Whether you’re a builder, roofer, plumber, electrician, or otherwise engaged in the trade industry, construction accounting is often the last and least of your concerns. However, forgetting to get your accounts in order can be a recipe for failure. Here are key insights accountants for construction want you to know.
A Guide on What You Should Know, According to Accountants for Construction
Taking control of your finances and books is just as important as taking on more work to grow your business. However, not all tradespeople and entrepreneurs have an idea of how to do it and where to begin. This article is a short guide to get you started.
1. The Ideal Structure Differs for Every Business
Not all businesses in the construction industry are the same—some focus on building, while others specialise in plumbing, electrical works, and roofing, among others. Remember that your particular circumstances dictate how you should structure your business.
For instance, if you have big projects, it may be better to set up your business as a limited company instead of a sole trader or partnership. Talk to a team of accountants for construction from Sterlinx Global to know what suits your needs best.
2. Estimate Projects Correctly
The first step in managing finances is to grasp project costing. Regardless of your usual contract size, you must have a solid understanding of how much you should quote a job.
Learn to break down a project’s materials, labour, and other overhead costs. Be detailed in doing this so you can arrive at an accurate break-even figure. Before sending out a quote, don’t forget to have allowances for any unforeseen expenses from delays and oversights.
3. Project Management Is Crucial
Experienced contractors and subcontractors will tell you that construction works rarely go according to plan. Despite extensive preparations, jobs sometimes require recalibration or revision as they progress, negatively impacting costs and profits.
Control costs by staying on top of ongoing projects with detailed timelines and budget schedules. It’s best to anticipate or address any deviations and delays early on to prevent them from snowballing.
4. Keep an Eye on Your Margins
Revenues shouldn’t be your only measure of success—simply because you have more work doesn’t mean you’re earning well.
Accountants for construction will tell you that gross profit and margins are a better gauge of financial performance. These figures show how much you’ve earned on a contract, given the costs incurred for rendering the service.
For example, a £400 project requires £300 in labour and materials, resulting in a £100 profit and gross profit margin (GPM) of 25% (£100 / £400). If that’s an acceptable rate, aim to maintain it for every job and monitor it regularly throughout a project’s lifecycle.
5. Avoid the Cash Flow Pitfall
In the construction business, tracking the movement of your funds can be complicated. There’s often a disparity between billing and recognising revenue.
For instance, with progress billing, you only get paid for the percentage of work completed. Even with cash expected to come in, you may still have insufficient funds to purchase materials.
Balancing your business’s cash flow is necessary to ensure you’re not cash-strapped at any point in your operations. Rein in your receivables by regularly invoicing your clients—for those that cannot pay on time, stop work to prevent money from being tied up further in the project.
Asking for a down payment is common, especially when the work requires costly materials.
6. There Are 4 Construction Accounting Methods
To address challenges in accounting, construction businesses often use more than one accounting method for every project. As a contractor, you must understand the key differences between each.
The cash basis method recognises revenue upon cash collection and expenses with money spent. On the other hand, the accrual method records revenue when earned and expenses when they occur, without considering when money changes hands.
Besides cash and accrual basis, there are two more methods: percentage-of-completion (PCM) and completed-contract (CCM). With PCM, revenue and expenses are apportioned based on the project’s progress. CCM only recognises a project’s financial activity upon its completion.
Each accounting method will impact revenues, expenses, and tax due. Most companies use a combination of two or all four. Talk to a construction accountant to know which fits your business, as it can be a complex topic.
7. Compliance Is Tricky
Legislative accounting requirements in the UK are constantly changing, and keeping up with changes is something you may have overlooked because of your workload. However, that’s often not a reasonable excuse to waive charges.
Many accountants for construction will tell you that estimating your obligations to the HMRC is confusing. And mistakes on VAT, corporation tax, and CIS can be expensive.
8. Beware of the CIS Trap
Under the Construction Industry Scheme (CIS), contractors must withhold a certain percentage of payments to their subcontractors and remit these to HMRC. These deductions are considered advance payments towards a subcontractor’s taxes and National Insurance contributions.
The deduction rate is 20%, but it increases to 30% if a subcontractor is unregistered for CIS. If you’re a contractor, consider registering as a subcontractor in case you take on a project as one. The CIS registration process depends on your business structure.
Since additional CIS measures are put in place or revised occasionally, calculating the deductions and filing returns with the HMRC can be complicated. Let an accountant handle it to avoid the pitfalls.
9. Know the VAT Reverse Charge
In addition to CIS, those in construction have to deal with the VAT domestic reverse charge.
The scheme, an extension of CIS, was introduced to change the handling of VAT for certain construction industry services and building materials. It applies to transactions between VAT-registered contractors and subcontractors.
Instead of subcontractors accounting for VAT in their invoices, the contractors will settle the VAT directly to HMRC. This change was made to minimise fraud as VAT-registered construction businesses charged for VAT but never remitted the amount.
10. It’s Better to Work with a Professional
The nature of businesses in the construction industry creates complex accounting and tax management issues.
Different contract terms, project-based revenues and costing, and varying project timelines make it difficult for contractors to keep up with accounting. Delays in managing accounts can impact your finances.
While it pays to know the basics, it’s more efficient and cost-effective to outsource the heavy lifting to a team of accountants for construction.
Since they specialise in this practice area, they’re well-versed in the industry’s unique accounting rules for taxation and reporting.
Frequently Asked Questions on Construction Accounting
Can I use cash basis accounting for my business?
It depends. If you are VAT registered and have an income of £150,000 or less, you can recognise revenues and expenses through the cash basis method. To date, it is only allowed for sole traders and partnerships and not limited companies. Always check the HMRC website for updated guidelines.
Should I only hire a bookkeeper instead of an accountant to maintain accounts?
You could, but only if you have an excellent grasp of accounting and tax management.
It is understandable that you want to be cost-efficient in running your business. However, going without a dedicated accountant for construction may cost you more in the long run. Higher HMRC obligations and hefty fines are avoidable expenses with a specialist on board.
Is my business covered by CIS even if I don’t build structures?
According to HMRC, CIS encompasses most construction work. There are exceptions, such as architecture and surveying, scaffolding rental, carpet fitting, materials delivery, and unrelated work on a construction site.
So even if you’re a self-employed plumber, electrician, or roofer, you are still covered by CIS guidelines.
Being in the trade industry can be lucrative, especially when you understand how to handle your finances. However, doing the math right requires proper management of your books. Let these 10 important facts guide you, but it also helps to have a team of accountants for construction from Sterlinx Global.