Challenges and Best Practices for Construction Accounting Record Keeping

In the construction business, accurate financial record keeping isn’t just good practice—it’s essential for survival and success. The industry’s unique challenges, such as long-term projects and complex revenue recognition, make standard accounting practices insufficient.

Many construction company owners excel at building but struggle with the intricacies of financial management. This gap can lead to cash flow issues, strained relationships with lenders and bonding agents, and missed opportunities for growth.

Robust record keeping provides the foundation for informed decision-making, securing favorable financing terms and maintaining a competitive edge in a demanding market.

Challenge 1: Overreliance on Cash Balance

Many contractors fall into the trap of using their bank account balance as the primary indicator of financial health. This approach is tempting due to its simplicity; a quick glance at the account balance seems to provide an instant snapshot of the company’s financial situation. However, this oversimplification can lead to serious misjudgments and poor decision-making.

The danger lies in the fact that a healthy bank balance doesn’t always reflect the company’s true financial position. For instance, a contractor might see $5 million in the bank and feel confident about taking on new projects or making large purchases. However, if $4.5 million of that is earmarked for upcoming payments to subcontractors or suppliers, the company’s actual financial flexibility is much more limited than it appears.

Best Practices to Overcome Cash Balance Overreliance

To avoid the pitfalls of relying solely on cash balance, implement these best practices:

• Implement a comprehensive financial reporting system. This should include detailed accounts payable and accounts receivable schedules, as well as work in progress (WIP) schedules. Regularly reviewing these reports provides a more accurate picture of your financial position.
• Develop cash flow projections. Create and maintain rolling cash flow forecasts that account for upcoming expenses, expected payments from clients and potential project delays. This allows you to anticipate cash crunches before they occur.
• Monitor key financial ratios. Pay attention to ratios such as the current ratio (current assets divided by current liabilities) and the quick ratio (current assets minus inventory, divided by current liabilities). These provide a more nuanced view of your company’s liquidity.
• Regularly reconcile accounts. Ensure all bank accounts, credit card statements and other financial accounts are reconciled monthly. This helps you catch discrepancies early and provides a more accurate financial picture.

Through these practices, you’ll gain a more comprehensive understanding of your company’s financial health — enabling better decision-making and reducing the risk of cash flow surprises.

Challenge 2: Poorly Timed Distributions

Another common mistake in construction accounting is taking large distributions at year-end without considering the impact on financial ratios. This often occurs when contractors flush with success after a profitable year decide to reward themselves or their shareholders with substantial payouts in December.

While the desire to reap the rewards of a successful year is understandable, the timing of these distributions can have unintended consequences. Lenders and bonding agents rely heavily on year-end financial statements to evaluate a company’s financial health and determine credit lines or bonding capacity.

Large year-end distributions can negatively impact key financial ratios, potentially limiting the company’s ability to secure favorable financing or bonding terms in the future.

Best Practices for Strategic Distributions

To avoid the negative impacts of poorly timed distributions, consider these best practices:

• Plan distributions strategically. Instead of taking large distributions in December, consider waiting until early January. This approach maintains stronger year-end financial ratios without affecting the actual financial position of the company.
• Consult with financial advisors. Before making significant distributions, consult with construction accounting professionals. They can help you determine the optimal timing and amount for distributions that won’t jeopardize your company’s financial standing.
• Monitor key financial ratios. Keep a close eye on ratios like the working capital ratio and debt-to-equity ratio. Understanding how distributions affect them can help you make more informed decisions.
• Implement a distribution policy. Establish a clear policy for owner distributions that takes into account the company’s cash flow, upcoming project needs and financial ratio targets.

In taking these steps, construction companies can balance the desire for owner compensation with the need to maintain strong financial ratios. This in turn ensures continued access to favorable financing and bonding terms.

Challenge 3: Neglecting Regular Financial Updates

Many construction companies focus solely on year-end financial statements while neglecting monthly or quarterly reviews. This approach can lead to inaccuracies, missed opportunities for financial optimization, and delayed detection of financial issues.

The reasons for this neglect are often rooted in the nature of the construction industry itself. Contractors are typically focused on project management and execution, with financial management taking a back seat. Additionally, the complexity of construction accounting (with its long-term projects and percentage-of-completion calculations) can make regular financial updates seem daunting.

Waiting until year-end to address financial inaccuracies can lead to significant problems. By the time issues are discovered, it may be too late to make meaningful corrections or adjustments to improve financial performance.

Best Practices for Regular Financial Updates

To keep your financial records accurate and up to date throughout the year, consider implementing these best practices:

• Conduct monthly or quarterly financial reviews. Set aside time each month or quarter to review your financial statements, including balance sheets, income statements and WIP.
• Establish a month-end close process. Develop a standardized procedure for closing your books each month. This should include tasks like reconciling bank statements, updating WIP schedules and reviewing outstanding invoices.
• Engage professional advisory services. Consider partnering with a construction accounting firm like James Moore for regular financial reviews.
• Train key staff members. Invest in financial training for project managers and other key personnel. This can help them understand the importance of timely and accurate financial reporting.
• Use key performance indicators (KPIs). Develop a set of KPIs relevant to your business, and monitor them regularly. This allows you to quickly identify trends or issues that require attention.

These practices can help construction companies maintain more accurate financial records throughout the year, facilitating better decision-making and reducing the risk of year-end surprises.

Challenge 4: Lack of Internal Controls and Segregation of Duties

Many construction companies, especially smaller ones, lack proper internal controls and segregation of duties in their accounting processes. This oversight can lead to significant errors in record keeping and increase the risk of fraud. For example, having the same person open mail, write checks and enter data into the accounting system creates opportunities for mistakes or misappropriation of funds.

The consequences of poor internal controls can be severe. Without proper checks and balances, errors can go undetected for long periods, leading to inaccurate financial statements. This inaccuracy can, in turn, affect decision-making, relationships with lenders and bonding agents, and potentially the company’s financial stability. A lack of segregation of duties also opens the door to potential fraud, which can have devastating effects on a construction business.

Best Practices to Improve Internal Controls

To strengthen your internal controls and reduce the risk of errors and fraud, implement these best practices:

• Separate key financial duties. Assign different individuals to handle cash, record transactions and reconcile accounts. This separation makes it more difficult for any single person to manipulate financial records.
• Implement a system of checks and balances. Establish procedures where one employee’s work is reviewed by another. For instance, have a manager review and approve all payments above a certain threshold.
• Regularly review and update internal control procedures. As your business grows or changes, your internal controls should evolve too. Conduct periodic assessments to ensure your controls remain effective.
• Provide training on the importance of internal controls: Educate all employees on why these controls are in place and how they contribute to the company’s financial health.

This way, you’ll create a more secure and accurate financial environment that reduces the risk of errors and fraud and improves the overall reliability of your financial records.

Challenge 5: Inaccurate or Outdated Work-in-Progress (WIP) Schedules

Work in progress (WIP) schedules are crucial tools in construction accounting, yet many contractors fail to update them regularly. This neglect can lead to inaccurate revenue recognition and potentially misleading financial statements. The problem often stems from a “set it and forget it” mentality, where initial contract amounts and estimated costs are entered but not revisited as projects evolve.

Inaccurate WIP schedules can have far-reaching consequences. They can distort a company’s financial picture, leading to poor decision-making about taking on new projects or managing cash flow. And don’t forget, lenders and bonding agents rely heavily on these schedules to assess a company’s financial health. Inaccurate WIP reporting can negatively impact a contractor’s ability to secure financing or bonding for future projects.

Best Practices for Maintaining Accurate WIP Schedules

To ensure your WIP schedules remain accurate and useful, you should follow these best practices:

• Update WIP schedules monthly. Regularly adjust for change orders, revised cost estimates and actual progress on the project. This frequent updating provides a more accurate picture of each project’s financial status.
• Adjust contract amounts for change orders: As soon as change orders are approved, update the contract amount in your WIP schedule. This keeps your revenue projections accurate.
• Revise estimated costs based on project changes. External factors like weather delays or material cost increases can impact your project costs. Regularly review and update your cost estimates to reflect these changes.
• Implement a formal review process: Have project managers review and sign off on WIP updates for their projects. This ensures those closest to the project are validating the financial data.
• Use WIP reports to identify potential issues: Regularly analyze your WIP schedules to spot potential cost overruns or underbilling situations early. This proactive approach allows you to address issues before they become major problems.

By maintaining accurate and up-to-date WIP schedules, you’ll have a more reliable picture of your projects’ financial status. This is key for better decision-making and improved credibility with lenders and bonding agents.

Streamline Your Construction Accounting with James Moore

Adopting these best practices in construction accounting record keeping is not a one-time effort, but an ongoing commitment to financial excellence. It requires a shift in mindset from seeing accounting as a necessary evil to recognizing it as a strategic tool for business growth.

For personalized guidance on implementing these best practices or for more in-depth financial advisory services, work with James Moore. Our construction accounting team can help assess your current bookkeeping and accounting practices and develop new systems better aligned with best practices. Contact us today to get started.

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