How to Do Accounting for Contractors and Construction Businesses

As a contractor or construction professional, you know what to do on the job site. But do you have the same expertise with the accounting ledger? It’s natural to feel nervous and overwhelmed with all the financial aspects of running a construction business. After all, you’re a contractor, not an accountant.

Fortunately, accounting basics are much easier to understand than you may realize. Here’s what you need to know about accounting for contractors, including how finances differ from other professions and how to ensure your business stays profitable.

The Unique Aspects of Construction Business Accounting

Construction contracting is different from most other industries, such as retail or manufacturing. These differences play an important role in how you’ll need to maintain your books, so they’re important to understand.

Here’s a rundown:

Project-Based Accounting

A professional contractor typically works multiple jobs at the same time. Each job varies in complexity and completion time.

Payments vary, too. As a contractor, you might receive a partial payment upfront, full payment on completion, or agree to another payment arrangement.

Project-based accounting generates individual profit and loss statements for each project. Essentially, you keep track of the finances for each job separately, which is different from the record-keeping used in more traditional businesses.

Tracking Sales and Expenses

Construction is a huge industry that involves many different services and expenses, including labour, design, engineering, material purchases, and more.

A significant part of accounting for contractors involves accurately tracking the types of services you’re providing and the expenses you’re generating for each job. It can become tricky if you’re purchasing materials used across multiple jobs.

Along these same lines, overhead costs can change significantly from job to job. For example, a job might require extensive travel and additional staff. You’re rarely operating at a consistent level of overhead expenses.

Inconsistent Contract Lengths

Construction has some of the most inconsistent project completion dates of any industry. Simple projects could take days or weeks, while more elaborate jobs might take months or even years.

Cash won’t flow into the business in the same amount or at the same time each month. However, you’ll still need to handle monthly expenses, such as overhead and payroll. Balancing cash flow with outgoing payments requires specific accounting practices not needed in other businesses. 

Revenue Recognition

Also known as income recognition, revenue recognition is the process used to acknowledge when money enters and leaves your company accounts. It’s often referred to as how you determine when money becomes “official” for accounting purposes.  

Unlike a traditional business, you likely won’t bill and collect on a contract within one month. So, you’ll need to choose an accounting method that provides an accurate account of your profits and expenses and makes sense for your unique billing situation.

The most common accounting methods used by contractors are the following:

• Cash Basis
• Accrual
• Percentage of Completion

Keep in mind you might end up using more than one method. Many contractors find it easier to use one method for in-house bookkeeping and another for tax purposes. For instance, in some situations, you might defer some tax revenue until the following year to ease your tax obligations.  

Let’s take a deeper dive into each accounting method.

Cash Basis Accounting

Cash basis accounting is the simplest, most commonly used type of accounting in general (although not for contractors specifically).

With this type of accounting, you record income on the day it enters your bank account. You also record overhead expenses as deductions right away.

Cash basis accounting is easy with a traditional business that has consistent expenses. But it’s not necessarily the most accurate option when determining the true financial health of your construction business. For example, you might have significant up-front expenses when starting a job, which could skew the true picture of your finances.

Accrual Basis Accounting

Accrual basis accounting tracks revenue and expenses as earned, which might be different than when the money actually enters or leaves your accounts.

It’s a process based on what’s called the matching principle, which means all profits and expenses should be recorded during the same period or, in the case of contracting, by the project.

Accrual provides a more accurate picture of your company’s finances than the cash basis type. It also lends itself well to contracting, as clients can take a while to pay invoices.

Percentage of Completion

The percentage of completion method is one of the most popular and accurate accounting methods for contractors and construction professionals.

You record income and expenses while working on the project. Income is recorded as sections of the project are completed.

The percentage of completion accounting method provides the most accurate financial picture of your company at any given time. It also easily allows you to account for any aspects of the project that run over or under schedule.

An alternate version of this accounting type is the completed contract method. You only record income and expenses after the project is finished. Typically, it’s only used when percentage completion accounting isn’t possible (for example, if the project mainly consists of a single element).

What is Job Costing?

Traditional businesses often use what’s called a general ledger (G/L). It tracks everything that affects the financial health of the entire company. However, the project-centric aspect of contracting means a G/L usually isn’t the best way to track income and expenses. Instead, contractors need to know about job costing.

Remember this formula:

Materials + Labor + Project-Specific Overhead = Total Project Cost

Job costing is a way to track all financial issues related to individual projects. It allows you to track cost activities (framing, design, foundation) and types (labour, materials, additional expenses). Many times, contractors use job costing alongside a general ledger.

A general ledger is excellent for looking at the pure finances, but job costing provides a look at additional metrics, including:

• Physical project completion in units
• Costs incurred in dollars
• Labor spent in hours

Job costing is typically organized by job activity, job phases, or sub-jobs. For example, you could track Materials, Electrical, Plumbing, and so on. You can track whatever categories make the most sense for your business. (The system of tracking categories is called a job cost structure.)

The Benefits of Job Costing

Job costing has two main benefits for contractors.

First, it creates an orderly, but flexible, way to monitor the money going in and out at any given point in a project. You can customize the job cost structure as needed based on the nature of the job.

Also, job costing helps you plan for the future. You can allocate overhead, which is a way to identify costs shared across jobs, such as equipment and materials. You can also discover patterns related to spending across multiple jobs. Ultimately, job costing can help you improve cost estimating and budgeting.

Retainage Explained

Retainage is a concept unique to the construction industry. It’s a process where the client has time to examine the finished product before authorizing a portion of the final payment.

Contract retainage protects the client. After all, faulty work, substandard materials, or other potential issues aren’t always readily apparent.

Typically, retainage is from 5% to 10% of the total project estimate or the invoice. The client pays the amount to the contractor, but the contractor doesn’t record it as part of the cash basis or accrual method of accounting.

Instead, the retainage portion is put into a separate asset account. Once the project, or portion of a project, is completed to a client’s satisfaction, the money is moved from the asset account into the company’s receivable account.

Always stay on top of retainage. Most contracting businesses operate on thin profit margins, so any significant delay in receiving complete payment could negatively affect the ability to cover expenses and take on new jobs. 

Keep Your Business and Personal Bank Accounts Separate

Set up a separate bank account for your business. Never mix your personal account with your business one. Although this probably seems like an obvious tip, it’s often overlooked, especially by companies with a single employee.

A separate bank account for your business offers several advantages:

• Legal Protection – Establishing a business bank account helps protect your personal assets if your business is sued.
• Tax Benefits – If you don’t separate personal and business funds, the Canadian Revenue Agency will consider your business a sole proprietorship, and you’ll likely face heavy scrutiny when you file your taxes.
• Increased Credibility – You don’t want to pay for materials or other expenses with a personal check. A dedicated business account adds legitimacy to your company.
• Easier to Track Expenses – With a business account, you can use a business credit card, which provides an orderly record of expenses.

Fortunately, opening a business bank account in Canada is usually straightforward, especially if you’re a Canadian citizen. You’ll need two pieces of official ID, such as a driver’s license, passport, or birth certificate.

Non-Canadian citizens are sometimes allowed to open bank accounts in Canada. Policies vary, so you’ll need to check with each financial institution.

What Records Do You Need to Track for Your Construction Business?

Here’s a simple tip you’ll always want to keep in mind:

Organized, detailed records are the secret to successful business accounting.

Although maintaining detailed records can feel tedious and time-consuming at first, stick with it. You want record-keeping to become automatic during your workday.

It’s helpful to divide records into three general categories:

Daily Transactions

First, you’ll want to record all the transactions made throughout the course of normal business. The four most common types are the following:

• Accounts Payable
• Accounts Receivable
• Labour Costs
• Materials Costs

For each one, write down a description of the transaction, the date, and the money received or spent. Note that you’re only keeping a record here. As explained above, these numbers might not necessarily be “official” on the day you enter them into your ledger, depending on your accounting method.

You have many options for recording daily transactions. Accounting software is usually the easiest option, especially if you use a cloud-based service you can access from the job site. Plus, software lets you print professional invoices. (If it’s easier, you can also keep a journal and transfer the entries to your accounting software later.)

Business Expenses

Keeping an accurate record of expenses is extremely important in the contracting business. As explained earlier, expenses will vary significantly from job to job. You’ll need to know what you’re spending so you can charge enough to make the job profitable.

Typically contracting expenses include:

• Payroll
• Materials
• Equipment (operating costs, rental fees, etc.)
• Subcontractor fees

You’ll most likely want to organize your expense records in two ways: by service and individual job. Tracking expenses for an individual job is a given, but tracking across jobs is also helpful because you can identify any trends over time.

The best way to track expenses is with an accounting program. You’ll also want to keep all of your physical receipts. Many people opt for an app that scans receipts, as storing them digitally is often easier than keeping them safe on a busy job site.

Reconcile Bank Statements

Finally, you’ll want to make sure your entries match the bank’s records. Every month, your bank will send you a record of all transactions associated with your business account. You’ll need to compare the two sets of records and look for any mismatches.

Due to the nature of construction invoicing, an accounting error could compound over time, especially if you’re using percentage billing. Always track down the source of any discrepancy, even if it’s only off by a small amount.  

Reports Used by Contractors

Whether handling your accounting needs yourself or working with a professional accountant, it’s helpful to understand the most commonly used reports in construction accounting.

Accounts Receivable (AR)

Your AR tracks all bills you’ve sent out but haven’t received payment on. If the report is what’s called “ageing,” it also charts the amount of time the bill has been outstanding. Typically, ageing is divided into 30-day increments.

Accounts Payable (AP)

Accounts payable tracks all of the money your business owes, typically to vendors and subcontractors. As with accounts receivable, AP is also aged into 30-day increments between 30 and 90 days.

Job Profitability Report

It compares your estimated costs to actual ones. You’ll want to track job profitability throughout the project so you don’t wind up spending more than necessary.

Job Cost Report

The job cost report details up-to-date project costs. It’s often given to the client as a type of progress report. A job cost report can be created at any time, although it’s usually generated consistently, such as every two weeks or monthly. 

Types of Billing within the Construction Industry

Most industries use fixed-price, point-of-sale pricing. You likely encounter this type of billing practice every day. For example, at the grocery store, the prices of each item are clearly listed, and you pay for the items before leaving the store.

But construction billing is different, affected by project-based payments, long-term contracts, and other factors. Here are several types commonly used in the industry.

Fixed Price

Also known as a lump-sum contract, a fixed-price contract is an estimate that covers the total cost of the entire project. For instance, it’s when a contractor tells a client they’ll build a deck for $10,000.

There are two different types of fixed-price contracts:

• Fixed-Price Hard Bid – The client will never pay more than the initial quoted estimate.
• Fixed-Price Negotiated – While the quote is relatively set, some wiggle room exists for unforeseen situations.

A hard bid is risky for contractors. An issue entirely out of your control, such as changed site conditions or an employee injury, could add extra costs and time to the project. Most of the time, a fixed-price negotiated bet is safer financially. The client still gets a solid idea of costs, but you’re protected against unexpected disasters.

Both types of fixed-priced contracts are typically billed throughout the project as different aspects finish.

Time and Material

The time-and-material billing method combines the labour rate, material costs, and a standard markup for overhead. The main benefit is that the profit percentage is built directly into the estimate, which acts as a type of failsafe against cost overruns.

Here’s an example:

You pay an employee $20 per hour. Their services are billed to the client at $50 an hour. Additionally, you charge a standard 2x markup for materials.

For this job, the employee needs to install a $20 component. If it takes them two hours, you would bill the client for $140, which is $100 for labour and $40 for materials.

Time-and-materials billing streamlines invoicing, but you’ll still need to keep accurate records of your expenses. 

Paying Your Taxes the Smart Way

Most contractors prefer paying their taxes quarterly, avoiding a big tax bill at the end of the year. The Canadian Revenue Agency allows three options for calculating quarterly installment payments:

• You can pay one-quarter of your current tax bill at the end of each quarter throughout the year
• You can pay one-quarter of your taxes from the previous year at the end of each quarter this year
• One-quarter of the tax owed from before the previous years is due the first quarter of the year, and one-third of the difference between the last year and the first payment each subsequent quarter.

Most construction companies use one of two tax calculation methods when paying quarterly.

• The first option is called the Completed Percentage approach. Taxes are calculated based on quarterly income and expenses.
• The other method is referred to as the Completed Contract approach. Taxes are calculated based on each project.

Many contractors prefer the Completed Contract approach because it offers a deeper look at information related to each job. You’ll track income, expenses, profit, and taxes. Although it sounds more complicated, you’re likely already tracking all this information, so it usually doesn’t involve much extra work.  

Professional Accounting Software: Is It Necessary?

In a pinch, you can get by with any standard spreadsheet or accounting software, such as Quickbooks or Excel. However, professional contractors typically prefer to use software designed for construction professionals.

Most specialized software isn’t ready to go right out of the box. You’ll need to input a variety of details about your company first. But once it’s set up, professional accounting software can adapt to the unique needs of a construction company. 

Should You Hire an Accountant?

Professional accounting software and diligent record-keeping will go a long way, but many contractors decide to enlist the help of a professional accountant. How do you know if your business will benefit? Signs include:

• Significant growth in a short period
• Over $1 million in revenue
• More than eight employees on the payroll
• You need expert financial forecasting for your business

Practically all contractors benefit from professional accounting services. They can help you save both money and time. When an accountant handles your finances, you’re free to focus on other aspects of your business. Additionally, you can rest easy knowing your financial records are accurate.

Note that an accountant is different from a bookkeeper. A bookkeeper tracks money entering and exiting the company accounts, but an accountant offers a broader array of services, such as financial reviews and more detailed analysis.

While you can hire an accountant as a full-time employee, most contractors and construction professionals prefer to hire an accounting service. They can provide help on an as-needed basis, scaling to meet your budget and company size.

Conclusion

Accounting for contractors can feel complicated at first, but the basics are fairly easy to grasp, even if you don’t have a strong financial background.

First, you’ll want a solid understanding of how accounting for a contracting business differs from more structured and predictable enterprises such as retail or manufacturing.

Then, you’ll need to select a method of revenue recognition, considering both the individual project and the overall cash flow of the business.

If you follow the guidelines above, and don’t hesitate to consult with a professional accountant as needed, you can take control of the financial health of your contracting business – and bring it to greater heights than ever before!