Construction accounting is a specialized practice, and not just because of the dozens of transactions involved with each build. There are several accounting methods that can be used by contractors to help track income and expenses, improve cash flow, and ultimately increase profitability. Here are the top four accounting methods we recommend for our custom home builder clients.
The Cash Basis Method
The cash basis method recognizes revenue when cash is received and expenses when cash is spent. Income or loss is the difference between cash in and cash out. This method is ideal for small businesses and those with limited transactions because it is easy to understand and implement. Contractors and custom home builders record revenue only when payment is received and expenses only when they are paid. However, this method does not provide an accurate picture of the business’s financial health as it does not take into account the time value of money or future obligations.
The Accrual Basis Method
The accrual basis method follows the matching principle of accounting, recognizing revenue in the period earned, not when received, and expenses in the period incurred, not when paid. This method uses revenue accruals, such as accounts receivable, and expense accruals, such as accounts payable, to capture transactions regardless of when money changes hands. This provides a more accurate representation of the business’s financial position and is preferred by many contractors and custom home builders.
The Percentage-Of-Completion Method (PCM)
PCM is the most common way construction companies recognize revenue and expenses because it apportions both over time, using a ratio aligned with the projectâ€™s progress. This method estimates the total amount of inputs or outputs for a construction project and applies a ratio of actual activity in a period to the projectâ€™s total estimated activity. PCM provides a more accurate representation of revenue and expenses for long-term projects, as it accounts for the progress made in each accounting period. However, it requires a detailed understanding of the project’s progress and can be more complex to implement.
The Completed-Contract Method (CCM)
CCM is used to account for construction projects that are completed within a single accounting period. Under this method, revenue and expenses are recognized only when the project is completed. This is straightforward and easy to implement, but it does not provide a real-time view of the project’s financial performance.
Our financial experts at Home Builders Financial Partners can help you identify and implement the right accounting method for your custom home building business, allowing you to easily monitor expenses and maximize profits. We use proven financial management strategies that allow our home builder clients to stay on top of project costs while maximizing their financial resources.
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