Tracking the financial minutiae of your contract schedule requires great attention to detail. But do you know what else requires great attention to detail? Construction projects! In the hustle and bustle to win, work on and complete jobs, it’s understandably easy to make accounting mistakes with your contract schedule or to simply lose perspective on the overall picture.
Maintaining an accurate schedule of contracts is key to profitability. Contractors often reach the end of a financial reporting period believing they’ve turned a healthy profit. Unfortunately, after accounting adjustments, the profit margin turns out to be much thinner than anticipated. Fortunately, there are ways to prevent such unpleasant surprises.
Start with the estimate
Every job begins with an estimate and, from a profitability perspective, every project ends there, too. Overly optimistic estimates could paint a rosier financial picture than the one that ultimately materializes because of delays and unforeseen cost increases. Then again, if you come in too low with estimates, you may win jobs but never reach your sought-after profit margin.
Finding the right balance is a topic for another article. What’s important in terms of an accurate contract schedule is that you continually ensure that: 1) your estimate for each job reflects accurate, realistic costs to complete, and 2) your current projections show that you’re on track for true profitability.
Of particular importance are estimated losses. It’s one thing to lose a percentage point or two off your profit margin; it’s another to actually lose money on a project. If your costs to complete are notably at odds with your estimate, the first order of business is to determine why and whether you can salvage the job.
If losses can’t be helped, you’ve got to apply the proper accounting approach to the situation so you know precisely how the struggling project (or projects) will affect your bottom line. Under the percentage of completion accounting method, for example, you must recognize the full estimated loss of the project in the period in which you identify the estimated loss.
Put a system in place
As you may have gathered, to track how a project’s costs are developing in relation to the estimate, as well as to generate accurate accounting data, you’ve got to have a system in place. Your CPA can help you set one up or review your current one.
The precise data points you should track will depend on the nature of your work. But a solid billing and cash forecasting schedule should typically review items such as:
- Average earnings
- Expected expenditures
- Typical billing schedules
- General financial effects of these types of projects
- Potential cost-escalating events
Keeping track of these things will not only help you predict future earnings and cash flow, but also allow you to identify patterns and areas where you may be able to improve cash flow management across your contract schedule.
Integrate indirect costs
Another element of doing business that can throw off your contract schedule is indirect costs. Debate often erupts regarding the difference between these expenses and overhead. Generally, overhead refers to the costs of running a business — any business. Examples include rent, office equipment and supplies, salaries for executives and clerical staff, insurance, taxes, advertising and marketing expenses, and accounting and legal fees.
Indirect costs, however, are expenses related to a contract that aren’t necessarily specific to one job. For instance, if you pay for activities such as project management consulting, purchasing, contract administration and safety oversight, these likely fall into this category. The costs of repairs and maintenance to equipment not specific to one project are also usually considered indirect costs.
A spike in indirect costs can negatively affect profitability estimates. Maybe you’re working on a number of particularly complex jobs that call for more outside consulting. Or perhaps bad weather has put undue stress on vehicles and equipment, necessitating more repairs. If you neglect to account for such costs, or do so incompletely, surprising cost overruns within your contract schedule may result.
In addition, rare is the construction company whose indirect costs remain at minimum levels. So, as you track these expenses, distinguish which ones are fixed and which are variable. You may be able to trim variable indirect costs, improving your overall financial position.
Keep an eye on the big picture
It’s easy to get overly focused on the details of one or two projects — especially if those jobs run into trouble or are more complicated than your other work. But keeping an eye on the big picture provided by your contract schedule is essential to preserving a healthy bottom line.
We welcome the opportunity to put our construction industry expertise to work for you. To learn more about how our firm can help advance your success, please contact Dave Wolfenden at (302) 254-8240.