Accounting and Cost Tracking for a Construction Company

Construction accounting, at its core, is about understanding how the work a construction company performs translates into financial results. It creates a connection between what was estimated for a project, what is being spent, where the project stands, what that means for profitability and cash flow for the specific project, and ultimately for a construction company.

That starts with job costing: tracking labor, materials, subcontractors, equipment, field and indirect overhead, and other costs to individual jobs. From there, work-in-progress (WIP) reporting puts those costs into the context of project progress, billings, revenue earned and expected profitability. Together, these give owners and project managers a clearer picture of how each job is performing, what may be changing, and where there is an opportunity to respond and mitigate any risks that are being discovered during the process.

Job Costing

For each project, costs are assigned to the job by category (cost code) so they can be compared to what was originally estimated and used to track how the job is performing per the cost code. The goal is to be able to look at a project and understand not only what has been spent, but how those costs compare with the budget and what they may mean for the final outcome.

For example, if a contractor estimated $100,000 for labor on a project but has already spent $75,000 when only half the work is complete, that is something management needs to analyze and swiftly identify an opportunity to recover the cost. The $75,000 spent is not necessarily a problem by itself. The important question is what that spending means for the cost of the remaining work and the project’s expected profit.

This is why job costing is more than simply recording expenses. It gives contractors a way to compare actual costs incurred to date with the original estimate, identify where costs are running differently than expected, and update their expectations as the project progresses. Labor, materials, subcontractors, equipment, and other project costs can each be evaluated to see where the project is on track and where it may be starting to move away from the original plan.

This is where communication not only with a project owner, but also internal communication between accounting and project management matters. The project team knows what is happening in the field, while accounting sees the financial side of those activities. A project manager may know, for example, that additional labor or materials will be needed before those costs appear in the accounting system. When those two pieces of information are connected, management has a better understanding of what the numbers are really telling them.

Timing matters, too. Information that arrives after a decision has already been made isn’t nearly as useful as information that gives you a chance to act. If costs are not being tracked accurately and consistently, it becomes much harder to identify when a project is starting to move away from its original estimate.

It is also important to look beyond the costs incurred to date. Contractors need to consider what it will cost to complete the remaining work. If the estimated cost to complete increases, the expected profit may decrease even if the project is still showing a profit based on costs incurred so far.

Work-in-Progress (WIP) Reporting

A WIP, or work-in-progress, report brings these pieces together. It shows how the amount of work completed, costs incurred, estimated costs to complete, billings, revenue earned, and expected profitability relate to one another.

Construction projects happen over time, so these things don’t always occur at the same pace. Costs may be incurred before a project is billed, revenue may be recognized based on the progress of the work, and cash may not be collected until later.

This is one reason the percentage-of-completion concept is important in construction accounting. For long-term projects, revenue is often recognized as the work progresses rather than simply when a customer is billed or pays. The percentage of completion is generally based on how much of the project has been completed relative to the total work expected, often using costs incurred compared with total estimated costs.

The point is not simply to recognize revenue earlier or later. It is to better align the financial results with the work being performed. If a project is 50% complete, for example, the accounting should provide a reasonable picture of the revenue and profit associated with that portion of the work, rather than allowing the timing of invoices or cash receipts to tell the entire story.

WIP reporting also helps management understand the relationship between project progress and billing. A contractor may have billed more than the amount of revenue earned based on the work completed, or may have performed more work than has been billed. These situations are commonly referred to as overbilling and underbilling.

Overbilling is not necessarily a problem, and underbilling is not necessarily a problem. The important thing is understanding why the difference exists and what it means for the project and the company’s cash flow. A project that has been billed ahead of its progress may provide cash that helps fund current operations, while a project that is underbilled may require the contractor to finance costs until the work can be billed and collected.

The goal of WIP reporting is to understand how each job is performing while there is still time to recognize and respond to problems. It gives owners and project managers a way to look beyond individual transactions and understand how the financial results relate to the actual progress of the job.

Learn From Completed Jobs

The information gathered throughout a project also becomes valuable once the job is complete.

Every finished job gives a contractor more information about what it costs the company to perform its work. Over time, those results create a history that can be used when estimating and bidding future projects.

Maybe labor consistently costs more than expected on a particular type of project, material costs have been consistently different from estimates, or certain types of work produce better margins than others. Those patterns are much easier to see when job costs are tracked consistently.

The more reliable the history, the more contractors can use their own experience instead of relying entirely on assumptions when pricing future work. Actual job-cost information can also help contractors evaluate whether their estimating assumptions are realistic and whether the margins they expect to earn are being achieved.

Cash Flow

The timing of costs, billing, and payments explains why profitability and cash flow aren’t the same thing.

A contractor may have a profitable project but still need to cover payroll, materials, and subcontractor payments before receiving the customer’s payment. Billing delays, collections, retainage, and the timing of progress billings can make those differences even more significant.

Overbilling and underbilling can also affect cash flow. A contractor that has billed ahead of the work performed may have collected cash before incurring some of the related costs. Conversely, a contractor that has performed work but has not yet billed for it may be using its own cash to fund the project.

This is why looking at profitability alone is not enough. Owners also need to understand when costs are expected to be paid, when work can be billed, and when customer payments are expected to be collected.

Looking at job costs, project progress, billings, and expected cash needs together gives owners a better idea of both how the business is performing and what financial demands may be coming in the weeks and months ahead.

Accounting Should Help Manage the Business

Ultimately, the purpose of construction accounting is to provide information that helps owners and managers make better decisions.

A useful accounting and cost-tracking process should help answer practical questions throughout the life of a project:

• Are we spending what we expected?
• How much of the project is complete?
• What will it cost to finish?
• Is the expected profit changing?
• Are we billing appropriately for the work being performed?
• Are we ahead of or behind our expected billing position?
• Will we have enough cash to cover upcoming expenses?

And when those same questions are looked at across completed projects, the answers can help improve future estimates, bidding, and planning.

Construction accounting is more than recordkeeping. It is a way to connect the financial information in the accounting system with what is actually happening on the job. When that information is accurate, timely, and understood in the context of project progress, it becomes a tool for managing the jobs you have today, improving the bids you make tomorrow, and making more informed decisions as the business grows.