Why Basic Accounting Isn’t Always So Basic
Why Basic Accounting Isn’t Always So Basic
By James Zapata
Basic accounting…is that really a thing? Sounds like a bit of an oxymoron to us. Basic implies easier, simpler, and more likely to be understood and done correctly. While accounting functions may certainly be basic in certain instances, the construction industry presents several unique challenges that can make accounting functions substantially more complex. We’ve identified a few key reasons why basic accounting isn’t always that basic for the construction industry. If you run into one of these, it might be a sign that you need to re-evaluate some processes, call in a professional, or switch accounting solutions.
One of the biggest things that can make effective and timely accounting tasks difficult is a lack of consistent documentation. We see this with companies that have several systems that house documents. It might be something as simple as general ledger expenses not matching inputs from a separate schedule. Documents like a WIP schedule, profit analysis sheets, and any other relevant documents that might be used by project managers, estimators, or the accounting department need to be kept accurate and up to date to streamline accounting processes.
The Profit Margin Concern
Not only does accurate documentation make accounting tasks easier in the end, it also allows management to make better decisions. Let’s say a project begins with an estimated 20% profit margin. As the project progresses, several changes are made at the customer’s request, but change orders and amounts are not recorded and tracked throughout the duration of the project. In fact, no extra amount is charged for several changes because the company likes the customer and wants to keep their business.
At the end of it all, the margin has plummeted to 3%, making the project significantly less profitable to the company than anticipated, in addition to causing issues in other areas of the business. Not ideal. If you find your company repeatedly encountering this issue, consider setting a threshold of appropriate expense amounts the company can absorb when you do want to please a customer, and require that all change order amounts be approved by a knowledgeable party who will analyze the effects on profit margin. Otherwise you might be keeping their business but harming yours.
When the Problem Isn’t in the Process
Sometimes your accounting processes and amount of business received are fine, but you’re still losing money. This is the point when you might want to take a look at your estimators, project managers, and CPA’s.
If an estimator consistently bids too low, you might find yourself with a lot of work and not a lot of pay. Hold estimators accountable for inaccuracies as much as possible. Track month by month and look at margins upon completion of each project to evaluate the value your estimator delivers to your business.
Your project manager may also be inadvertently hurting your margins by not charging enough (or not at all) for changes to the original project. If a customer wants two extra floors, they need to pay for them. If they don’t, your business will. You might also encounter issues with the amount billed. As a professional in the construction industry, you need to charge for your services before they’re delivered, because you must be able to pay for expenses related to materials, tools, and labor. If the client is under billed, your company essentially covers the cost for them until you can catch up in your billing cycle. (For help tracking progress, you can use a WIP schedule.
The construction industry is a unique one. In other industries, you bill when services are completed. This is not the case with the construction industry, because of the significant amount of resources required to work on an ongoing project, from materials to tools to labor. Because of this, you don’t recognize revenue when you bill, but rather as you incur costs associated with the revenue.
Having a CPA who understands the ins and outs of the construction industry is imperative to providing relevant and transparent financial information as well as maintaining a strong and confident relationship with your bonding agent. CPA’s can add the most value when they have a deep understanding of you and your business.
Simplify Accounting: Establish a Process
For tracking purposes, make sure that estimates and change orders are updated across your company. If you don’t have controls in place to make sure this happens, create an established process for updating information in a timely manner.
For example, you might require all estimators, project managers, or anyone else making changes to estimates or change orders to submit them to someone with an accounting function. Have that person, or someone in the department, be responsible for updating all documentation.
You might compile a list of relevant documentation to make this process easier. Better yet, have all changes vetted through a project manager to ensure that profit margins are staying constant. If you’re not sure how to track this effectively, you can use a profit fade analysis tool like this one.
Accurate information not only helps you simplify accounting processes, but also helps you track the health of your business.
James Zapata is Audit Partner for MiddletonRaines+Zapata, LLP, a leading Houston-based CPA firm offering a full suite of accounting, tax, audit, and consulting services to the small and middle markets.” firstname.lastname@example.org
Vince – the blogger’s Reality Bite: As a small business owner, I would suggest that you get even more involved in the accounting process than Zapata suggests. Particularly when dealing with new employees such as estimators and project managers.
We work in an industry that includes many hucksters, and the more you are involved in the review and approval of accounting processes, the better able you will be the thwart these hucksters.
The Punch List is Triune’s proprietary blog for discussing issues and providing insights specific to the commercial construction industry. Copyright 2013 TMV, LLC (Triune). Any and all rights reserved.