Chapter 5 - Construction Financial Management

Construction Economics & Financial Management
[CEM-6105]
Adama Science and Technology University
Department of Civil Engineering
Master of Science in Construction Engineering and Management 1
Targeted Students: Instructor:
1st Year CEM Students Dr. Meseret Getnet
January, 2020
Chapter 5
2
Construction Financial Management
2
Why do Construction Companies
Fail?
 Ineffective financial management systems
 Lines of credit constantly borrowed to the limits
 Poor estimating and/or job cost reporting
 Poor project management
 No comprehensive business plan
 Communication problems
Construction Economics
Construction Accounting & Financialand Financial
Management, 3/e Management © 2013 by Pearson Higher Education, Inc
Steven Peterson Upper Saddle River, New Jersey 07458 • All Rights Reserved
What is Financial Management?
 Financial management is the use of a company’s
financial resources
 Financial resources include:
 Cash
 Assets—such as equipment
Why Is Construction Financial
Management Different?
 Project oriented:
 Greater variety of projects (products)
 Harder to determine the cost of projects
 Cannot stockpile completed work for future use
 Greater need for detailed job cost accounting
Why Is Construction Financial
Management Different?
 Decentralized:
 Must track equipment
 Payment terms:
 Progress payments
 Retention
 Heavy use of subcontractors
Who Is Responsible for Construction
Management?
 Owners
 General Managers
 CFO (Chief Financial Officer)
 Estimators
 Project Managers
 Superintendents
What Does a Financial Manager Do?
 Accounting for financial resources
 Managing costs and profits
 Managing cash flows
 Choosing among financial alternatives
Accounting for Financial Resources
 Making sure costs are accurately tracked through
the accounting system
 Ensuring that the construction accounting system
is functioning properly
 Projecting the costs at completion for the
individual projects, including unbilled committed
costs
 Determining whether the individual projects are
over- or underbilled
Accounting for Financial Resources
 Making sure that the needed financial statements
have been prepared
 Reviewing the financial statements:
 Inline with the rest of the industry
 Identify potential financial problems before they
become a crisis
Managing Costs and Profits
 Controlling project costs
 Monitoring project and company profitability
 Setting labor burden markups
 Developing and tracking general overhead budgets
Managing Costs and Profits
 Setting the minimum profit margin for use in
bidding
 Analyzing the profitability of different parts of the
company and making the necessary changes to
improve profitability
 Monitoring the profitability of different customers and
making the necessary marketing changes to
improve profitability
Manage Cash Flows
 Matching the use of in-house labor and
subcontractors to the cash available for use on a
project
 Ensuring that the company has sufficient cash to
take on an additional project
 Preparing an income tax projection for the
company
Manage Cash Flows
 Preparing and updating annual cash flow
projections for the company
 Arranging for financing to cover the needs of the
construction company
Choosing among Financial Alternatives
 Selecting which equipment to purchase
 Deciding which area of the business to invest the
company’s limited resources
Construction Accounting Systems -
Purposes
 Process cash receipts and disbursements
 Prepare financial statements
 Pay Income and employment tax
 Provide data for financial management
Cost Reporting Versus Cost Control
 Cost Reporting:
 Provides data after the opportunity has passed for
management to respond to and correct the

problems
 Shows where the company has been
 Reactive approach
 Cost Control:
 Provides data in time for management to analyze
the data and make corrections in a timely manner

 Proactive approach
Components of a Cost Control
System
 Strong job cost and equipment tracking
 Costs must be current & up to date
 Uses “management by exception” Management by
Exception: a policy by which management devotes
its time to investigating only those situations in
which actual results differ significantly from
planned results. Else, higher management is to
mainly target & address “strategic” plans &
decisions!
 Follows established procedures
 Data must readily be available
Components of an Accounting
System
 General Ledger:
 Chart of accounts
 Balance sheet and income statement
 Job Cost Ledger:

 Costs by project
 Equipment Ledger:
 Costs by piece of equipment or vehicle
Method of Accounting
 Cash
 Accrual
 Percentage of completion
 Completed contract
Cash
 Revenue is recognized when payment is received
 Expenses are recognized when bills are paid
 Easiest to use
 Little use for financial management because data is
not up to date
Accrual
 Revenue is recognized when the company has the
right to receive payment
 Retention is not a revenue until the job is
complete
 Expenses are recognized when the company is
obligated to pay bills
 More accurately reflects the financial condition of a
business: compared to cash.
Percentage of Completion
 Revenue is recognized throughout the project
 Retention is recognized throughout the project
 Expenses are recognized throughout the project

 Estimated profits are equally distributed throughout
the project
 Based upon expected revenues and expenses
Completed Contract
 Revenue is recognized at completion of the project
 Expenses are recognized at completion of the
project
 Revenues and expenses are known
 Useless for financial management
 May create large swings in income
Balance Sheet
 Assets = Liabilities + Owner’s Equity
 “Snapshot” of a company’s assets, liabilities, and
owner’s equity
Current Assets
 Cash
 Accounts Receivable-Trade
 Accounts Receivable-Retention
 Inventory
 Costs and Profits in Excess of Billings (Underbillings)
 Notes Receivable
 Due from Construction Loans
 Prepaid Expenses
 Other Current Assets
 Total Current Assets (sum of above)
Fixed and Other Assets
 Land
 Buildings
 Construction Equipment
 Trucks and Autos
 Office Equipment
 Total Fixed Assets (sum of above)
Fixed and Other Assets
 Less Accumulated Depreciation (Contra Account)
 Net Fixed Assets
(Total Fixed assets – Les Accumulated

Depreciation)
 Capital Leases
 Other Assets
 Total Assets (Total Current Assets + Net Fixed
Assets +
Other Assets)
Liabilities
 Current Liabilities
 Accounts Payable-Trade
 Accounts Payable-Retention
 Billings in Excess of Costs and Profits (overbillings)
 Notes Payable
 Accrued Payables (including taxes and vacation)
 Capital Lease Payable
 Warranty Reserves
 Other Current Liabilities
 Total Current Liabilities (sum of above)
Liabilities
 Long-term Liabilities
 Total Liabilities (Total Current Liabilities + Long-
term Liabilities)
Owner’s Equity (Corporation)
 Capital Stock
 Retained Earnings
 Current Period Net Income
 Total Equity
Income Statement
 Spans a period of time
 Represents the transactions that occur between two
balance sheets
Income Statement
 Revenue
 Construction Costs
 Equipment Costs
 Gross Profit (Revenue – Const. Costs – Equip. Costs)
 Overhead
 Net Profit From Operations (Gross Profit – Overhead)
 Other Income and Expense
 Profit Before Tax (Net Profit – Other Income and Expense)
 Income Tax
 Profit After Tax (Profit Before Tax – Income Tax)
Construction Costs
 Materials
 Labor
 Passes through payroll system and is charge to a
job
 Subcontract
 Always includes labor component
 Equipment
 Other
Equipment Costs
 Rent and Lease Payments
 Depreciation
 Repairs and Maintenance
 Fuel and Lubrication
 Taxes, Licenses, and Insurance
 Equipment Costs Charged to Jobs (Contra)
 Equipment Costs Charged to Employees (Contra)
 Total Equipment Costs
Relationships
 Balance Sheet
 Assets = Liabilities + Equity
 Income Statement
 Revenue = Expenses + Profit
 Balance Sheet and Income Statement

 Change in Equity = Profit
Job Cost Ledger
 Provides breakdown of construction costs on
income statement
 May provide a breakdown of revenues on the
income statement
 Costs are broken down by:
 Job
 Phase (optional)
 Cost code
 Cost type
Job Cost Ledger
MATERIALS
COST CODE LABOR
...
PHASE # MATERIALS
COST CODE LABOR
...
...
MATERIALS
JOB # COST CODE LABOR
...
PHASE # MATERIALS
COST CODE
...
LABOR
...
...
MATERIALS
JOB COST COST CODE LABOR
LEDGER
...
PHASE # MATERIALS
COST CODE LABOR
...
...
MATERIALS
JOB # COST CODE LABOR
...
...
PHASE # MATERIALS
COST CODE
...
LABOR
...
Management, 3/e Management
...
© 2013 by Pearson Higher Education, Inc
Job Cost Code Structure
Relationships
 Income Statement and Job Cost Ledger
 Revenue = Revenues
 Construction Costs = Construction Costs
 Excludes Committed Costs not Recognized
 Materials = Materials
 Labor = Labor
 Subcontract = Subcontract
 Equipment = Equipment
 Other = Other
Equipment Ledger
 Provides breakdown of equipment costs on income
statement by piece of equipment
 May provide additional breakdown
Equipment Ledger
RENT AND LEASE PAYMENTS
DEPRECIATION REPAIRS
REPAIRS AND MAINTENANCE MAINTENANCE
EQUIP. #
FUEL AND LUBRICATION TIRES
TAXES, LICENSES, AND
EQUIPMENT INSURANCE
LEDGER EQUIPMENT COSTS ALLOCATED
RENT AND LEASE PAYMENTS

DEPRECIATION REPAIRS
REPAIRS AND MAINTENANCE MAINTENANCE
EQUIP. #
FUEL AND LUBRICATION TIRES
...
TAXES, LICENSES, AND

INSURANCE
EQUIPMENT COSTS ALLOCATED
Relationships
 Income statement and Equipment Ledger
 Charge Costs = Cost Allocated
 Costs = Costs
 Rent and Lease Payments = Rent and Lease

Payments
 Depreciation = Depreciation
 Repairs and Maintenance = Repairs and Maintenance
 Fuel and Lubrication = Fuel and Lubrication
 Taxes, Licenses, and Insurance =
Taxes, Licenses, and Insurance
Accounting Transactions
Debits and Credits
Invoice (Materials) Charged to a Job
without Retention
Invoice (Subcontractor) Charged to a
Job with Retention:
Paying Invoices
Labor Charged to a Job
Construction
Steven Peterson
Economics and Financial Management
Upper Saddle River, New Jersey 07458 • All Rights Reserved
Labor Charged to General Overhead
Paying Employee’s Wages
Paying Payroll Taxes
Paying for Benefits
Vacation Time for Jobsite Employees
Recording Office Rent
Recording Office Depreciation
Recording General Overhead
Invoices
Billing a Client
Billing for Retention
Receiving Payment from a Client
Purchase of Equipment with a Loan
Loan Payment
Equipment Depreciation
Leased Equipment with an Operating
Lease
Leased Equipment with a Capital Lease
Lease Payment on a Capital Lease
Construction
Steven Peterson
Economics and Financial Management
Upper Saddle River, New Jersey 07458 • All Rights Reserved
Amortization of a Capital Lease
Invoice for Equipment Repairs
Equipment Charge to Job
Equipment Charged to an Employee
Sale of Equipment
Purchase of Inventory
Charging Inventory to a Job
Signing a Construction Loan
Drawings Funds from a Construction
Loan
Recording Changes in Costs and
Profits in Excess of Billings
Recording Changes in Billings in
Excess of Costs and Profits

Chapter 5 - Construction Financial Management

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 5 - Construction Financial Management

Uploaded by

Copyright:

Available Formats

Construction Economics & Financial Management

Adama Science and Technology University

Department of Civil Engineering

Master of Science in Construction Engineering and Management 1

Targeted Students: Instructor:

1st Year CEM Students Dr. Meseret Getnet

Construction Financial Management

 Harder to determine the cost of projects

 Cannot stockpile completed work for future use

 Greater need for detailed job cost accounting

 Heavy use of subcontractors

 Identify potential financial problems before they

management to respond to and correct the

the data and make corrections in a timely manner

 Balance sheet and income statement

 Job Cost Ledger:

 Expenses are recognized throughout the project

(Total Fixed assets – Les Accumulated

 Balance Sheet and Income Statement

 Construction Costs = Construction Costs

 Excludes Committed Costs not Recognized

RENT AND LEASE PAYMENTS

TAXES, LICENSES, AND

 Rent and Lease Payments = Rent and Lease

You might also like