construction financial platforms.
Due to the accounting being done on a different level, it makes it slightly more complicated to understand whether what you do is profitable or not. You need to manually add somehow a reference to the documents in analog or digital form so that you can keep track of everything.
It is very likely that you can just get by using email, Excel, and your accounting software if you’re smaller. You can keep the contract documents in a local folder or cloud storage somewhere. And you can just refer back to them when you are approving costs. This works fine for smaller projects and keeps the process very simple.
As soon as you start to have projects in the multimillions or have tens of subcontractors working on your projects, the whole system starts to shake. Against this, there are various temporary solutions. You can start by hiring quantity surveyors to do the data entry. Or you can sleep less on the weekdays and give up parts of your weekends. Like some of our friends and customers have done.
Or, you can use a quantity surveying platform that does all the calculations for you and makes your life easy again.
Do you think you are already having difficulties with cost tracking?
Planyard contractor software helps ambitious teams smash their targets and accelerate their growth.
- No more spreadsheets
- Saves project managers’ and QSs’ time
- Easy to implement and use
- Real-time and accurate financial forecasts
- No more duplicate data entry