To be efficient and profitable in business, you must implement cost controls. And this begins with knowing your company's numbers. Successful construction business owners know their numbers by regularly reviewing the following four reports: over/under billing, overhead allocation, cash flow by job and production-style reports.
Over/under billing reports help contractors follow revenue recognition rules, stay on top of their billings and secure required project bonding.
Proper Revenue Recognition
Running frequent over/under billing reports shows contractors whether their jobs have reported greater profits than they should (over billing), or if they have not billed enough based on the percent of completion (under billing). This provides an accurate snapshot of each job's financial health and a better overall financial picture.
Contractors will commonly be over and under billed. For example, consider a job that has an estimated cost of $80,000 with a contract fee of $100,000. If the project is 50 percent complete, the contractor should have billed $50,000 (50 percent of the contract amount).
If the contractor billed the project owner $60,000, the job would have over billed, which can give a false impression of profitability. On the flip side, if the same construction company billed $40,000, they would have under billed.
Over/under billing reports also play a key role in the bonding process. Many project owners offset their risk by requiring contractors to obtain bonding. Bonding agents require over/under billing reports to ensure accurate job reporting and verify that jobs finish according to the contract.
In addition to direct material costs, labor, burden, subcontractors and equipment, companies must account for indirect costs (overhead) to determine a job's true profitability. Selecting the best method for calculating these indirect costs and using construction accounting software will give contractors insight into the company's financials.
Non-job-specific overhead costs might include office staff salaries, rent, utilities, marketing, travel, advertising, etc.
Generally, one of two methods can be used to allocate overhead in construction--job cost and general ledger. Before choosing a method, first consult a construction CPA or accounting professional.
The job-cost method--which is simple to follow but often less accurate--uses a single, predetermined rate, multiplied by job costs to determine overhead costs. To calculate this predetermined rate, contractors typically estimate the percentage of actual costs that represent overhead (based on past overhead costs). This results in a single rate that applies to all jobs.
General Ledger Method
The general ledger method for overhead allocation tends to be preferred. This method requires contractors to track actual overhead costs the same way they track direct job costs. Then, contractors can proportionately distribute the overhead back to the active jobs. This method allows for more complex formulas to accommodate weighting overhead expenses based on the most relevant types of costs.
Contractors who use and understand overhead costs have a more accurate understanding of all costs and a company's true bottom line.
Cash Flow by Job
Construction business owners should view and understand cash flow across the entire company based on general ledger activity as well as cash flow by job.
Contractors should analyze cash flow by job to see how each project affects cash inflows and outflows. This allows contractors to identify profitable jobs that fund themselves and recognize underperforming jobs that absorb funding from other jobs.
At the very least, a contractor should be able to view net cash flow--cash received or collected through cash receipts per job, minus what was paid out of accounts payable and gross payroll.
In conjunction with cash collected and cash paid out of accounts payable and payroll, contractors can use this information to see the cash flow percentage to the contract. They can then alter cash flow projections (based on actual cash activity) and identify trends for certain types of jobs.
For example, government jobs may always be profitable for a company, but during the job's life cycle, this may put a strain on cash due to the time it takes to be paid. Looking at the cash flow by job report allows contractors to make good bid decisions.
Contractors should regularly review production-style reports to pinpoint which tasks fall over (or under) the estimated production.
These reporting processes can also be automated with construction software, allowing for improved efficiency during a job's life cycle. This provides historical data that can be used when bidding and predicting the success of future jobs.
With a good estimating program, contractors can budget estimated quantities, man hours and equipment hours to complete each job's task code. These quantities can be exported into accounting software so that contractors can also enter quantities completed into payroll or job costing.
Job cost reports that compare estimated versus actual production per man hour within a job can then be produced on a real-time basis. This allows contractors to see trends and make adjustments while the job is active. For instance, a contractor who has exceeded estimated labor hours on a specific task can make adjustments to compensate this. Good historical data allows a better forecast of production per task and labor hours on future jobs.