Top Financial Mistakes Construction Contractors Make and How to Avoid Them
The construction industry is no stranger to financial challenges. Long project timelines, significant material orders, and upfront labor expenses often characterize this type of work. Construction contractors need careful management of their finances to ensure financial stability and profitability. With help from a South Jersey accountant, you can avoid these issues that lead to reduced profitability, missed deadlines, and even bankruptcy. Here are the top financial mistakes construction contractors make and how to avoid them in your company.
Not Documenting All Work
In the construction industry, project managers can make changes on the fly without proper documentation. However, this can lead to a wide range of financial challenges for contractors, including reduced profit margins and even losses on a project. Unfortunately, these problems stem from the industry’s split-second nature, where decisions and changes are based on a brief conversation and a handshake. Without proper documentation, these changes may go unnoticed and unrecorded, leading to additional costs that may not be billed.
If you want to address this challenge, you need to implement better processes to facilitate mid-project changes. You will need a detailed scope of work, which outlines all project requirements and specifications from the start of the project. The scope should be supported by a detailed change order process that allows contractors to put together pricing and document project changes before sending them to the finance team for invoicing. By implementing these processes, contractors can avoid undocumented changes and ensure all work is invoiced. With that, you can reduce the risk of financial losses and improve your company’s overall profitability.
Late Invoices and Missing Bank Draws
Projects often have invoice submission deadlines for monthly draws from the bank. Missing these deadlines can result in delayed payments and cash flow issues. Late invoicing can significantly impact a construction company’s financial health. If workers and vendors are not paid on time, the company’s financial risk increases, leaving a lack of available cash to put back into the business. The causes of late invoicing can vary, but common issues include lax reporting systems, poor communication between the field and finance departments, or an overworked financial team.
Consider hiring contractor accounting services to address these challenges to ensure all invoices are submitted on time. By addressing these issues proactively, you can ensure workers and vendors are paid on time.
Insufficient Cash Reserves
Sometimes, the construction company will have to cover the labor and material expenses before receiving a full payment from the client. As a result, construction companies may need help to cover costs and make essential payments, such as payroll. This can lead to unnecessary loans or payment delays, which can accrue interest costs or cause distrust among vendors and employees. Insufficient cash reserves can be a significant issue for construction companies since it limits their ability to grow their business.
If you want to avoid these issues, consider requiring a 25-50% deposit on projects, which can help reduce the labor and material costs being fronted by your company. You can also renegotiate vendor contracts to extend billing cycles or pay some or all expenses after completing the project. However, this approach works best when a good, trusting relationship with vendors exists. By implementing these strategies, you can reduce your financial risk, keep more cash on hand, and preserve working capital to grow the business more strategically. Additionally, having sufficient cash reserves can help you weather seasonal fluctuations and unforeseen circumstances, providing a foundation for long-term success in the industry.
Misunderstanding and Misallocating Costs
When it comes to understanding costs in the construction industry, you need to have a clear and comprehensive understanding of all the expenses associated with a project, including materials, labor, equipment, and administrative costs. Without an understanding of expenses, construction companies may be pricing jobs incorrectly, resulting in projects that are destined to be unprofitable. By properly allocating and tracking costs for each project, companies can gain a more accurate view of their profitability and make more informed business decisions.
You will want to analyze your income statements and identify costs that need to be properly allocated. When you take a more strategic approach to cost allocation and tracking, you can maximize profits on all projects and achieve greater overall profitability.
Front-loading costs refer to spending a large amount of money upfront in a project’s early stages. Permits and site preparation expenses are all included in this practice. While it may seem necessary to get a project off the ground, front-loading costs can lead to cash flow problems later on in the project when the money runs out before completion. Front-loading costs can strain a construction company’s cash flow. In turn, the company may need to take out loans or delay vendor payments, which can negatively impact business relationships. Additionally, it may result in a project’s completion taking longer than anticipated, leading to potential penalties and damages.
You should develop a comprehensive project plan outlining expenses and expected timelines to prevent front-loading costs. With that, you can allocate resources and manage cash flow more effectively. Additionally, consider spreading costs throughout a project, negotiating with vendors for payment terms, and setting aside contingency funds to cover unexpected expenses.
Consider TMD Accounting for Your Construction Company Financial Needs
As a family-owned and- operated accounting firm, we have extensive experience assisting with accounting for construction business clients. Our team provides personalized, high-quality service to meet your financial situation. See how we can help your construction company succeed. Call us at 856-228-2205 to schedule a consultation.