Construction Accounting Best Practices for 2024

ISTOCK/COM/IRYNA DROZD

By Julian Xavier of CliftonLarsonAllen LLP claconnect.com

Construction has had strong results in general over the past few years, and many contractors continue to maintain strong backlog positions even now. However, with the current uncertainty around inflation, interest rates, and labor shortages, it is timely to take a closer look at construction accounting practices to ensure a company is positioned well to respond to and survive economic downturn. While some remain best practices, key focus areas include using technology to do more with less, timely monitoring of project performance, cash flow management, and strategic planning.

Technology 

Managing the financial health of the company and accounting processes can be a challenge, especially with the ongoing shortage of personnel. However, current technology enables construction companies to streamline their accounting processes, improve accuracy, and enhance efficiency, for example, through:

  • Automation of recurring accounting functions
  • Better use of data and data analytics
  • Dashboards with key performance indicators (KPI’s) updated on a real-time basis.

Accounting Automation 

Automated technology has helped many construction accounting teams become more efficient for many basic accounting processes, especially when staffing is tight since the process is simplified and requires less training and work hours to complete. For example, an automated tool to help with financial statement closing/reporting can generate a report with a click of a button instead of having to check and copy across systems using manual intensive Excel workbooks.

Payroll automation software is also typically completely integrated with the accounting software, which helps with efficiencies. Project teams can enter time remotely in the field, allowing data to be captured in real time. Other automation opportunities include using robotic process automation for repetitive tasks like data entry of payables/receivables, workflow automation to help increase speed and efficiency of document approval, and artificial intelligence (AI) powered tools that provide instant responses and guidance to user questions.

Data and Analytics

Many construction companies have significant data in a raw and unstructured form in disparate, siloed software platforms. This prevents your ability to leverage data for insights into your business. Proper use of data can enhance a company’s ability to spot trends and insights related to performance metrics.

Today many best-in-class construction companies use a data scientist (either employees or consultants) to help extract data from various platforms to help detect patterns and trends. Additionally, with the continued growth and use of AI, data can be used with predictive analytics on projects and other areas of performance.

Dashboards

Progressive construction companies are dialed into the KPIs that track profitability, improve cash flow, and prevent job fade that hurt the bottom line. KPIs historically were generated and analyzed at the end of the reporting period, which is too late to take corrective action and mitigate issues. Today dashboards can drill down into data such as past due accounts receivable, jobs with large underbillings, and jobs that have costs exceeding budget. Data can be reviewed by top management daily to help stay focused on what’s most important to the company’s performance.

The construction industry has in the past been slow to adapt; however, more companies than ever are developing a technology-savvy culture, which drives performance and attracts new talent.

Project Performance

Construction projects have a number of risk variables that can lead to potential profit fade, from labor overruns and subcontractor performance issues to scheduling delays and changes in conditions, which lead to increased costs, materials price increases, delayed delivery of materials, and more. All must be monitored closely for them to be addressed in a timely manner.

Recently, companies bid on jobs with large profit margins with less of a focus on risk factors. However, if the industry slows down, contractors will need to tighten their bids and pay more attention to performance to mitigate risk.

One way to do this is to compare your company’s estimates against projects that were less profitable to identify which areas you do well in and which areas could be a cause for concern to inform future bids. Given the steep increases in labor and material costs, it is critical that estimating tools are updated to reflect current market conditions to prevent cost overruns leading to an unsuccessful project.

Should the construction market slow down, it is also important to evaluate whether a project is a good fit for your company. Some factors to keep in mind when bidding on a project are: does the type of work fit your expertise; have you worked with the customer before; and the location of the project. Many of the best contractors have a go/no-go template that they fill out on significant project opportunities to determine whether they should pursue the opportunity. This type of discipline can make sure that projects taken on are the right risk profile for the company.

Change orders are also an area that, if not managed properly, can have a negative impact on project performance. One of the distinguishing factors between poorly performing firms and best-in-class firms is their management of the change order process. Keys factors are that project teams identify and communicate issues as they happen, thereby negotiating and securing change orders as the project progresses versus waiting until project completion. Too many underperforming contractors do not capture and get paid for work that is out of scope either due to lack of proper understanding of the terms/scope of their contract or reluctance to ask for more dollars from a long-term customer. Their mindset must change to one of getting paid for all the work and costs to which the contractor is entitled.

Cash Flow Management

A common phrase in the construction industry is “cash is king”! This is still the case today, and cash flow is extremely important for any contractor’s financial strength. Key principles to follow to help improve cash flow include focusing on and having regular follow-up on past due receivables. It is important for companies to know why they are not getting paid, to look for trends on a customer-by-customer basis, and to make sure project teams and accounting are reaching out to the customer to get paid quickly.

If there is a large expenditure on a critical aspect of a project, contractors should plan to have the cash to cover it or try and bill the customer ahead of time to pay for the expenditure. Additionally, front loading project billings in the schedule of values allows a contractor to generate positive cash flow on the project.

If you have the luxury of having cash on your books that you do not need in the short term, look at investing options. With the current higher interest rates, you can get a return, even on short-term money, at relatively low risk.

Strategic Planning/Budgeting

When times are good, most contractors have sufficient profitable work on hand that strategic planning and budgeting might not seem as critical. However, preparing and monitoring business plans/budgets can make sure they are trending in the right direction.

Comprehensive construction benchmarkingto see where you stand with the competition is important to discover what metrics to focus on to see where you might have room to improve from a financial perspective against your peers. Many times, your surety company will provide this information for you, or your CPA firm can also typically provide this information. You can also prepare yourself by referencing benchmark information published by CFMA or other organizations.

Another way to help monitor results and performance is to prepare at the beginning of each year a business plan with goals set for top-line revenue, margins on projects, overhead spend, and other income/expense items such as interest income/expense. This plan should be reviewed and agreed to with top management of the company and monitored on a quarterly basis to see how the company is performing against plan. Any negative deviations should be addressed and a call to action made to the project teams as appropriate to increase new work targets, improve project margins, improve cash flow, etc.

As noted above, many of these recommended best practices are not new, but given the need today to do more with less staffing, spending the time and effort to fine tune these processes and leverage technology can lead to stronger financial results and help minimize the risk of project profit erosion.

Julian M. Xavier is the Managing Principal of CliftonLarsonAllen LLP’s Construction Industry. He serves on CLA’s and has over three decades of experience in accounting in the construction industry. Xavier is a member of the AICPA, California Society of Certified Public Accountants, Construction Financial Management Association and a participant on the NASBP CPA Advisory Council. He can be reached at [email protected] or 925.407.2025.