The key to a good accounting system for your construction company is a solid foundation. This week, Wade explains where many contractors go wrong when setting up their books for the first time and how to avoid those common accounting pitfalls.
Topics we cover in this episode include:
- Building a solid foundation for your accounting system
- Start with your Chart of Accounts
- Job Costing and how construction accounting is unique
- How to get started when you have no system in place
- Reporting the right amount of detail
- Purchase Order systems
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Rob Williams, Profit Strategist | IronGateESS.com
Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | McWins.com
[00:00:00] Rob Williams: Welcome to the Contractor Success Forum! Today we’re discussing common construction accounting setup mistakes for your accounting systems in the construction industry.
And here on the Contractor Success Forum, we discuss how to run a more profitable, successful construction business. And with us today, we have Wade Carpenter, Carpenter and Company CPAs. And we have Stephen Brown with McDaniel Whitley bonding and insurance agency. And I’m Rob Williams with IronGate Entrepreneurial Support Systems.
And today we’ve got the exciting construction accounting, because everybody loves talking about construction accounting, but we–
[00:00:46] Stephen Brown: –not doing anything about it.
[00:00:48] Rob Williams: Yes! Exactly. We like to talk about it. So what are all these things– Stephen? Have you ever seen anybody mess up their accounting systems?
[00:00:58] Stephen Brown: I have, and it’s brutal. You know, you put a lot of time into a bad accounting system and then it throws out lousy info that doesn’t do you any good. And you don’t want to give it up because you’ve got some ownership in that system. Hey, I’m sticking with it. Well, I can just say that construction accounting is an art form and there are certain gurus that exist out there in this country. They’re there to help.
[00:01:20] Rob Williams: We have one with us!
[00:01:21] Stephen Brown: Wade is right here. Wade Carpenter. Wade, tell us how to set up. What are some problems that contractors have? What do our listeners need to know this week?
A good foundation is key
[00:01:31] Wade Carpenter: Well, the first thing I want to say is, just like building a house or building a building, the foundation is key. And your accounting system, if the foundation has never set up properly, it’s like you’re building on sand. You never put that down into rock and get it embedded in there.
If people would just sit down and talk about what they need, you know, get with somebody that knows what it’s supposed to look like. That’s the number one problem I see is people don’t understand what it’s supposed to look like when it’s finally done.
[00:02:03] Rob Williams: I was just thinking about a new client I had yesterday and the way things look. And I think a lot of people think setting it up is just, what are your chart of accounts? And that’s such a small thing about it, but it was different.
And we got into this conversation and I said, you know, it really doesn’t matter because I see residential ones look at overhead in a different way, and then job costs. The commercial guys tend to put everything into the job, but that’s not the accounting system. We just think about our P and L report. So that’s not even what we’re talking about here, is it Wade?
[00:02:33] Stephen Brown: I think of this as like a football game. You wanna score a touchdown. In my mind, a touchdown is financial information that allows you to make good decisions, to make more profit. That’s the touchdown, when you have a system in place that’ll do all that stuff.
[00:02:47] Wade Carpenter: Yep. Well, I’m gonna give you another analogy.
[00:02:50] Stephen Brown: All right.
[00:02:51] Wade Carpenter: Let’s just say, I bought you a thousand piece puzzle and I brought it to you, but I ripped the picture off the front of the box, brought it to you and dumped it on the table in front of you and flipped everything upside down. So only the gray cardboard side is showing. And then I said, put this thing together.
[00:03:10] Stephen Brown: Rob could do it. I couldn’t
[00:03:12] Rob Williams: Yeah.
[00:03:12] Wade Carpenter: Without flipping the picture. You have no idea where to start and you may start with the edge pieces and you say, hey, I need a system. So you start go looking at all these systems and then you can get, really overwhelmed with all the things. So some of those pieces I’m gonna talk about as we go through this.
[00:03:31] Stephen Brown: Okay. All right. I like that analogy.
[00:03:34] Wade Carpenter: We don’t know what it’s supposed to look like when it’s finally done.
[00:03:37] Rob Williams: Wow. I just had this awful flashback of being in the 1980s in our conference room with hundreds of invoices, just sitting out here on the table and what do we gotta do with them? It’s oh my God, I just had that horrible picture of that jigsaw puzzle.
[00:03:53] Wade Carpenter: Right.
[00:03:54] Rob Williams: Everywhere and purchase order things. And what do we do with all–
[00:03:58] Stephen Brown: Well, you got through it, Rob, just like everybody has to. So, Wade what’s next?
Chart of Accounts
[00:04:03] Wade Carpenter: Well, once we’ve got this thing together, we flip it over and we can see how the pieces fit together. But, I know we, we started talking about the chart of accounts, and that is one of the key areas to that. Actually had a contractor call me out of Ohio last week and he was asking me, can I go to an accounting class and get this set up myself?
Number one, we’re gonna talk about some of those other quirks of construction, but you know, just understanding how the Chart of Accounts works, that doesn’t get you there because there are certain pieces of it that to make it fit together, there’s a certain level of detail where you don’t have enough detail and then there’s way too much detail.
Just to give an example, I’ve got a, basically a security installation kind of contractor. They have over 800 lines in their Chart of Accounts. And she can’t see the forest for the trees and she keeps adding them and she thinks, well, hey, I’m gonna roll it up and I’m gonna see the big picture, but she doesn’t.
So there is a point where you want some kind of level of detail, but then there is also a point where get too much. Does that make sense?
[00:05:11] Stephen Brown: Yeah, absolutely. Keep it simple, stupid.
But you were talking about the foundations of this system. What are those?
[00:05:19] Wade Carpenter: The Chart of Accounts is one of the pieces of it.
[00:05:21] Stephen Brown: Okay.
[00:05:22] Wade Carpenter: Especially with the Chart of Accounts on a contractor, the Cost of Revenue section is key and really knowing what should be going into the cost of your projects. It’s pretty simple to understand your labor materials, subcontract equipment, those things that you can directly tie to that job. Then there’s a lot of other things like payroll taxes and workers comp insurance and those kind of things that, hey, it’s hard to say, well, if I put it down here, how am I seeing it up here?
So properly setting that up too.
[00:05:55] Stephen Brown: Yep.
[00:05:55] Rob Williams: The thing that I’m thinking about now is integrating these things, too. I’m shocked that after 30 or 40 years, everybody’s systems are not integrated where all this stuff is still in one system. I thought we would’ve hit that by the early 1990s.
[00:06:09] Wade Carpenter: They’ve got several systems out there, but you know, the next piece of this that you don’t have in a standard company that doesn’t do construction, is the job costing piece. Now we talked about like getting the chart of accounts there, but you know, the job costing piece, that’s where we can also get too much detail or not enough detail and where people get really out of whack is hey, they got this system. And, oh, well, this other vendor comes in with their phase code, cost code kind of thing. Xactimate or all these other ones to make, say, QuickBooks online supposedly talk to it.
[00:06:47] Rob Williams: Supposedly.
[00:06:48] Wade Carpenter: –not, it does not. Well, it doesn’t honestly.
But anyway. If it was set up properly, it would be better than nothing. But they throw these canned phase code cost code type structures out there, and it doesn’t fit the type of construction you do. And that’s again where we’re talking about way too much detail versus not enough detail.
[00:07:12] Rob Williams: That is a really good point because I’ve seen so many different things. And I’ve been in different industries at the same time in my companies. I mean, there is a way that the commercial side looks at it and the way the residential side looks at it, and they’re very different. And a lot of those guys, especially in the residential, all they think accounting system is the job costing.
And some of those guys, because they’re not actually getting bonds from Stephen there. I guess they’re turning something into the bank, but their accounting system is just about the job cost. That’s all anything is. And some people look at it very differently than that, it’s not as important.
But we don’t tend to have a common set of things that’s an industry standard, even though we keep trying, we keep trying, we keep trying. Well, maybe you could say it’s an industry standard of one part of the construction industry common. And then another part is common.
I always get these questions. They’re wanting me to compare something to somebody else. It’s okay, the way you’re keeping this is not the way everybody looks at it. And everyone is different. And so when we get into this job costing system. Anyway, wherever we get in here, it gets so confusing to me that you gotta make it work for yourself and understand that there’s not just one thing that people just want me to snap my fingers and say, poof! Here’s what it is. They’re like, okay what is the way to do it? So well, I haven’t found a way.
How to get started when you have no system at all
[00:08:37] Wade Carpenter: Like you said, a general contractor is not gonna be the same as a concrete contractor or electrical contractor. They’re gonna have different codes. And I refer to them like phase code cost code, kind of structure.
But when I start talking to a new contractor and they don’t have any system at all, or they run it out of their bank account, almost universally, everybody says, yes, I want job cost reports, but either I don’t know how to set it up or I don’t want to take the time to make it work.
And going back to the analogy with my puzzle, let’s say we’ve got our puzzle together. Well, if somebody has no system at all for job costing, I would rather them have a basic level of detail where we’re talking about. We just dump it into labor materials, subcontract equipment, and other.
That is better than nothing. And that’s more like, we take our puzzle, we put it together with a hundred pieces instead of a thousand and we, flip it over and we can see that picture. Well, imagine that picture is your black and white TV from the sixties that, we had our rabbit ears. Like you’ve got a fuzzy picture, but you got a better picture than nothing. Right?
[00:09:43] Stephen Brown: Okay.
Accounting with the right level of detail
[00:09:43] Wade Carpenter: But there’s also a level of too much detail. Just like the one with the Chart of Accounts that’s over 800, you know, I’ve got one that I’m putting in right now and the CSI standard codes, I mean, I’ve got it in a Excel format and it’s over 20 pages long if you put every single one of them in there.
So that’s where you can get way too detailed. And when everybody’s doing the detailed, you’ve got several project managers, they’re not consistent with what everything goes in, and when you roll it up, it doesn’t make a lot of sense.
Again, back to our puzzle analogy. Now we’re at a 5,000 piece puzzle we turned over. Maybe that’s on our TV, and these new TVs now, they have such resolution that you’re focusing in way too thin and my old eyes can’t see it anymore. You know, you can’t see the big picture without because you’re focusing in on too much detail.
[00:10:33] Rob Williams: That’s great. I just had that conversation yesterday. We were talking about all the detail and wanting to get all the labor and everything coded to each job. And then we were losing perspective. It’s okay, how’d you do on this one? And they don’t know. And I said, somehow you gotta go back while you have this detail, but where is that picture? And our, our analogy was the way I used to do these detailed takeoffs. When we had a digitizer in the 1980s, we thought that was the fanciest thing in the world.
[00:11:01] Stephen Brown: Sounds impressive.
[00:11:02] Rob Williams: Studs and everything. And then dad would come back with his pencil in five minutes and tell me, oh, well you’re off on the concrete by this much. And you’re off on that. Cause he had a general perspective of it. So there’s something about, I love what you were saying, you were kind of comparing it to the forest of the trees analogy. You just can’t see, you get that much detail and you lose the big picture.
This is an example of me. I would have that much detail of every, I mean, I was estimating the nails, because I was making the purchase orders, and I had so much detail that I completely could make a huge mistake because I didn’t have the big picture. In this job costing thing. So that’s where I need the Wades of the world because how do you get that balance and how do you fix that? I usually don’t see somebody that has that detail, that they also have a general, whatever that pencil method is to see if you’re in the ballpark.
[00:11:59] Wade Carpenter: Right.
[00:12:01] Rob Williams: But it’s just way off, because we’re seeing these job costs are coming in on these jobs and these estimates and these margins. And the conversation is, okay, we got all this detail, but we just know it’s not right.
[00:12:12] Wade Carpenter: Well, I see that all the time.
[00:12:13] Wade Carpenter: And some of the other things I wanted to chat about really quickly: retainage.
[00:12:17] Rob Williams: Oh, that’s a big one.
[00:12:18] Wade Carpenter: Retainage receivable, retainage payable. I just picked up a client that you wouldn’t believe how big they are. They’re a general contractor. And they were not putting the retainage payable on the books. Huge miss when you’re talking this, you know. And a lot of people, it’s more on the retainage receivable side, where they turn in the pay app and they’ve got– well, that is also supposed to go into a receivable, but it should not go into your regular accounts receivable.
It should be tracked separately because it’s gonna make your aging look way past due. But it’s also, you’re not capturing the revenue if you don’t put that in there as well. That’s just yet another example of one of these little pieces of this puzzle that you just don’t understand how it fits in.
[00:13:05] Rob Williams: I remember when I went to the commercial jobs for the first time and we had this retainage, it’s kinda what is that? Because I was a subcontractor doing the framing. And then I was asking some of the other subcontractors, I said, well, what do you do? How do you do that? He said, well, I just like to not keep up with it. And it’s a wonderful Christmas present surprise when it comes in.
So the advice is just don’t track it. And then you don’t have to worry about it. He said, put all your profit in that it comes in before the retainage. And then if I get a check for retainage, it’s just a bonus. I’m like, okay, that was some really good advice there. I guess we should follow that, but I couldn’t believe that’s sort of the attitude of so many of the smaller contractors that didn’t have these systems in place.
[00:13:48] Wade Carpenter: It is nice when that big check comes in, but you know, when you need a bond from Stephen and that retainage is not sitting on your books, well, if you’re doing percentage of completion books, it looks like you are so far away under-billed it’s gonna wreck your working capital.
[00:14:04] Rob Williams: Oh yeah.
[00:14:05] Wade Carpenter: And a lot of people do not know how to set it up properly. How to make it pull out of there. And it just, it’s confusing to a lot of people.
[00:14:13] Stephen Brown: Make me out to be the bad guy. No, you’re right.
[00:14:16] Wade Carpenter: No.
[00:14:16] Stephen Brown: No, you’re right. You don’t account for it and that’s profit. That’s your money. If you do it and if you owe it you’re right. It’s not billed properly.
[00:14:24] Rob Williams: That is true. You just had me thinking about that. I don’t usually see a line item on the balance sheet for that. I wonder where that does show up.
[00:14:33] Wade Carpenter: It–
[00:14:34] Rob Williams: Is it just in the receivables when it comes out of the balance sheet somewhere?
[00:14:38] Wade Carpenter: Well, it, it should be carved out pro properly, but a lot of people–
[00:14:43] Rob Williams: I–
[00:14:43] Wade Carpenter: –don’t do it.
[00:14:43] Rob Williams: –usually see it.
[00:14:44] Stephen Brown: I’ve seen payables and receivables, 30, 60, 90 days, and then a separate retainage column.
[00:14:51] Rob Williams: That would make sense. Oh, it’s column, but I guess maybe it rolls into the receivables on a lot of these guys.
[00:14:57] Wade Carpenter: I mean some of the better construction accounting systems actually do a receivable report like that, where they’ll have the retainage out on a different line item.
Purchase Order systems
[00:15:05] Wade Carpenter: But just to move on, purchase order systems. A lot of people they’ve had a bad experience with one. Guys out in the field and they don’t want to call in or they can’t get somebody and get a PO number so they can’t get, and it’s a hassle to them. Or they’ve had a bad experience.
Well, I’m not saying every company should have one, but you know, if you’ve got a general contractor and you’ve got subs and you’re not tracking those POs, I mean, the POs can be a huge help to getting jobs costed because if something comes in on a PO, as long as they put the PO number on there, you can see where it’s supposed to be, what job it’s supposed to be on and where it goes.
So a lot of people when I bring that up, it’s oh, they roll their eyes. But again, it’s another piece of that puzzle where if you get it set up properly, it can be a huge help.
[00:15:57] Rob Williams: Yeah, the purchase orders. I’ve had a lot of experience in that, and the different systems. And that just can be the craziest thing because I was the not very smart guy in the office making a rigid purchase order system. And being in the field, it’s unbelievable the complexity of the systems that a superintendent can make to get around the purchase order system.
They will get it, then they’ll order four extra things here and then they’ll have it all planned out how it’s gonna go to these other houses. Because that dumb office is messing up their jobs and he’s gonna make sure it works right. And so he has gone to this huge ordeal to change and plan for the next jobs down the road and everything.
They manipulate these systems. So I guess to me, what I learned is these perfect systems. You got to have the flexibility in the fields– in the jobs that I’ve been on, that have that. Of course the purchase orders for the most part that I did were detailed line item type purchase orders.
Some of them are more just like for a job and a bid. And a lot of times the commercial industry it’s a little bit easier because you just have a line item and a bid for a purchase order. So when it comes in and it doesn’t have all the detail.
But that purchase order system has gotta be a team effort and that’s not only to get your cost control right. But make sure that job works and it is going and it doesn’t stop the job. And the subcontractors will be involved with them too, because they’re losing money when they can’t finish a job, because their material’s not there. And so they hate the purchase order system.
So it’s a–
[00:17:36] Stephen Brown: It’s a big deal.
[00:17:37] Rob Williams: Yeah, that PO–
[00:17:37] Stephen Brown: Get it right.
[00:17:38] Rob Williams: Huge. Huge thing. We could probably have a whole series just on that.
[00:17:44] Wade Carpenter: I’m sure they’d definitely be not listening to that one. So.
[00:17:47] Rob Williams: Right. Or we could have a, we could have a venting POs, like a vent against your Purchase Order system. And we may have a huge crowd.
[00:17:57] Wade Carpenter: Yeah.
[00:17:57] Stephen Brown: Well, let’s out a podcast called Purchase Order Systems Suck.
[00:18:04] Rob Williams: It would raving success.
[00:18:06] Stephen Brown: Hate those things. Well, we’ll just give it a new name and try to make it sound sexy. Wade, what other issues do contractors have?
[00:18:13] Wade Carpenter: Well, there’s some, construction-specific, depending on how you’re structured, things that we could talk about. I won’t go into a lot of detail, but just one I had two weeks ago it was new one I took on.
They were on a completed contract for tax purposes and they had some kind of hybrid method in house. And so for tax purposes, they had absolutely no idea how that was supposed to be. And it’s very similar for, I don’t really wanna talk about home builders, but– no offense to Rob.
[00:18:42] Rob Williams: No. I was just thinking when you were saying it, I was thinking, this was me. You must be talking about me because we had no idea how the tax and we created all kinds of crazy systems that were hybrid.
[00:18:52] Wade Carpenter: But, I mean, in that point, you should be having things on your balance sheet that normally went in your P and L. There’s other systems like, if you’re keeping it on percentage of completion, you have the over and under billings and keeping that consistent and not turning in something to Stephen where they haven’t adjusted that all year. It was one picture at the end of the year, but now it’s a completely different picture six months later.
I won’t go too deep into that. This is kind of a high level talk today, but.
[00:19:18] Stephen Brown: I think not enough information and too much information is hugely important for folks to understand when they’re setting up their accounting system. And I like your analogy about the jigsaw puzzle, where you can’t see the picture. Those foundations, you know, get with Wade or your construction oriented CPA, and make sure that y’all are clear on what those foundations are and how to set them up to have a system that works for you.
[00:19:44] Rob Williams: That’s right. Stephen, you were just reminding me of, you get all that information, but make sure you know what you’re gonna use it for, because I know we got obsessed in the back room of having all this detail, but nobody used it, you know, at certain points. So, what’s the point, it’s just a lot of wasted effort.
It’s just like doing a jigsaw puzzle. You get so involved in this that you wanna get it right. And you kind of wanna get a fit, and you forget that you’re doing it for a purpose. Why are you even doing it? Who’s, is anybody looking at this? So.
[00:20:17] Stephen Brown: In, in my mind I picture just a, literally like a, dashboard of a car that just has gauges on it. And, each one of your projects are running. You can have certain elements of each project that you wanna know every week, every month. Same thing goes for what you need to show your bank or your bonding company, that exact same information.
Are you able to make money on your projects? Are you able to track the profits? Are you able to show us how you’re performing? And do we have any ideas for you? It all goes hand in hand to success and making money, doesn’t it?
[00:20:51] Wade Carpenter: Yep.
[00:20:52] Rob Williams: It does. And knowing whether you’re making money and being able to make these adjustments.
[00:20:58] Wade Carpenter: Right. Going back to what Stephen said about the foundation, I mean, this is one of the key things. And instead of building your accounting system on sand, you need to get it embedded in rock. So what I would say is get some help before you start buying the system.
I see people buy very expensive construction accounting systems and it comes with its own phase code, cost code kind of thing. But it never gets set up right, and you spend thousands and thousand more for consultants and it just never takes because they just not put that high level puzzle together.
What we’re trying to do is Hey, let’s get this puzzle piece together, turn it over so that you can see a clear picture of what you’re looking like. So you can manage a healthy company around it.
[00:21:45] Rob Williams: Oh man, that’s great advice. Most of the time I bought a system or changed an accounting system it’s because I was at some trade show and I was like, oh, look at that pretty graph up there. I want that. That’s what I want on this screen. They’ve got this great booth.
[00:22:02] Stephen Brown: Oh,
[00:22:02] Rob Williams: –that to be me. And I’d come back home, I’d show up with some system, and they’re like, oh my God, what has Rob done?
[00:22:09] Stephen Brown: Yeah. You know, artist’s rendering on future construction projects where beautiful people are walking through the plaza, that sixties looking stuff, man, that makes me crazy too. You’re right. Bells and whistles. But that doesn’t get the job done. You don’t need that. You just need that good foundation. Right? Wade
[00:22:28] Wade Carpenter: Yeah. And just what Rob said, those bright, shiny objects. You see these things and say, hey, yeah, I do want that. But you have no idea what it takes to get that pretty graph and stuff to spit out.
[00:22:40] Rob Williams: Well, great. Well, this has been really helpful, Wade. Anything else that you guys have questions to wrap up or?
[00:22:46] Stephen Brown: I would say as always, your construction accounting is the, speaking of firm foundation, this is the firm foundation of your financial board of directors. So get a good one like Wade. Get what you pay for.
[00:23:01] Wade Carpenter: My only wrap up comment would just be, normally when I’m talking to a contractor, we can’t answer the question in 30 minutes. I usually spend hours and hours talking through how they do certain things. Because if you just put a cookie cutter system in there, which is what a lot of people will do, it’s not gonna be any better than anything else you– software or whatever’s not gonna help you.
[00:23:24] Stephen Brown: Right. You gotta understand how they’re doing business in order to help give them the right advice.
[00:23:30] Rob Williams: Yeah, the grass is always greener on the other side is what I’ve noticed with every time this conversation comes up. Whatever we have is wrong and we need to have this because they’re like me looking at that booth at the trade show and see this greener grass over there and they wanna switch to that.
[00:23:47] Stephen Brown: They certainly have their place.
[00:23:48] Wade Carpenter: I think we’ve overdone the analogies on this one.
[00:23:51] Rob Williams: Okay. Well, this has been a wonderful, informative episode of the Contractor Success Forum and our common construction accounting setup mistakes. It’s always fun to talk and rag on our mistakes that we make. So, thanks a lot. And we have Stephen Brown and Wade Carpenter and I’m Rob Williams. And thank you for joining this.
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