This article is very long and is designed to provide guidance and knowledge for the small contractor. I’m sorry, but I’m here to help you and in business, the devil is in the details. For this to work, there are a lot of details to address. But once done, you will be amazed at the value it will bring to your business. I’m not talking about a few hundred dollars of improvements, I’m talking about 10’s of thousands of dollars EVERY YEAR! Bottom line money that goes into your pocket.
First read for an overall understanding and if you desire to implement QuickBooks, then read to absorb the information and use the information to assist you in setting up QuickBooks in your construction company. In addition, use the comments section below and ask me questions. Better yet, tell me how the software is working for you and tell me about your business. I really do want to help.
Prior to beginning, you should understand a few terms. The first is class accounting. To get a well-rounded understanding of class accounting, please read Class Accounting in Construction. As a small contractor you may be in the business of not only building new homes but doing additions and renovations to existing homes. Class accounting in QuickBooks allows you to separate these divisions and understand which particular area of construction performs well and which ones need improvement.
The second term is phase accounting. This type of cost accounting is designed to break a project out into nine distinct groups of costs. As costs accumulate inside each phase for a particular project, the contractor can begin to identify areas of improvement to better achieve financial success. The following is an introduction to phase accounting: Use Phase Accounting in Construction.
Now that you understand ‘Class’ Accounting and ‘Phase’ Accounting you can begin to see the advantages of creating a feedback loop of information to help you identify areas where you miscalculated or underestimated the costs for a particular function of the project.
There are two more terms you need to grasp. The more important of these two is percentage of completion method of accounting for a construction project. The other is the completed contract method of construction. There are articles that cover these two terms in depth at Construction Industry Standards webpage on this website. Suffice it to say that the preferred tool is percentage of completion over completed contract. You do not need to select a method at this moment, but once you have selected a method of accounting, read the corresponding article that illustrates how to use QuickBooks for that method of accounting in construction.
The key to the software is to properly set up the software to meet your needs. You lay out a chart of accounting accounts, buckets to dump data into, then identify your classes of work, create the nine phases of costs (QuickBooks uses item numbers) and finally identify the projects.
Once the setup is done, you proceed to enter data into the system via an item expense entry. This entry identifies the project, the phase code, and the class of work for the expense. This is the critical point of data entry and if done correctly and consistently, the final reports will surprise you. Data is entered from three source documents. The first is the vendor bill coming into the front office. The second is via the payroll and the third source document is a credit card charge or debit card entry. All three require the three codes to properly enter the data.
Once the data is entered, the job is tracked on a regular basis through accounting periods and accounting reports are prepared. I’ll illustrate these reports for you and teach you how to read and understand the information conveyed.
From here, the job is completed and other reports can compare similar jobs and as a contractor you can pinpoint areas of improvement. This can be in estimating or negotiating better fees from subs or suppliers.
Chart of Accounts
Once the software is installed and you have provided the basic information of name, addresses and respective identification numbers (Company, Company Information), it is time to set up a chart of accounts. The software comes with a preloaded set and I encourage you to use this as your starting point. However, you will need to modify this set of accounts to meet your needs. Any modification of the chart of accounts is done in Company, Chart of Accounts.
The first modification is to the current assets section of the balance sheet. This is achieved by creating a master account for all the construction work. This is called ‘Construction in Progress’ or ‘Construction in Process’. I prefer ‘Construction in Progress’. During use, this account reflects the total dollar value of construction work that is ongoing in your company. It consists of the accumulated hard costs for construction.
Note that this account is a balance sheet account. Each accounting cycle, you will transfer some of the dollar value from this account to your profit and loss statement to reflect the percentage of completion method in accounting. If you use completed contract method, then once a project is completed, the hard cost dollars associated with that project will be transferred to the profit and loss statement.
You will not need to create a set of sub accounts related to your respective projects as the project accounting aspect of this software separates the dollar value of the ‘Construction in Progress’ account out into the respective projects.
For the profit and loss statement, you will want to add two groupings of accounts to the Cost of Goods Sold section. The first is a master account labeled ‘Direct Costs of Construction’ and the second is ‘Indirect Costs of Construction’. Each should get a set of sub-accounts based on the model format as describe in Best Format for the P&L in Construction. The following is a sample layout of this section of the P&L.
So you should add the respective sub-accounts to each master account. Land, Materials, etc. are coded as sub-accounts to Direct Costs of Construction. The same goes for the sub-accounts of Indirect Costs of Construction. This is done by checking subaccount under account name and selecting the corresponding master account from the list.
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The key to this is that when you transfer costs from the Construction in Progress account to the Profit and Loss statement, these costs are broken out into their respective sub-accounts. As data is entered for the indirect costs each day, that dollar value accumulates immediately to the indirect costs of construction section of the profit and loss statement.
Classes of Work
Now that you have a set of accounts to work with, it is time to set up your classes or divisions within your company. A typical small home contractor has the following classes of work:
- New Home
*For information about the different classes of construction, see Class Accounting in Construction
Go to Lists, Class Lists and create your business divisions. In general, I would stay away from the sub-classes. However, you may desire to add sub-classes to some of your divisions. Examples would be having a sub-class of ranch style and custom made homes under the New Home class. Or you could separate Spec from Design/Build in New Home class. For additions, you could go with zip codes to reveal more profitable territories. The key is to think this out before you create your sub-classes of information.
If you have concerns or questions, ask me via dave (use the ‘at’ symbol) businessecon.org. I usually respond within a couple of hours.
This is where the real value of accounting comes in handy. By creating the core nine phases of construction, you can compare your estimated amounts against actuals to identify areas for improvement in estimating projects. The whole goal is to make a profit as a business. A feedback loop from your accounting software will clearly identify areas in need of improvement in your work.
As an example: one of my builders discovered that he woefully underestimated the foundation element of construction. By breaking out the two sub-components of the footer and the foundation, he discovered that the foundation was much greater in cost than he anticipated – to the tune of $1,100. He talked with the brick mason and discovered that the reason was the additional courses of block needed to take in the slope of the land. He completely forgot that as the house foundation stretched over the slope that additional courses of block had to be laid to level the house.
There should be nine phase codes. In QuickBooks, they do not use the term ‘Phase’. Their term is ‘Item List’. So create your nine phases of construction similar to the nine phases I describe in Use Phase Accounting in Construction. Or use the following list:
01 Project Management (paperwork)
02 Site Development and Landscaping
06 Walls (insulation, sheetrock, trim, interior doors, painting)
08 Cabinets (Kitchen cabinets, countertops, bathroom cabinets, appliances, tile work)
09 Extras (Decking, railings, sound system, exterior buildings, change-orders)
When you create a new item code, select service as the item type and give it the same name I use in the Phase Codes. In the description section, use the basic description I illustrate and then select the ‘Construction in Progress’ account as the account identification. Do not set a rate. It is not needed in construction accounting. Also, do not check the ‘This service is used ….’; this requires a different level of accounting expertise not needed for you in this situation.
In QuickBooks, they do not use the term project; they use ‘Jobs’. It is rare for the same customer to call you back for more jobs. Generally, these are one shot contracts in construction. So think of all your work in the term of ‘Jobs’. To add a job, go to Customers, New Customer and Job. Put in the customer’s name and all the information related to that customer. Then on the Job Info tab, add the project to the list. Where it says Job Description, put in your company’s numbering system. I strongly encourage you to use a system I explain in these articles:
This numbering system allows you to identify project on a timeline and not by address. A timeline format allows for easy retrieval of financial information in the future. If you are considering switching over to QuickBooks as your accounting software, now is the best time to convert the entire office and related paper systems.
Now you have the software setup to work for you. But unless the data is entered into the software and coded correctly, the setup will not help you. So read the next section in understanding how to code the respective costs.
You should only use 4 entry points to insert project financial transactions for any project. The first is the traditional vendor bill. The second is payroll, the third is a credit card entry and the final source comes from a direct check or cash payment for supplies or services. The sections below discuss each of these three types of entries.
When a supplier or sub has completed their step, they send a bill to your office. That bill should receive approval via the normal channels as explained in Construction Document Flow System and in Construction Processing Documents. Once approved, the bill is entered via Vendors, Enter Bills in QuickBooks. Select the Items tab as this allows you to charge the particular bill to one of the phases. Remember, in QuickBooks, Items equals Phases in our language.
On the entry screen, you select the vendor, enter the reference number associated with the bill and then enter the total amount due. Now sometimes vendors send invoices to include work done at several job sites. Don’t let them do this. Invoices should be separated by jobs. On the item tab, select the phase code associated with this particular function and enter some description. I usually try to enter information that is not common to the situation. As an example, if the vendor supplied the windows and one of the windows was damaged, include this here in your notes; this way nobody can argue with you in the future. If the particular item received is associated with a change order, note this in the description section. The description section allows you to expand beyond the typical and already known information about this vendor or supplier.
Once you have entered the information, select the customer and the corresponding job and then select your class associated with the job. If you have a sub-class such as a particular model of a new home contract, select that instead of the generic or master class.
Now some bills are very detailed. As the window example above, you may have 5 separate line items of detail associated with the windows. Me, I would just enter the total associated with the windows. The same goes for the lumber, imagine how many lines of invoicing the supplier sends related to framing materials. Just enter the total instead of the details. The only time I would get involved in the detail line item entries is when you are dealing with change orders, and that is a different discussion for a different day.
To successfully enter data via payroll, you need to change the preferences for the software. First off, you must have QuickBooks Pro to use for payroll entry. Regular QuickBooks does not have a payroll entry section within the software. The minimum level version is Pro. In the Edit, Preferences section, select Payroll & Employees. Check Job Costing, Class and Item Tracking; this will allow you to enter these three required elements for each payroll entry.
As you enter payroll, each employee should indicate on his card the particular job, the phase code of work and what he/she did for that time. One of the columns in the timesheet is the payroll item column. These are the standard types of salary, hourly, wages, commissions etc. It is sometimes a good idea to enter notes associated with employee’s time especially for phase code work that they did for some subcontractor. This provides documentary support in your dealings with your subcontractor, especially if you desire to back charge them for the work your staff performed.
Credit Card/Debit Card Entry
Many contractors set up accounts at Lowe’s or Home Depot or use a credit card to purchase materials or even pay subcontractors. This information should be reported to the front office as frequently as possible, I personally suggest each day. This way data can be entered in a timely fashion. Even debit card entries should be entered regularly to allow for proper reconciling of the respective bank, credit card and supplier cards. Remember, much of this information is available online and it is an excellent idea to keep up with the information in a timely manner.
As an item is purchased, save the receipt and code the receipt to the proper phase. Turn the ticket into the front office for processing. The ticket is entered in via Banking, Enter Credit Card Charges in QuickBooks. Just as in the vendor entry, select Items and proceed to enter data similar to the Vendor Bill section above.
In every situation, there is always some kind of an odd item paid for via some odd way. Anymore, paying with cash is odd! If you happen to write a direct check for some supplies or even for interest on the job, be sure to select the Items tab and enter the data just as if it were a vendor bill. If you pay cash, enter it via the vendor bill section and create yourself as the vendor. Your total cash expenses will accumulate and you can reimburse yourself for those expenses.
The only section that doesn’t have the ability to enter all three required elements is a general journal entry. DO NOT ENTER DATA VIA GENERAL JOURNAL ENTRY. Only your accountant or CPA should use this type of entry and they should know what they are doing in order to get all three elements of information into the entry to post to the job.
If interested in my help as an accountant or consultant, contact me through the ‘My Services’ page in the footer.
Now we get to see the results – the good stuff. If you setup the books and enter the data in accordance with the information above, you will be able to identify issues with your work. I personally love to review these reports as it really points out problems and helps the owner to fix the issues.
In helping you to understand the value of what you have done, this section is laid out to cover from the broader aspects of reporting down to the detailed elements of any given job. So let’s get started.
Below is a snapshot of a Direct Margin Report I generated from a client’s QuickBooks file. I changed the name to protect the client’s privacy. From the information provided, any casual observer would instantly discover that manufactured home construction is by far more profitable than custom home construction.
Direct Margin by Class Report – Click to see the report.
This is a direct result of the class grouping described above. From here, the owner of the small construction business would want to know, which project in the new home construction created the issue.
To determine which particular project caused the issue, we need to pull a report by project for Custom Homes.
The following is an example of that report:
Job Profitability by Class – Custom Homes – Click to see the report.
From this report, you see that ‘Lot 61’ cost more than the revenues generated. It also appears that this particular job is complete whereas ‘Terry’ is still underway. Note that client did not use the numbering system I suggested in Construction File Structure, but used a nomenclature format to identify jobs. Since Lot 61 lost money and it appears to have generated no margin whatsoever, then this particular job held the company back from generating a reasonable profit. Based on what is a reasonable profit in construction, see: What is a Reasonable Profit in Construction? , this job should generate no less than $175,000 in margin to offset costs associated with indirect costs and overhead. So it is apparent that this job cost the company some serious money and so, we need to figure out what went wrong. The best tool is to break the job out into the respective nine phases and identify those phases that have excessive costs.
Some details – The revenue reconciles to the total revenue reported in the class report above by adding the $183 (reimbursed expenses) back to the total revenue in the Job Profitability Summary and getting back to the adjusted amount in the Direct Margin report above ($566,886). Notice that the Job Profitability Summary does not include the closing costs in the Direct Margin report. This is because in construction, contracts are analyzed based on the adjusted contract value (amount after closing costs are paid).
Since Lot 61 is the culprit in all of this, we need to find out which phase caused the problem. Prior to reviewing the phases, let’s take a look at the entire history of dollar transactions recorded to this project. In this report, I specifically left out the source document name (vendor name, employee name, or supplier name) and the corresponding memo line. I did this to protect the identity of the client.
Review this pdf document for an idea of what this report looks like:
Custom Transaction Detail – Lot 61 – Click to Review
Now we are interested in grouping these expenses into the respective phases of work. This is an example of the report for Lot 61:
Costs by Phase – Lot 61 – Click to Open.
If you are a contractor, you can see that there are three phases that appear outright expensive. The first is project management, the second is site development, and the final expensive phase is framing.
To gain access to the detail, point the cursor over the dollar amount associated with the respective phase and click. A detail report is displayed like the following for 07 – Flooring:
Phase Code Detail Report – Click to Review.
I did make some changes to the report in order to protect the client information. But you can ascertain the main idea. Any bill, check or credit card entry is recorded directly to the phase because the phase code is one of the three required data entry points for each type of transaction. The source name column is narrowed to prevent you from seeing the entire name of the associated subcontractor. In your report, you will expand the column and if you provide additional information in the description section of the transaction, you can view that information in this report too. Based on the above, it appears that S. Lacy N… installed most of the flooring, most likely in this case, hardwood floors. In addition, it appears some laminate and carpet is installed too. The contractor would compare the estimated amounts against the actuals to determine if there is a problem.
If there is a discrepancy, then the contractor would review the invoices involved and find out where he and the subcontractor had differences in the estimated and the actual.
For this particular job, the phase report was able to help the contractor identify issues with the concrete poured in 02 – Site Development and cost overruns in the purchase of the land. In 01- Project Management; a lot of interest was paid to the bank for an extended period of time it took to complete the job. And finally, huge cost overruns in the framing and the framing material on the job in 04 – Framing. The framing labor cost was almost twice the actual estimated costs.
The key to success in construction is creating a feedback loop to help the contractor identify areas of improvement. This is can be achieved by using QuickBooks in construction accounting. If the contractor properly sets up the software and inputs the three required elements in each transaction – Class, Project ID, and Phase Code; he can generate reports to point him to the source problem.
The above information was designed to show you the basics of how this works and the real life example illustrates the value the software brings to any small contractor. Naturally, there is a lot more to this than just these few steps. There are features in QuickBooks that allow you to insert the estimated information into the job and compare the actual final dollar amount against the estimated. Other features include progress invoicing, change orders and tracking the amount paid against the actual revenue earned as you progress through the project.
I strongly encourage you to use other sources of information plus information I provide on this website to assist you in creating a successful feedback loop. Act on Knowledge.
I also encourage you to read the next article about transferring the Work in Process financial value to the Cost of Goods Sold section of the Profit and Loss Statement. Read QuickBooks in Construction Accounting – WIP to CGS to continue learning about using QuickBooks in construction accounting.
If you need more help contact me via the ‘My Services’ page in the footer section or send me an e-mail via dave (use the ‘at’ symbol) businessecon.org. If interested in my help as an accountant or consultant, contact me through the ‘My Services’ page in the footer.
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