Top 5 Financial Challenges Facing Construction Businesses

Construction businesses deal with a particular set of financial challenges, often beyond their own control. Smart companies must learn how to evade pitfalls like poor job estimation, while best managing unavoidable situations like inflation and change orders. A keen eye out for the most common stumbling blocks in accounting for construction will keep your company completing jobs without misstep.

Inflation and rising cost of construction materials and labor

In construction, more so than other industries, businesses are at the mercy of the markets when it comes to raw materials and labor costs. When rates rise, construction companies must adapt pricing quickly or risk falling behind. Additionally, businesses often must front the cost of materials before work even begins, which can strain an already tight cash flow. Add in a shortage of qualified workers, and construction companies are stuck giving in to high input costs or missing out on much-needed resources.

Quick tips:

• As inflation fluctuates, build a buffer for unexpected cost increases into pricing models.
• Work with suppliers to establish lines of credit to help with upfront costs.
• Keep overhead low to increase your margin of error.

Managing cash flow and slow payments for construction companies

Having to wait 30, 60, or even 90 days to receive payment for completed work is not uncommon in the construction industry. In the meantime, workers and bills still need to get paid. This can create a serious cash flow crunch if not managed properly. Smart accounting for construction means carefully monitoring projects’ progress and knowing when to request partial payments. You can also take out short-term loans to bridge the gap until receivables come in.

Quick tips:

• Build a cushion of cash or credit to cover expenses while waiting for payment.
• Use progress billing to help ensure you’re getting paid regularly for completed work.
• Keep close tabs on receivables and follow up on payments as soon as they’re due.

Inaccurate allocation of overhead in construction

Accurate allocation of indirect costs, or overhead, is critical in accounting for construction. Many companies allocate expenses based solely on direct labor hours, but this can lead to over or underestimation, eating into profits. For a more accurate picture, allocate overhead based on the costs actually driving each job, such as equipment, materials, or a combination, rather than on labor alone.

Quick tips:

• Develop a reliable allocation method guided by your biggest, most consistent expenses.
• Track actual costs throughout projects to get a true picture of where money goes.
• Use information from completed jobs to continuously fine-tune your process.

Mismanagement of change orders when accounting for construction

Modifications to the scope of work happen frequently and unexpectedly on construction sites. Not only do change orders disrupt your timeline, they can cause errors in the budget and wreak havoc on your bottom line. That’s why having a budgeting system that factors in change orders as soon as they’re approved is vital in accounting for construction. With the right management, you can keep a close eye on costs and your project on track.

Quick tips:

• Always discuss additional costs with the client upfront to avoid expensive misunderstandings.
• Include a line item in your budget for expected change orders.
• Never begin out-of-scope work before the change order is approved.

Poor job estimating processes for construction projects

Construction projects are complex and ever-changing, making it difficult to predict costs upfront. Businesses may want to lowball bids to win jobs. But future curveballs like off-track forecasting, incorrectly recorded costs, and mismanagement of change orders will put them in the red. Rather than bid too high and lose work altogether, the key is finding a happy medium in your job estimation process. Take the time to do your homework and thoroughly understand all costs involved before submitting a project bid.

Quick tips:

• Compare actual costs to estimated costs regularly, ideally month-to-month, and make sure both accounts cover the same items.
• Conduct on-site visits to get a better feel for the scope of work and potential challenges.
• Get quotes from subcontractors and suppliers for a realistic idea of the costs involved.

Building an accounting partnership your construction company can trust

These tips stretch the gamut of difficulties to consider in accounting for construction. At the end of the day, the best financial advice is to work with professionals familiar with your industry. SME, CPAs is well-versed in the tax, audit, and accounting needs unique to construction businesses, given our many years of partnering with firms to improve processes, prepare for the future, and keep books error-free. Contact us today for specialized expertise that will set your business up for success even when facing today’s many challenges.