Are we flying blind? I don’t know, it is too hard to see.
The Connection: May 2024 Issue #02
The most challenging thing for any project team and business leader is having the wrong data for project accounting. Worse yet, having no data at all. It is critical to have the right tools to extract data. But knowing what to do with it, and how to use it, is just as important.
The construction industry is unique in many ways, including project accounting. The Architectural industry is similar, since both services will cross different periods including year-end. Recognizing cost and revenue simultaneously, along with achieving the right profit, requires updating the estimate at completion. It is more complex than this for sure. Before further exploration into that topic, we must focus on some other critical items for companies to improve their visibility.
Selecting the right method of construction accounting
Teaching construction accounting is not commonplace; individuals must learn the methodology outside normal educational areas. There are only three accounting methods accepted.
Cash Basis, Completed Contract and Percentage of Completion.
- Cash Basis only records revenue when cash is received and records costs when invoices are received, which can cause many issues due to the disparity in recording times. This can cause serious issues as you can assume the project is doing better than expected.
- The next is the Completed Contract, which is essentially that, records revenue and costs once the work/obligation is complete. This method is only recommended on short-term contracts, not spanning multiple periods.
- The third is the Percentage of Completion, which is the most widely accepted construction accounting method. This accounting method also works Architects. This method is the most accurate, but like everything else in these industries, it is based on estimations.
We asked the construction financial experts at New Lyfe Accounting to provide their insights regarding these methods. “The Percentage of Completion method recognizes revenue as a percentage of the work completed during a reporting period and is often used for long-term contracts. It is the most common method used in construction and what we adhere to most often at NLA. Whichever method you choose, ensure that you have the systems and processes in place to produce the required data.”
Speak to your accountant or partner with experts like NLA to determine what is best for your business.
Team Dynamics in project accounting
Project teams, project accounting and finance teams must be able to fully understand all the critical items related to contract management. They must have the correct project controls in place, along with routine project budget check-ins to make all necessary changes in the Work in Progress schedule (WIP). In this low margin industry, aligning operations and finance in methodology, putting the tools and training in place to protect the company’s profitability, is critical. Having a strong relationship and respect between CFO/Finance and Operations team is a must. There can be friction of course, this industry is stressful as we all know.
Finance teams often say, “project teams cannot estimate”. Well, estimating is an art and science. Similar to construction project accounting, not everyone in architecture and construction knows estimating. It again is a learned art, and it is well, an estimate after all.
From experience, we identify several key areas in team dynamics that we must address, and they are as follows.
Respect, Alignment, Communication, and Trust.
- Respect: You can only respect one another when you have a true understanding of what the other does, what they know and don’t know, and why they don’t know what they don’t know. The lack of not knowing is an opportunity, don’t waste it not being humble enough to work it out together.
- Alignment: Nothing will sink you quicker than misalignment between operations and finance. If you respect what the other does, you can find alignment in come goals, and know who is responsible for what and how to support the other. It is both teams’ responsibility, not just one.
- Communication: How each group speaks may require translation. Though some terms may seem interchangeable, they are not, and assuming they are, will only be more challenging. This gets easier as you have built relationships and gained respect for the other, worked through goal alignments and aim to deliver clearer and more understandable communication between the parties.
- Trust: This ties back to respect; however, there must be a consensus to trust that each group has training in their respective fields, and together you can help train one another. Once each team respects the other, finds common alignment and begins communicating so each group understands, trust levels will increase. Both parties must understand that the other is doing the best they can and pass less judgement and stop looking for who to blame.
The NLA experts added “Clear and consistent communication is key to running a successful construction organization. Communication from leadership should inspire, foster trust, and generate positive change. Be authentic with your communication, letting people know who you are, where you’re from, and what you value. Be present and visible within your organization, finding ways to interact with all of your stakeholders. And remember, listening is a powerful communication tool.”
Seeing the data and acting (or not acting)
Is your data a gold mine, or mine field? Chances are it’s a little bit of both. But being willing to figure out which it is, must be step one. You will only know how many holes you have in data upon reviewing. Data can expose that you have a wrong process or the wrong pricing strategy if you are willing to explore.
For business defining a cost strategy is one of the most critical, and frankly contentious parts in business. But it is difficult to know how to price if you can’t see your costs. And if you find your costs are too high, then you have some options. Increase pricing, if the market allows you to, or you must reverse engineer and see where minimal impact but high-cost allocations are. Once known you must address them and determine a new competitive price that the market is willing to pay that will cover your costs and add to the bottom line.
But you can only accomplish this if you collect the data, aggregate it, and know what to do with it. Junk in/junk out still holds true in construction and architecture financials. If invoices are not entered at the right time, or if project team time is not properly tracked, or if projected costs are not updated based on current knowledge or are misallocated, your financials will become misleading. And this is called flying blind.
“Many times, contractors just want the end picture – the financial statements, WIP schedule, projections, etc. They don’t understand that there is so much back-end data making up those numbers. If data is inaccurate, it’s almost always due to a process (or back-end) problem” experts at NLA added. “Instead of putting a bandaid over it, analyze your processes so you can be more efficient, reduce the potential for errors, and ensure you have accurate and timely data to inform those larger pieces.”
There are many technologies to choose from, however many cannot fulfill all things to all people. There is no silver bullet. Most ERP systems due not have construction focused solutions nor Architectural. Finding one that fully encompasses the project life cycle for teams is limited. Your data solution may require software solution that extracts and aggregates the data into usable dashboards.
Companies like Deltek, BQE, Monograph, briq and HubiFi support construction companies and architectural firms with the decentralized data and focus on construction and project accounting methods and reporting. It is important for Operations and Finance teams to work collaboratively in reviewing which options work best for both parties to support the business needs and goals.
Stop Ignoring the Core Issues
The first step is recognizing you have an issue, the next step is doing something to address it. Continuing knowing there is a problem, is like allowing water penetration to continue after the first sign. We would never recommend that to any client, and we should never allow bad data to keep penetrating our business. Reach out today for more information on supporting your business with trainings, technology assessments, CFO and project accounting support.
