8 Accounting Basics for Contractors and Construction Businesses
Accounting is an essential part of running a successful construction business. However, managing your business finances correctly doesn’t always come naturally—especially if you’re not much of a number’s person. Further, owners in the construction industry face unique challenges compared to other types of businesses.
In this guide, we address some of those challenges, as well as covering the basics of accounting. Follow this resource step-by-step to establish an effective accounting process, avoid costly mistakes, and make more money.
Here’s What We’ll Cover:
How Is Construction Business Accounting Different?
Construction accounting is more complex than it is for most businesses due to the nature of the work, per-project pricing, fluctuating operating costs, and more. Construction companies need to be able to track and report expenses, bid on projects, manage payroll, and a slew of other accounting responsibilities.
Below are the key ways in which construction accounting differs from other types of accounting.
Contractors work from project to project and typically manage multiple projects at one time. Projects aren’t necessarily paid for as soon as the project is completed: There may be an upfront deposit required, the project could be paid in full, or it can take months before the final invoice is settled.
For these reasons, construction companies may need to generate separate profit and loss (P&L) statements for each project.
Regular businesses typically offer 1-5 different types of products or services, whereas construction businesses offer a wide range of services. This may include service work, design services, consulting, engineering, sourcing materials, and more.
This can make it difficult to track expenses and effectively calculate profit generated from each service category.
Fluctuating Overhead Costs
Construction companies also experience fluctuating overhead costs. Consider the cost of insurance, travel, workers’ compensation, materials, subcontractors, equipment, and more. You will need to factor this into your construction accounting.
Cost of Goods Sold
Most businesses simply record the cost of the products sold, but construction businesses are quite different. Each job incurs direct and indirect costs that may fall into a wide range of categories. It’s essential that contractors have an effective method for keeping track of income and expenses, and for reconciling every transaction.
Your company may manage short- and long-term contracts, often with varying end dates. This means you may not get paid at the same time every month. To stay on top of cash flow and keep your books in check, you will need a flexible yet organized accounting system.
1. Separate Personal and Business Finances
The first step for any owner is to create at least one separate bank account that will be used exclusively for your business.
You can go to a bank or credit union to set up a company checking account that suits the needs of your firm. This will make it easier to keep your finances organized.
To set up a business bank account, you will need:
- Social security number or employer identification number (EIN)
- Personal identification, such as driver’s license or passport
- Business license
- Organizing documents filed with the state
2. Break Down Project Costs—Job Costing
Since construction accounting is project-centric, you’ll need a way to track, categorize, and report transactions for each job. This is called job costing.
Job costing is a method for allocating expenses and revenue to each specific job. Not only will this help you prepare for tax time, but it provides an accurate accounting of profitability for each contract.
It essentially ensures that your service price covers all overhead expenses while ensuring that a profit is made.
Job costing is calculated by determining the cost of labor, materials and overhead on a specific job (Total Job Cost = Direct Materials + Direct Labor + Applied Overhead).
Read our complete guide on How to Calculate Job Costing.
3. Record Day-to-Day Transactions
Use a journal, spreadsheets, or accounting software to record day-to-day transactions like accounts payable, accounts receivable, labor costs, and material costs. You’ll want to include a description of each transaction, the date of the transaction, and the revenue received.
You can use construction invoice templates to bill your clients, and keep a paper record of all projects and revenue generated.
4. Track Business Expenses
You’ll also want a “job costs” journal or spreadsheet to keep track of your expenses. This will include payroll, subcontractor fees, equipment, and material purchases. Again, be sure to note the date, description, and payment made.
You’ll also want to categorize these expenses by service, and by individual job so you can easily track how much money came in as well as how much you spent on expenses. Using an expense tracker and saving your receipts can help you keep track of all of your expenses.
The most common expenses construction industry businesses have include:
- Business registration and licensing
- Bank fees
- Tools and equipment
- Travel expenses (including fuel)
- Trade school tuition
- Vehicle maintenance
- Phone and internet expenses
- Software subscriptions
- Membership fees (unions and associations)
- Mileage (tax write off)
- Lease payments
- Safety equipment and uniforms
- Employee payroll
- Advertising and marketing
5. Reconcile Bank and Supplier Statements
Each month your bank will send you a record of your income and expenses. You will then want to reconcile your transactions to make sure they match up with your own accounting system, invoices, payments, etc.
Reconciling your transactions involves:
- Comparing your bank records to your expense receipts
- Looking for any discrepancies between your accounting system and your bank account
- Comparing any transactions to what you have in your expense of revenue sheets
- Contacting your bank to discuss any discrepancies
6. Pay Estimated Taxes
It’s recommended that you pay estimated quarterly taxes throughout the year to avoid any big surprises come tax time. These estimated payments can be calculated with the help of your accountant and/or your automated accounting software.
To pay estimated quarterly taxes, you have a few options, including:
- Signing up for the Electronic Federal Tax Payment System (EFTPS) online
- Paying online via the IRS website
- Paying using debit or credit card
- Sending a check or money order by mail to the IRS
Many construction companies us a “completion percentage” approach, meaning they calculate estimated taxes based on quarterly income and expense reports.
However, you can take a “completed contract” approach as well, which involves calculating taxes owed on each contract. A benefit of this approach is that you can track income, operating expenses, profit, and taxes on the micro-level so you gain a better understanding of where you stand on each construction project.
The important thing is that you adopt a strategy that works best for you, and stick with it so there’s no confusion come tax time. If you need extra help, it’s recommended that you seek out an accountant or professional tax preparer.
7. Hire an Accountant (Optional)
While it’s possible to manage your accounting on your own, owning a construction company comes with many complexities that may lead to you making costly accounting errors.
As a decentralized owner with jobs and contractors at multiple locations, it might make sense to hire a professional accountant to help you reconcile a variety of transactions for various jobs and services.
An accountant will help you make sense of the numbers, manage your books, generate reports, estimate your quarterly tax payments, and much more.
Nervous about the cost? The average hourly rate for an accountant in the U.S. is about $35, making it quite affordable for the average owner. However, these rates may vary depending on the size of your company, the number of jobs and employees you manage, and your unique needs.
8. Leverage Professional Accounting Software
Invoice templates and spreadsheets will only take you so far. If you truly want to master your construction accounting and avoid costly mishaps, you may want to look into online accounting software.
This will make it easy for you to send invoices online, track expenses, monitor payment status, generate financial reports, and more.
Even better, clients are more likely to trust businesses that use professional accounting software over manual methods because software provides a safe, convenient way for them to pay online.
Plus, you’ll have all the tools you need to stay on top of your bookkeeping and make smarter financial decisions.
Get started with FreshBooks’ accounting software for construction businesses.
Construction accounting doesn’t have to be a headache. With the right process, you can save time on your invoicing, accounting, bookkeeping, and tax preparation, even without previous accounting experience.
Improving your process starts with understanding how construction accounting is unique, and determining the different types of job costs you can incur on each project.
The best way to stay organized is track your day-to-day transactions, reconcile your accounts on a regular basis, and use smart accounting software.
With the steps in this guide, you have everything you need to do accounting for your construction company the right way.