Cost Accounting and Financial Management for Construction Project Managers

Len Holm

• Publisher: Routledge
• Year: 2018
• ISBN:
  9781351376945
• Edition: 1
• Topic: Arquitectura
• Subtopic: Práctica profesional en la arquitectura

Proper cost accounting and financial management are essential elements of any successful construction job, and therefore make up essential skills for construction project managers and project engineers. Many textbooks on the market focus on the theoretical principles of accounting and finance required for head office staff like the chief financial officer (CFO) of a construction firm. This book's unique practical approach focuses on the activities of the construction management team, including the project manager, superintendent, project engineer, and jobsite cost engineers and cost accountants. In short, this book provides a seamless connection between cost accounting and construction project management from the construction management practitioner's perspective.

Following a complete accounting cycle, from the original estimate through cost controls to financial close-out, the book makes use of one commercial construction project case study throughout. It covers key topics like financial statements, ratios, cost control, earned value, equipment depreciation, cash flow, and pay requests. But unlike other texts, this book also covers additional financial responsibilities such as cost estimates, change orders, and project close-out.

Also included are more advanced accounting and financial topics such as supply chain management, activity-based accounting, lean construction techniques, taxes, and the developer's pro forma. Each chapter contains review questions and applied exercises and the book is supplemented with an eResource with instructor manual, estimates and schedules, further cases and figures from the book.

This textbook is ideal for use in all cost accounting and financial management classes on both undergraduate and graduate level construction management or construction engineering programs.

CHAPTER
1
Introduction

Financial management overview

Project engineers (PEs) and project managers (PMs) are not typically known as accountants. Their responsibilities as construction 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 financial management activities performed at the jobsite are not thought of as ‘accounting’ per se they do fall under the cost accounting 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 company 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. This book is not meant to be a repeat of standard business-school accounting textbooks or accounting courses, there are many good ones available, but the focus here is on the financial operations of the construction jobsite team and how they interface with the accounting needs of the home office.

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, lean construction techniques, time value of money, taxes and audits, and the developer’s pro forma.

Construction is a risky business. 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 history 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.

Accounting purposes

There are several reasons a contractor should establish a formal cost accounting system, both at the home office and at the jobsite. Four of the more prominent ones include:

• Prepare financial statements for internal and external use;

• Process cash-in (revenue) and cash-out (expenditures);

• Prepare and file taxes as required by the Federal Government as well as some state and local jurisdictions;

• Manage the internal financial affairs of the company:

∘ Are we making money?

∘ Are we returning an adequate return on equity (ROE) to our investors?

∘ Are we focusing on the proper type of work? Is our company operating in the proper market?

∘ How are our people performing?

Consistency is important for cost accounting and financial management for contractors. Their financial reporting tools must be consistent from year to year, from project to project, and from month to month within each project. In order to report costs and projected profits consistently, contractors must have reliable financial management systems in place, particularly as it relates to cost control.

Cost control in construction is an important topic and is discussed in detail in several chapters of this book. It is important to distinguish between cost reporting and cost control, especially as it relates to jobsite cost accounting. The foremost question to ask is: Can the jobsite team really control costs or are they simply just reporting costs? And can they really ‘control’ the operations of the construction craftsmen in the field, or are they doing their best to ‘manage’ the process so that the craftsmen can achieve the estimate? Most construction management and cost accounting textbooks focus their cost control discussion simply on cost reporting. But if timely modifications and corrections are not made to the processes, the jobsite management team is not properly managing costs and cannot achieve the bottom-line fee, let alone improve it. To have an effective cost control system the construction project team must follow some basic rules:

• Cost reporting data has to be timely and accurate. If actual cost data was not input to the accounting system accurately, then the results will be of no value to the jobsite team.

• Eighty percent of the costs and risk on a project fall within 20% of the construction activities - this is known as the Pareto 80-20 rule. The jobsite team should focus on the riskiest activities. The 80-20 rule is expanded on throughout this discussion of financial management.

• The original estimate and schedule should be shared with the contractor’s field supervision, including superintendents and foremen. In order for them to plan and implement the work they need to have been given the complete picture.

There are many bad examples of construction cost accounting, especially as it relates to cost control. We will be sharing some of these throughout...