Among the differences between the accounting of a construction company and that of a regular business is the use of an accrual basis rather than a cash basis. This is because the tax withholding and retainage procedures are different. This is also because construction companies usually have an inventory of goods and services that are sold. The cost of these goods and services is then charged to the customers. This results in a much higher number of invoices being processed.
Accrual Vs. Cash Basis Accounting
Depending on your construction business’s size and scope, a construction accountant may need to use either an accrual or cash method of accounting. The IRS suggests three steps to help you determine which method is best for your company.
First, you should understand what the difference is between the two methods. The most obvious difference is when income is recorded. The cash method reports revenue when cash is received, and the accrual method records expenses when they are incurred.
You will also want to examine how your chosen method affects your bottom line. The cash method allows you to defer income until the end of the year, which can be beneficial. If you are still deciding whether to choose an accrual or cash method of accounting, consult a construction CPA.
In addition, you should consider your future tax situation. You may have to pay taxes on income that is not yet taxable. If you plan on using the cash method, account for any inventories you will need to purchase. You can also ask customers to hold payment on December invoices until January. This will give you a better picture of your financials for next year.
You should also consider whether your construction business will be eligible to use the completed contract method. This is a newer method that more construction companies can use.
Another advantage to choosing the cash method of accounting is that it is easier to track transactions. With the accrual method, you need to record every expense for goods and services before you cash the check.
You can save money by using the cash method if you have a small business. You will not have to invest in fancy software to manage your bookkeeping. However, you should still work with an accountant to get the most accurate picture of your financials.
Tax Withholding and Retainage
Depending on the details of your construction contract, retainage can vary. Sometimes it is a percentage of your total contract price, but other times it is a fixed amount. Regardless, retainage provides benefits to contractors and owners alike.
Retainage is usually held back until the completion of a project. This can have an impact on your cash flow. Retainage also offers you leverage with your subcontractors. Often, you can charge higher rates to compensate for the money you are holding back.
Many states have different regulations regarding retainage. These regulations can include how long the funds are kept, how much they can be withheld, and how long it takes to release the funds.
When you are getting ready to start a new project, it is important to know how you will handle the money you will be withheld from your contractor. If you don’t know, it can be a very confusing process.
Retainage is money that is withheld from a contractor’s payments to a subcontractor. This financial incentive incentivizes the contractor to finish the job on time and well. Retainage is often withheld at a 5%-10% rate. Some contractors hold back a larger percentage.
Some states limit the amount of withheld retainage on public projects.
Cost of Goods Sold
Accurate cost of goods sold in construction accounting can take time and effort. The sector is complex, and the costs are often categorized differently than in other industries.
Having an accurate cost of goods sold can help you calculate your gross profit margin and understand your company’s health. It can also make proactive adjustments to boost your net profit.
The cost of goods sold is the sum of all direct and indirect costs incurred by your business during the production of your products. It includes all the costs incurred to produce your products, including materials, labor, and shipping. It also excludes distribution, marketing, and other overhead costs.
To compute the cost of goods sold, you need to know the starting and ending inventory. The average inventory is calculated by dividing the ending inventory by the beginning.
This is important because it demonstrates that your inventory turnover is fairly good. A high turnover indicates that your products are being produced and sold.
To determine your gross profit, you will need to subtract your cost of goods from your sales revenue. You may need to use customized accounting software to do this.
To properly calculate the cost of goods sold in construction accounting, you must use the appropriate accounting procedures. This will enable you to accurately determine the cost of selling your products and alert you to any overspending.
To calculate your cost of goods sold in construction, you need to make sure that you record all costs associated with the production of your products. Your inventory accounting method may also affect your cost of goods sold in construction. This is especially true if you have a lot of inventory.