How To Manage Construction Finance?

engineers (PEs) and project managers (PMs) are not typically known as accountants. Their responsibilities as managers (CMs) generally revolve around the paperwork documentation performed at the jobsite to support superintendents and subcontractors in the construction of a building. And, although much of the activities performed at the jobsite are not thought of as ‘accounting' per se they do fall under the umbrella, especially when we add and financial management in the title. In addition, everything that is done at the jobsite is connected with the operations of the construction in the home office, and it is important that jobsite managers understand why they manage finances and how management of finances relates to the operation of the home office accounting department. Focus here is on the of the construction jobsite team and how they interface with the accounting needs of the home office.

Construction budget

There are many detailed studies on cost accounting, including construction cost accounting. There are also many pure studies on project management, including construction project management, but the glue that ties these two topics together is a broader study of construction financial management. Financial management includes many CM topics, beyond just cost accounting, including:

  • Estimating anticipated construction costs,
  • Cost control,
  • Cash flow projections and management,
  • Processing invoices from subcontractors and suppliers,
  • Processing pay requests to the project owner,
  • Managing change orders,
  • Financially closing out the construction project, and
  • A variety of other advanced financial management topics such as activity-based costing, construction techniques, time value of money, taxes and audits, and the developer's pro forma.

Construction failures are very high every year, especially with smaller start-up contractors. There are many statistics and metrics regarding how many contractors fail each year, and maybe just focusing on one year is too specific, but generally approximately 70% of the contractors in business on the first of any year will fail within seven years. Because construction is such a risky business, construction company owners or investors therefore expect a very high rate of return (ROR) on their investment. If all they could get on their out-of-pocket up-front investment in the company was 1–2%, then they would be better off putting their money in the bank where it is insured by the Federal Government and earning a guaranteed interest rate. In order to receive an acceptable ROR, contractors need to understand and manage their accounting and financial risks and responsibilities.

There are many causes or warning signs that a contractor might be in jeopardy of failing financially. These signs are important for not only the internal ownership of the company to be aware of, but also external strategic partners or stakeholders such as the contractor's bank and bonding companies, among others. The first and most common sign that financial difficulties may be boding is the lack of a good financial management plan or system. Some of the signs that a contractor may be suffering financial difficulty include:

  • Inefficient financial management system,
  • Borrowed on their credit line to the limit,
  • Poor estimating processes and/or results,
  • Poor project management systems and personnel,
  • An adequate business plan is not in place,
  • Internal and external communication problems, among others.

Often contractors think an increase in volume or total revenue will solve all of their financial problems. This is not necessarily the best solution. There are many reasons a contractor will choose to pursue construction work or feel they have the resources to do so. Some of the reasons they may choose to either bid or propose on a new construction project, or not to bid, include the following:

  • Although contractors are not expected to provide the construction loan, as will be discussed later, they still must have a sufficient positive cash flow, especially early in the project;
  • The contractor has sufficient bonding capacity which is especially important on a public bid project;
  • Qualified and available employees are already on the payroll and ready to start a new project;
  • The contractor has the necessary construction equipment, or immediate access to equipment;
  • The home office overhead is staffed adequately with specialists to support the project team including estimators, schedulers, and cost accountants;
  • They see a potential to make a reasonable fee;
  • The contractor already has a positive with the client, or is interested in a future relationship with the client, and/or they have a positive history with the architect or engineer, or are interested in a future relationship with those firms;
  • This type of work is already a specialty of the contractor; and/or
  • The contractor could use additional backlog.

The contractor's answers to all of these issues affecting their decision to pursue a project also impact the company's finances and approach to accounting both in the home office and at the jobsite.

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