Minimum Bottom Line Profit Should Average 9.4%!
For Trades & Subcontractors, at Least 11%
After Income Taxes Are Paid!
Taking the small construction company to the next level of financial success, requires implementation of cost accounting. This article is one in a series designed to illustrate how you implement cost accounting in a small construction business. The first step in this process is design a file structure. This includes creating a project numbering format, identifying classes of construction, and finally developing a phase breakout of your project work. The next article in this series will illustrate how to create a documentation flow system, and finally sorting the documents to the correct files. Future articles will cover setting up your accounting software (QuickBooks & Sage 50) files and generating and interpreting the financial reports.
Cost accounting is a measurement tool in accounting. By grouping costs and assigning them to a particular project, a reviewer of financial results can pinpoint discrepancies between the estimated cost and the actual cost. As an example, did the exterior siding costs exceed your budgeted amount? Cost accounting sorts the receipts into the respective groups (phases) and this information is used by the contractor to compare to his original estimate for that particular aspect of construction. Comparing actual costs to estimated costs is a step in the feedback loop. Learn more about feedback loops here: A Model of Excellence.
To begin this process, the reader should understand some core terminology. The following articles should be read prior to continuing. If you already have an understanding of this information, please skip over these articles and move onto implementing cost accounting below.
Class Accounting in Construction – identifies the concept of class accounting by breaking out small construction companies into the respective divisions of new home construction, remodelers, renovators, and restoration.
Understanding Phase Accounting – explains the concept of phase accounting and identifies some of the phases used in construction.
Think of this process as classifying the receipt to the particular class of construction, then to the project, then to the particular phase of construction for that project.
Design a File Structure
In accounting, a file structure is an organizational tool allocating administration resources in an efficient manner. With construction, pretty much everything is focused on the project. Therefore, design your file structure around the projects, classes of construction, and vendors. Before continuing, please read Create a File Structure for Accounting.
The first step is to create a project numbering system. Many contractors use the street address or the lot number as their identifying tool. I suggest using the contract date for the project. It is important to use a dating system that allows for easy access and reporting format. I suggest using the year first, the month and day format. As an example, if the contract was signed on February 16, 2013, then use 130216 as your numbering system. This allows for a chronological ordering system for the future. The numbering system continuously increases by using this format. It is important to use the year first in the numbering format because it is a great tool to separate projects by year by filtering on the first two digits within the accounting software.
Classes of Construction
The second step in designing a file structure is to create classes of work within the construction company. If you only do one class of work, give it a name. It is highly probable that future work will bring about a new class of construction within your company. By classifying your work now, it will be easier to implement new classes in the future. If you are a new home contractor, then use classification based on developments or types of new homes. The following are different examples with the classes highlighted:
Example 1 – You build new homes in three different developments; this works well if the developments are large and will be around for a few year
Yorkshire – homes built in the Yorkshire Subdivision
Water’s Edge – homes built in this subdivision on the water
Governor’s Landing – a totally separate development in another zip code
Example 2 – you build custom designed homes and sell ‘spec’ houses.
Example 3 – you work around 3 basic models of homes
* Livingston – a slab based model with 3 variations
* Covington – a basement model with no variations
*Breckenridge – a foundation based model with two floors and 3 variations
The idea is simple; create classes of construction that several projects will be built within the class. Do not create a class for one project, lump this project in with some other class.
Classes can be focused on your construction divisions, such as new home, additions, and remodeling. See Types of Residential Contractors for more guidance. If you are not in residential construction and perform some other type of construction, group your projects based on function, geographical territory, or even material based projects. The following are some examples:
Example – Site Developer: types of developments
Example – Road Contractor: core material based
Gravel/Other Material Based Roads
Example – Fencing Contractor: types of installations
Wire Fence (Chain link, Barb, Electric)
Temporary – construction type fencing
Phases of Construction
This is the core information for accounting. Phases are the steps in your construction process. If you are home builder/remodeler, then use the nine phase system as described in Use Phase Accounting in Construction. This article describes each phase and a numbering system. In general the phases are 01 – 09 and each is a step in construction. My suggestion is to keep it simple and stick to no more than nine phases. The first phase is the paperwork phase and includes non- material related items such as portable signage, debris removal, and even the port a john. The other phases have respected material issues and a lot of subcontractor elements.
If you are not in residential construction, phase out your projects based on the basic elements related to your industry. If you are in road construction, you could have an engineering phase, an underground utilities phase, site development phase, actual paving phase, grading and landscaping phase, and a signage/marking phase. Your phases should be relevant to your industry and easily understood by anyone in your industry.
Again keep the phases to no more than nine. It keeps the reporting simple and more than nine begins to add confusion to the bookkeeping staff as to where to record the receipt. As an example, if you break out landscaping between site development and final landscaping, the accountant will not know how to address the bush whacking aspect of work. Is this site development or landscaping? By combining the two, you make life easier for the accountant. This way, any bill that relates to exterior site issues is recorded to the site work phase. The Use Phase Accounting in Construction article above clarifies this issue well.
Creating your file structure is the first step in implementing cost accounting in your construction company. By designing a project numbering system, creating classes of work, and identifying a core set of phases you are building the foundation of a good cost accounting program for your construction company. Please continue in this series by reading about a document flow system for use with your cost accounting program. Act on Knowledge.