Interpretation of project accounts is generally not straightforward until a project is completed. When a project is finished, and Accounts discover mistakes, it’s too late to correct them.
During the execution of a project, procedures for project control and record keeping become indispensable tools to managers and other participants in the construction process. These tools serve the dual purpose of recording the financial transactions that occur as well as giving managers an indication of the progress and problems associated with a project.
In this blog we discuss 6 methods the role of Accounts Payable can contribute to cost tracking on a construction project.
1. Accounting vs Project Accounting
Understanding the difference between accounting and project accounting can be very useful for cost tracking. Generally businesses will have a good structure for financial accounting as it is legally required and vital to any businesses day to day function.
Financial accounting is reportable in periods throughout the financial year (monthly, bi-monthly, quarterly and yearly). Generally costs are allocated to departments or nominal codes or cost-centers which makes comparison easy from period to period.
Project accounting is inherently different as a project has a specific start and end date and means the accounting work ends when the project is completed. Costs are allotted to particular contracts as well as the accounting nominal codes.
Most construction businesses may have a method of allocation whether in excel or categories in an accounting software package but it can be quite simplistic as just allocating costs to a project. Project accounting should be working against an initial project budget and be tracked against the same to understand overruns.
Commonly with projects that are large, the overruns only become apparent when the project is complete and too late to make alternative plans to avoid problems. This is where the budgets may be broken down into smaller elements and be tracked against the same as the project progresses.
2. Understanding Of Project Structure And Budget
An estimate for a construction project will generally have a clear structure. This may be as simple as Labour, Material, Sub Contract, Plant & Machinery etc or as complicated as 100 elements or phases of a project. Either way, the estimate provides a key to the trackable budgets of each project element.
Breaking a project’s expected costs into smaller elements / budgets allows us to see how each element is performing as the project progresses rather than discovering an overrun at the end.
Discovering a particular element has overran its budget earlier can help project managers to take actions that could impact the budget positively later in the project can make a huge difference to the bottom line. Discovering particular elements of a project are always overrunning i.e. foundations for example could lead to understanding that they are being underestimated or not efficient on-site. Either way there should be specific learnings from overruns.
3. Overhead Distribution
It is critical to understand how overheads contribute to a project’s cost given that we are trying to track costs against an initial estimate. The best method for allocating overhead in construction is a way that’s fair. After all, the idea is to allocate costs that each project shares responsibility for, meaning the job either caused or benefited from the cost.
But, the costs should also be proportional to that responsibility. Figuring out how to strike that balance is the art of overhead allocation. There are many methods to apply overhead costs to a project and there is no one size fits all. The key is to understand what method is best suited and to apply it. We have discussed this in detail in a previous blog Construction Overheads Allocation.
4. Allocation Of Project Costs
As we mentioned, the project budget structure holds the key to cost allocation. Accounts payable need a very good understanding of what each cost is and where it is to be allocated. This is challenging especially when a project has numerous elements / phases or sections that will be individually tracked.
Purchase orders can be a big help in this context as the allocation is set by the owner of the Purchase Order. Accounts Payable can match the incoming invoices back to the PO to allocate. At LiveCosts we certainly see this on a daily basis.
Companies can manage without up to a certain level but at some stage the process becomes very difficult and Purchase Orders become a must.
5. Budget Monitoring / Reporting
All of the effort to carry out the above is of no use if there is no outcome. A good idea for any company is analysing what worked and what didn’t after the fact. This may be called a “post mortem meeting” and be held at the end of a project or better still a phase. This process will give you insight not only for this project but for future ones too.
This knowledge will be especially helpful if you intend to do additional work with the same team, client, and project manager.