Construction accounting basics
Small Business Guides
5 min read
Construction is unlike any other business. Building projects can last for months or even years – and you might be both an employer and a contractor. So how do you learn the basics of construction accounting?
Why is construction accounting different?
If you work in the construction industry, you’ll know there’s rarely a fixed business structure. The site manager probably doesn’t employ the other people working on a project. They are likely to be a contractor – and so is everyone else.
Contractors make up the bulk of the construction workforce. They may be working on several projects at the same time, spending a few hours or days on each. They might also employ their own subcontractors to help out.
Temporary workers will come and go as required. And if you do have a formal payroll, it may change on a weekly basis. So compared with a conventional business, this is much more fluid and changeable.
In this guide we’ll look at what you need to know about construction accounting. This will help you keep your business in the black and out of trouble.
Start at the beginning
Like any other entrepreneur, if you’re starting a construction business it pays to do it properly – right from the start. That means getting your business and your accounts in order before you take on any work:
- Incorporate your business
Incorporating as a small business gives you legal protection. This does depends on the type of company you set up, for example it could be set up as a limited liability company, partnership or sole trader.
- Buy insurance
Construction can be dangerous, from both a physical and a legal perspective. Get specialist insurance to cover you in case things go wrong.
- Hire an accountant or a bookkeeper – or both
Bookkeepers will help you manage your day-to-day accounts, processing expenses, bills and invoices. Accountants will help you with your business structure and advise on ways you can save tax. It makes sense to hire both. They will probably save you more than they cost.
- Keep your skills up to date
Laws change, especially safety laws. Keep your certification up to date by going on training courses. This is important whether you’re a builder, electrician, plumber, carpenter or other worker. Your insurance may also depend on up-to-date certification – and you’ll probably get more work too.
Get the details right
Construction accounting regulations vary around the world. You may have choices about how you manage your accounts. The following examples apply to the US, but other countries have similar arrangements:
- Cash accounting
This usually applies to smaller construction projects. Income and expenses are accounted for when money changes hands. Income is taxed after expenses are deducted.
- Accrual accounting
This is used on larger projects. Income and expenses are accounted for when they are incurred, not when they are actually paid. Accounts may be based on the proportion of the contract that’s been completed. That’s especially true for projects that span more than one tax year.
Your country may have specific laws that apply. In the UK, for example, there's the Construction Industry Scheme (CIS). This requires contractors to collect taxes from their subcontractors on behalf of the government.
As you see, this can be a complex topic. Talk to your accountant or bookkeeper, and also get to know the people at your local tax office. They will help you avoid expensive mistakes.
As a contractor or sole trader, you will be dependent on word-of-mouth marketing for much of your work. So take the time to build up a network of trusted contractors or subcontractors. For example, if you’re an electrician, get to know a reliable plumber. If you’re a builder, get to know a good carpenter.
A real-world social network will help you take on larger jobs, and you’ll be able to share work and refer each other to customers.
When you’re pitching for new business, make a good impression. Your estimates and quotations should look professional and be calculated properly. Good accounting software can help. It makes it easy to create documents, with comprehensive templates to impress your clients.
Make accounting part of your workflow
One of the most important things to know about construction accounting is that you have to do it regularly. That means you need to update your accounting software with expense reviews, your cash flow, updated employee information and generated invoices at least once a week. If you fall behind in your accounts, things can quickly get out of hand. It’s a fast-moving industry.
So it’s vital to build accounting into your workflow. Sign up to some good accounting software – and then make sure you use it.
This doesn’t have to be difficult. Modern accounting tools are cloud-based. This means that they are online, so you can access them from a smartphone or tablet even when you’re working on site.
Invoices can be sent, bills of material recorded, expenses tracked – all from your mobile device. Wherever you are, whatever the time of day or night, you always have the most recent view of your accounts.
By doing this, you’ll avoid undercharging due to missed expenses. You’ll also make the most of your business tax allowances. And you’ll reduce the risk of nasty surprises that could crop up if you were audited.
Beware of the cash flow trap
Construction accounting requires caution at times. Let’s say a client wants you to build a new warehouse. You pay for the necessary materials upfront, out of your own business capital.
Then, halfway through the project, the client goes bankrupt. You’re unlikely to receive more than a small percentage of what you’ve paid out for materials. Unless you have enough capital to ride out the storm, you’ll probably go bankrupt too.
This is why it’s important to keep your cash flow balanced. Big expenses should always be matched by big revenues. Invoice your client on a regular basis – and get payment upfront for major materials or labour expenses. If a client's payments stop for any reason, so should your work.
Many small construction firms fail because of bad debts. If you manage your cash flow carefully, you won’t be one of them.
Build for the future
Strong foundations are vital to the stability of any building. They're vital to the stability of your business too. So take the time to get your construction accounting organised – and keep them that way. It will save you a lot of trouble in the long run.