The Difference between Construction Accounting and Financial Accounting (Part I)

Occasionally we run into people that try to manage ongoing construction projects with only the data they get from their corporate financial system. This is a rookie mistake. Here’s one reason why:
 
Financial systems record actual expenditures and are, therefore, historical by nature. To manage a project to a budget you need to consider what was already spent. More importantly though, you need to consider what is going to be spent. You need to manage the future spend, what was encumbered or committed. That is more important than what was already spent (if you want to meet or beat a budget).
 
Most accounting systems don’t give you the tools or are not configured to do that.
 
Consider the following example. Suppose you have $100,000 to spend on a minor renovation. You hire a contractor and agree to a contract of $85,000, give him a deposit of $5,000 and he starts to work. According to the accounting system, you have only spent $5,000 to date (for the deposit) and have $95,000 left. The reality is, however, that you committed to spend $85,000 with the contractor and only have $15,000 left. Now consider this example in the context of a multi-million, or possibly billion-dollar capital program. You can quickly recognize the increased risk for missing your budget if you’re relying on your accounting system.
 
Having an accurate report on what was already spent will not forecast the project’s finances at its completion. Project managers that do not regularly review committed costs and other forecasted expenditures as a project progresses are likely to realize too late that it will exceed the budget.
 
Construction management software with cost forecasting capabilities makes it easier to input, update, track and report on the ongoing financial status of a project. An effective project cost forecast will dramatically increase the chances that a project will come in at (or even under) budget. Every estimate and actual cost is entered. When expenses exceed estimates, the excess and its impact on the budget is visible in the cost forecast. Corrective action can be taken to realign expenses with the budget.
 
This is a very simple concept. Yet I have seen example after example of organizations that look only at what was actually spent and end up over budget at the end of the project.