Anyone who has been around construction knows that the biggest problem most small contractors face is making sure they turn a profit on each job. This is so difficult because construction is a dynamic process; projects change, materials change, unforeseen issues on the jobsite often arise, and together, meaning job cost accounting for longer projects becomes a challenge.
For controllers and accountants of small contractors, the challenges multiply when trying to run an accurate job cost accounting system. Despite advances in many construction tech apps, few platforms support all the functions that go into accurate job costing, from capturing data in the field to running GL software and managing change orders.
The software applications that offer all these bells and whistles are often cost-prohibitive for small contractors running several thousand dollars per month.
Despite these challenges, a growing group of specialty trades are learning how to manage job costs like the big boys. They are doing it through a well-conceived job cost methodology, a set of related business processes, and a growing bevy of inexpensive construction tech apps. Below are industry best practices to improve profitability on every project with job cost accounting.
1. Project profitability requires accurate job costing.
For small contractors, managing profitability begins with understanding a basic accounting concept called cost of goods sold (COGS). In construction, COGS includes two buckets: indirect costs and direct costs.
Indirect costs are your overhead and account for items like liability insurance, marketing, or leased vehicles.
It is essential to understand what these costs are to price your work with enough margin to cover your overhead and leave a healthy profit for the business owner. Direct costs are made up of the labor and materials directly related to individual jobs or projects.
Rising building material costs and a short supply of skilled labor mean that even small contractors need to grasp accurate job costing to manage the business profitably.
2. Understand what type of contracts you are accounting for (T&M, FFP, etc.)
The first place to begin striving for more accurate job cost accounting is understanding what types of contracts require accounting tracking. This is either Time and Material (T&M) or fixed price (FP) for most small contractors. In a fixed price contract, your profit comes down to two things; how well you bid the job and how well you control Time and material costs. The extent to which a contractor manages these inputs is the difference between losing money and a rewarding profit.
Time and material contracts tend to be less profitable but can offer more predictable costs for customers.
In any event, pricing hourly labor rates, material cost markup, and invoicing customers requires a system for capturing accurate job cost data.
3. Determine how you will track Time and Materials (payroll, AP – invoices).
Tracking project job costs is done through your accounting processes. It relies on the way your field teams track their time and how they order building materials.
Requiring hourly employees to allocate each hour to a specific project is the most common way to capture labor costs for each project. Most payroll systems allow exempt employees to do the same. Setting up a payroll system that allocates billable hours on a project basis is a requirement for contractors.
Material Tracking can be more difficult as there are comparably fewer out-of-the-box tools that track material purchasing and receipt. Several fundamentals combine for a strong materials management function to accurately track material costs. These include a streamlined purchase order process, capturing receiving information when materials arrive at the job site, and a 3-way matching of invoices. When invoices are received from material suppliers, accounting controls should require a matching purchase order and receiving documentation. This ensures that material orders are approved and that incomplete or damaged materials are accounted for before paying the invoice and also serves as an opportunity to audit job cost codes that tie the transaction to a specific project.
The final consideration in determining how you will track time and material costs is ensuring that you have a watertight integration between third-party apps and your accounting software. For example, if you are using QuickBooks Online, integrating with ARCARO for Payroll and StructShare for material tracking allows you to use native integrations, making the exchange of data between systems more manageable.
4. Develop job cost codes and set up your chart of accounts.
Most accounting software packages allow for some form of project tracking and usually begin with setting up project codes mapped to individual transactions. These may also be identified as classes or tags depending on the platform and allow for reporting financial results based on the project. For example, an income statement would show only the revenue, COGS, and profit for a specific job.
Another important consideration is ensuring that your Chart of Accounts Should accommodates common building materials used in your business. For example, a roofing company would need to track asphalt shingles, clay tiles, tar paper, moister barrier, plywood, roofing nails, etc. This is important so that the estimates that support your bid/proposal process mirror the “buckets” you will use to track actual project costs. The level of detail within estimates and the terminology you use needs to match your chart of accounts to report accurate budget v. actual results.
To manage project costs like the big boys, you can take it a step further by using the percentage of completion accounting. Without getting too technical, this uses the accounting principle of matching expenses and revenues with the period in which they were incurred. Month-end journal entries are used to allocate costs appropriately. For many small contractors, where jobs are less than a month in duration, this may be unnecessary.
5. Account for Change Orders
Believe it or not, an overwhelming number of small contractors have no formal policy for addressing change orders. When the GC comes to you with a change in scope, that means additional Time and material costs that eat away at your bottom line. Having a formal process for documenting and approving change orders can be as simple as adopting a set of forms that require a signature from the owner or superintendent. The American Institute of Architects reference library is an excellent resource for boilerplate documents.
6. Capture data in the field for better job cost accounting accuracy
Accurate cost data comes from the field. Having the right technology and a well-conceived set of best practices for capturing job costs is great, but it only works when you get buy-in from field teams. Helping field teams understand how to use ConstructionTech apps to make their job easier is essential for adoption.
For example, when managing building material purchasing, look for solutions that help supervisors issue PO requests, get timely approval, and document receipt on the jobsite.
Applications like StructShare allow you to preload supplier catalogs to take advantage of preferred pricing. Real-time alerts allow for the approval of POs to prevent delays in placing orders, and when deliveries are received, field teams note damages or incomplete orders.
So much of the value in technology is the way it facilitates communication. This is important in industries like construction that require large groups of people working together at multiple locations. Search for tools that can help you capture data in the field to improve the way you track job costs and manage projects for profitability.
7. Securing Field Staff Adoption
Capturing data in the field circles back to adoption. How do you compel field teams to adhere to a process? Three things come to mind, keep it simple stupid (KISS), follow native integrations, and focus on “what’s in it for them.” For example, once you have outlined the steps in which you want Superintendents to use a new app, cut out as much jargon as you can and simplify the process. Penciling out a change management strategy is essential even for the slightest change in how a process like timekeeping or material ordering is handled. Build on this by helping teams focus on how a new tool will make tedious tasks easier. You might say something like, “we’ve invested in a new technology to help eliminate paper on the jobsite.”
8. Stick with native integrations and out-of-the-box process flows.
This is important to help small contractors with one-person back-office teams handle accounting, purchasing, and other tasks to minimize system administrator duties. If, for example, you are using QuickBooks Online, choosing a solution from the Apps Marketplace will limit integration issues and get you up and running with fewer configuration headaches.
The growing crescendo of reasonably priced construction technology apps gives small contractors an edge in managing job cost accounting. This comes at a crucial time when a short supply of skilled labor and rising material costs are forcing the trades to pay more for the labor and materials needed to complete each job. Following a simple set of principles can give Office Managers, Controllers, and Bookkeepers the tools to help small contractors manage job cost accounting and run profitable businesses.