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5 accounting questions contractors should ask when starting a new construction company

October 25, 2022

Contributors: , Andrew J. Rose, CPA, CGMA

When you’re thinking about starting a construction company, it’s vital to have a smart financial strategy in place, rooted in accounting basics.

The right financial strategy will reduce your administrative duties, keeping them from overshadowing your customer relationships and ability to work in the field. And when you establish this strategy early in your company setup, you can leverage accounting basics to reduce cost, increase profitability, and minimize tax liabilities. Here are five important questions to ask yourself as you begin building your new business:

#1: Will my choice of entity type support personal and business goals while helping me to save on taxes?

Each type of entity has its own costs and benefits, and you’ll want to choose one that makes the most sense for your organization. Contractors must determine what’s right on a case-by-case basis in order to stay in compliance with applicable laws and meet the owners’ personal and business goals for financial responsibility, legal liability, and transferability of funds in the most tax-efficient way.

When you understand how each type of entity is taxed, it will help you to then develop a solid financial and tax strategy for your business. However, in some situations, you can choose to be taxed in different ways between state and federal levels. Some LLCs may make an S election using IRS Form 2553 or make a corporation, partnership or disregarded entity election on IRS Form 8832.

#2: Are my job-costing practices aligned with effective cost management?

Though you’ll get more happiness in watching sales and revenue figures, it’s just as important to keep an eye on financial and operating costs. You need to make sure that your fees will stay in line with competitors while the jobs you take on need to create enough revenue to exceed expenses. This includes overhead, labor, and materials for each project. Your job-costing practices need to allow you to break down all the expenses per project. Accurate data allows you to make more accurate estimates, lower risk, and analyze each job’s profitability.

By tracking these costs at a very small level, you can quickly make needed pricing changes overall while adjusting costs on the fly before your projects start to show a loss. Your job-costing process needs to account for things such as unexpected supply price increases, additional labor and equipment costs, as well as similar expenses while capturing delay and scheduling costs against potential future claims.

#3: Can I maximize cashflow and financial standing while accurately assessing and projecting capital and liquidity needs?

Construction is an industry that can quickly see shifts in cashflow and liquidity, partially because many costs are paid in advance while billing and payments received can fluctuate. Regular accounting review allows you to take corrective or preventative actions when needed. Prepare financial statements, cashflow forecasts, and similar projections, then regularly measure them against actual cashflow.

You’ll also want to stay on top of financial options and surety bonding relationships by keeping your accounting practices transparent. When you need to communicate with these organizations, be proactive. If you suddenly have a new opportunity arise that requires funding, the relationships provide leverage. Try to seek flexible terms when approaching each financial obligation.

#4: Does my strategy account for risk management?

Risk management is vital to your business strategy. Take the time to step back from competitive bidding on occasion to evaluate your risks. Rather than issue low estimates out of fear, rate your projects using a system that includes work type, predetermined minimum profitability, bonding needs, and overall timeframe, and be sure to consider your workers’ skillset. Prioritize time and expense estimates with jobs that provide the best profit.

Subcontractors can also increase your risk, because your contracting firm has limited control. You’ll need to properly vet your subcontractors while minimizing both their and your risk exposure.

#5: Does my strategy leave options to leverage new technology?

Digital transformation is impacting virtually every industry, including construction, and the expense can be significant. However, it can provide a solid return on your investment. Advances provide new opportunities for vertical integration, such as operations structured for in-house distribution or using prefabricated, modular construction processes to reduce costs, improve efficiency, and improve profitability.

Cost-benefit analysis provides projected savings in time, efficiency, costs, and risks while improving profitability by automating manual software processes. As an example, estimating software that allows real-time costing, asset management, risk assessment, and customer relationship management improves your overall profitability.

Before starting your own business, ask yourself these five accounting questions to start off on the right foot. If you would like additional guidance, your Rehmann team of advisors can provide industry-specific advice for construction startups and established businesses. We’ll help you find the right solutions.