LGT's Profit Sense
When you're thinking about starting a construction company, it's crucial to have a smart financial strategy in place, rooted in accounting basics. The decisions you make early in the process have the potential to cause serious impacts on your company's financial and ongoing success.
Though accounting probably wasn't why you started your construction company, having the right plan in place for your financial strategy can help reduce your day-to-day administrative duties, keeping them from overshadowing your customer relationships or ability to work in the field. When you ask the following questions early in the company organization process, you can leverage accounting basics to reduce cost, increase profitability and minimize tax liabilities.
#1: Will my choice of entity type support personal and business goals while helping me to save on taxes?
There are multiple reasons as to why a specific type of entity is picked, with each one having its own pros and cons. Contractors must determine the appropriate entity type on a case-by-case basis in order to remain compliant with applicable laws, while also meeting the owners’ personal and business goals for financial responsibility, legal liability, and transferability of funds in the most tax-efficient way.
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By understanding how each type of entity is taxed, you will be able to develop a solid financial and tax strategy for your business. In some situations, you can choose to be taxed in different ways between state and federal levels. For example, some LLCs may make an S election using IRS Form 2553 or make a Corporation, Partnership, or Disregarded Entity election on IRS Form 8832.
#2: Are my job costing practices aligned with effective cost management?
Though you’ll be happier watching sales and revenues figures, it’s just as crucial to regularly review financial and operating costs. You need to make sure that your fees stay in line with competitors while your jobs create enough revenue to maintain a solid margin. This includes labor, materials, and overhead for each project. The company’s job costing practices need to allow for you to segregate and break down all the expenses for each job. Accurate data and information allow for accurate estimating.
#3: Can I maximize cash flow and financial standing while accurately assessing and projecting capital and liquidity needs?
The construction industry is one that can quickly see shifts in cash flow and liquidity. This is partially due to many costs being paid in advance while payment on billings can be uncertain as to when they will be received. Regular review of accounting records allows you to take corrective or preventative actions when necessary. Review can include preparation and review of financials and cash flow forecasts. Then you can regularly measure them against actual cash flow.
Is an ESOP right for your company?
You’ll also want to be sure that you are on top of financial options and surety bonding relationships by ensuring your accounting practices are transparent. When having to communicate with these organizations, be sure to be proactive. If you suddenly have a new opportunity that requires funding, the surety and financial relationships provide you with leverage.
#4: Does my strategy account for risk management?
Risk management is vital to your business strategy. Step back from competitive bidding occasionally to take the time to evaluate your risks. Don’t produce a lot of low estimates out of fear, instead, rate your projects using a system that includes the type of work, predetermined minimum profitability, bonding needs, timeframe, and if the necessary skill set is in line with your worker's skills. Prioritize time and estimating costs on jobs that provide the best profit and are the best fit.
Subcontractors can also increase your risk as your contracting firm has limited control in those situations. You’ll need to properly vet your subcontractors while minimizing risk exposure.
#5: Does my strategy leave options to leverage new technology?
Digital transformation is impacting virtually every industry, including construction, and the cost can be significant. However, new technology can provide a significant return on investment. Advances in technology provide opportunities for vertical integration, such as operations structured for in-house distribution or using prefabricated, modular construction processes to reduce costs and improve efficiency and profitability.
Cost-benefit analysis provides projected savings in time, efficiency, costs, and risks while improving profitability by automating manual software processes. For example, estimating software that allows for real-time costing, asset management, risk assessment, and customer relationship management provides the opportunity to improve overall profitability.
Before starting your own construction business, ask yourself these five accounting questions and make sure you are starting off on the right foot. If you would like additional guidance, our team of business professionals can provide you with industry-specific advice for startups and established businesses. We can work together to find the right solutions.