Construction Accounting 101

These questions aren’t easy to answer. But the financial health of your business relies on understanding these challenges, both by project and business-wide, at all times.

Construction projects generally have high costs and small margins, meaning the price of getting it wrong is high. That’s a big risk, particularly for SMEs, who may not have the working capital to survive a project or budget collapse.

So where do you start?

Check out this related article on using construction codes to help manage costs.

Getting to grips with financial management

To manage these challenges, a construction company will generally work to a system called cost value reconciliation (CVR).

This means bills will be based on the percentage of a project that’s been completed. If you’ve completed 10% of the project in the last quarter, you’ll get 10% of the agreed funds.

The goal here is to break long-term projects down into bitesize chunks, so you can start assigning costs and expenses to distinct accounting periods. This makes it easier to control costs, assess profitability and minimise overspend.

The key point is it avoids your construction firm working at risk, by balancing both the costs and profits of a project relatively evenly across its duration. So far, so understandable.

But here’s the rub: CVR is a unique process designed to meet the specific challenges that the construction industry creates. That means the tools and platforms used to manage their accounting often aren’t set up for this particular job.

The biggest example of this is in enterprise resource planning (ERP) products like Sage, Xero or Quickbooks. Construction firms of all shapes and sizes rely on tools like these to manage their accounts.

And for all intents and purposes, they do a pretty good job of dealing with tasks like accounts payable and receivable, expenses, invoices, payroll and others.

But the challenge is they’re not set up to manage CVR. So where does that leave construction companies?

Often, the solution here is an inelegant one: using your standard ERP for the basics and managing the rest in Excel or a similar generic spreadsheet tool.

This comes with its own set of complications.

Spreadsheets can be highly complex and time-consuming to update. Each new invoice or expense must be manually added for the spreadsheet to update.

That means if, for example, you’re looking at your cash flow for the last quarter, there’s a good chance the new equipment your site manager just ordered isn't included.

And that’s before we even consider the challenges of human error (we’ve all been there…), broken macros or the dreaded corrupted file.

Ultimately, spreadsheets make it uniquely difficult to get a clear view of your financial data, even if your ERP does a good job of managing the basics. And without this oversight, you can’t make effective business decisions.

Making CVR work for you

So what’s the solution? Is it time to bin your ERP entirely? Do you need to build an entirely new platform from scratch?

Thankfully not. If your ERP is managing, say, 80% of your financial management processes perfectly fine, then there’s certainly no need to reinvent the wheel here. Instead, let’s focus on improving your processes for the other 20%. There are several specialist products that either integrate with or work alongside a traditional ERP to manage those extra elements of construction industry accounting.

Of course, we think Archdesk is by far the best, but regardless of which construction management software you choose, there are several key priorities and features you need to look out for:

Real-time updates

Information needs to be captured, uploaded and updated in real-time, so the charts you’re looking at reflect the actual current state of your accounts.

Earned value analysis

Earned value analysis (EVA) helps calculate work performed vs. work outstanding – helping you calculate the progress of your project. This is essential for effective CVR.

Widespread integrations

Any platform you choose needs to integrate easily with your existing systems, including your ERP and any other tools used to manage payroll, financial accounting, forecasting and others.

Adaptability

As the old adage goes: man plans, fate laughs. No construction project goes 100% to plan – so you need to make sure your tools are easily adaptable and that you can instantly see the trade-offs and ramifications of last-minute changes.

Getting concrete results from your construction accounting software

Taken together, these tools can help manage priorities, forecast budgets and let you proactively spot risk before it ruins your best-laid plans.

That, ultimately, is what effective construction management is all about: To keep projects on time and budget, adapt quickly and avoid costly mistakes. Beneath all the complexity that really is the goal of good construction accounting. And if you can get that right, you’re well on the way to nailing the challenge and balancing the books once and for all.

If you want to dive deeper into the pros and cons of specific construction accounting software tools, check out our recent recap of the runners and riders.

Frequently Asked Questions (FAQs)

What type of accounting is used in construction?

By far the most common and useful method of accounting is the percentage of completion method, where costs are billed as a proportion of how complete the project is. This allows you to balance costs and expenses over the lifetime of a project.  

How do you account for construction?

Construction accounting has its own unique set of challenges. To manage these, businesses use a process called cost value recognition, which lets you calculate the progress of a project based on how close it is to being complete.

What is GAAP construction accounting?

The generally accepted accounting principles (GAAP) are a list of guidelines that all listed UK businesses must adhere to, including construction companies.

Why is construction accounting different?

Construction accounting is uniquely difficult because of the unpredictable nature of projects, the long timescales and the number of moving parts involved.