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Your Construction Business May Not Be Doing as Well As You Think Due to Inaccurate Financial Information

2018-02-20 10:30:40.0

| Author: FAS

FAS specializes in small business bookkeeping and tax services. We work closely with small businesses in Katy, Fulshear, Houston and nearby areas. Call us for Free Consultation: 832-437-0385 .






   Do you ever wonder why despite the number of continuing projects you are working on your company is still not profitable? Understanding the key factors that drive the profitability of your construction business is critical.

  Below are two fundamental but very important concepts that every construction business owner must know to be profitable:

  • Understand the impact of gross margin to your business profitability by looking at gross margin in absolute dollar amount and as a percentage of revenue, and 
  • Understand why using Percentage of Completion method provides you the true financial picture of your business.

 

Understanding the impact of Gross Margin in both dollar and in percentage for your construction business and why do you need to care is the first step.

  • Gross margin in absolute dollar term ($) is the money left over after you subtract all the job specific expenses and are used to cover overhead and leave money for profit.
  • Gross margin in terms of percentage (%) ideally should be consistent across jobs. With this gross margin analysis by project, you will be able to identify what projects are the least and the most profitable and what can you do differently to be more profitable for future projects. 

Below illustrates the importance of understanding gross margin measured in both dollar ($) and as a percentage of revenue (%). 

To calculate correctly your construction business’ gross margin by project, you need to understand, identify and capture direct and indirect expenses in your accounting system.

   The items below describe the typical expenses in construction companies and what type of expenses each should be classified to generate an insightful information to manage the project costs and to calculate correctly the gross margin:

  • Indirect Expenses

   Among the most common costs associated with indirect overhead for a construction business are the salaries and benefits of employees and personnel -- such as bookkeepers, executives and administrative employees -- who don't work on an actual job site; the business' physical office, rent, utilities, supplies, phone and Internet lines and insurance; and miscellaneous ongoing expenses, such as marketing, advertising, travel costs and legal fees.

  • Direct Expenses

   The direct costs most likely to accumulate on a particular project are temporary office structures, such as trailers, architect's quarters and leased office space; project-specific salaries for foremen, schedulers, engineers, and job superintendents; and job-specific equipment rentals, such as jackhammers, cranes, bulldozers, and backhoes. Temporary utilities -- the sanitation facilities and drinking water necessary for any job site — are also filed under direct expenses.

   Accounting system like QuickBooks Online is not equipped to assist you in identifying what are the direct and indirect expenses. The best way is to consult with your bookkeeper to assist in setting up correctly these various expense categories on your company’s chart of accounts.  

 

Why Is Job Costing in Construction Important?

  On construction business, it is essential to understand the costs of each project.  Job costing is used to accumulate the costs of each job, in order that profitability of projects can be assessed and the pricing of future projects improved. In summary,

  • Job cost reports provide crucial information about the current status of a job and can help estimate how you will finish on each job from a cost and revenue perspective.
  • It’s important to map out electronic workflow processes to ensure accounts payable invoices, purchase order and sub-contract commitments are entered in as quickly as possible and distributed to the proper job allocation.
  • Job costing provides discrete “buckets” of information about each job so that your bookkeeper can allocate costs directly to the job and division code, commonly referred to as the cost item or cost code.

  Once you have identified, captured, and recorded the expenses to the right cost bucket using job order costing, you will be able to determine the true project cost and the corresponding gross margin for each project. Understand that if you are not correctly identifying your direct expenses, you will not be able to determine your true project cost, and you cannot correctly measure your gross margin.

 

Why Is Using the Percentage of Completion accounting method Critical in Your Construction Business?

   Using percentage of completion method for your construction projects provides a more accurate picture of each project profitability.  Below are some things to keep in mind to achieve a reliable percentage of completion method of accounting:

  • The method works best when it is reasonably possible to estimate the stages of project completion on an ongoing basis, or at least to estimate the remaining costs to complete a project,
  • It requires accurate job costing and estimating, and
  • It requires monthly Work in Process (WIP) adjustment.

  Using percentage of completion method of accounting for your construction business is one of the best ways to correctly measure your company’s profitability.

If you need help with job order costing and understanding the percentage of completion method for your construction business, contact us today at cristy@fas-accountingsolutions.com or 832-437-0385.

 


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