In the construction sector, Cost of Goods Sold (COGS) is an important factor in determining your company's profitability. As a contractor, understanding how to calculate COGS will help you estimate the true costs of your projects, resulting in more accurate profit margins, better decision-making, and more efficient budgeting. This tutorial will break down COGS in construction, explain how to calculate it, and compare the benefits and drawbacks of various accounting approaches.
Understanding COGS in Construction
The direct costs of building a project are called COGS. These include the costs of goods, labor, and overhead that are directly related to building. Contractors need to know about COGS in order to set fair prices for their services, make sure they make money, and reach their financial goals.
Building up The cost of goods sold (COGS) for a project is different from the cost of goods sold for a normal business because it includes costs like materials, tools, and labor for subcontractors. These costs need to be kept straight for every job.
How to Calculate COGS in Construction
The calculation of COGS in construction is essential for determining the cost-effectiveness of a project. There are two main methods to calculate it:
Direct Costs Calculation
Materials: The costs of all materials used in the construction project.
Labor: Wages for workers and subcontractors directly involved in the project.
Equipment: Depreciation costs or rental fees for equipment used in construction.
Overhead: Costs that can be attributed directly to the project, such as site utilities or specific project insurance.
To calculate COGS in construction, use this simple formula:
COGS = (Beginning Inventory + Purchase) - Ending Inventory |
To calculate COGS in construction, use this simple formula:
COGS = (Direct Material Costs + Direct Labor Costs + Equipment Costs) |
The percentage method allows contractors to estimate COGS based on the percentage of the project completed. This method is especially useful for long-term projects where progress is made over several months or years.
Why is the Percentage Method Important?
The percentage of completion method is widely used in construction because it offers a way to recognize revenue and expenses more accurately as the project progresses. Rather than waiting until the project is completed, you can account for COGS periodically, as you reach milestones or certain completion percentages. This method helps with smoother cash flow management and more realistic financial forecasting.
Advantages of the Percentage Method
Improved Cash Flow: Recognizing revenue and expenses as you complete work ensures that your financials are up-to-date.
Accurate Profit Tracking: It allows you to track profits more accurately over time, helping in decision-making.
Financial Stability: By recognizing revenue incrementally, you can avoid large swings in your financials when a project is completed.
Risks with the Percentage of Completion Method
While the percentage of completion methods can be beneficial, it does come with some risks. It relies heavily on accurate project progress estimates, and any miscalculations or delays can impact the accuracy of COGS calculations. Furthermore, if the project experiences unexpected delays, you might prematurely recognize revenue before the work is completed, leading to inaccurate profit margins.
How to Manage COGS and Track Construction Costs
Contractors and building companies need to keep track of COGS in order to make money and run projects smoothly. Managing your building costs correctly means:
Setting a budget: Make a clear budget for each project that includes costs like labor, supplies, and overhead. Review your budgets often and make changes to account for any unplanned costs.
Job Costing: Using job costing software to track the expenses associated with each job allows you to monitor the costs of individual projects in real-time.
Accurate Reporting: Make sure your costs are in line with your plans by regularly making job cost reports to keep track of your COGS.
The Role of Accounting Software
It can be easier to figure out COGS and project prices when you use construction accounting software like QuickBooks or Sage 100 Contractor. These tools can keep track of your labor, supplies, and overhead automatically, which makes it easier to keep an eye on your finances and avoid making mistakes by hand.Â
Why Your Construction Business Needs a Bookkeeper
As a contractor, it can be hard to keep track of project prices and COGS calculations, especially if you have a lot of work to do. It's easy to forget about important costs, which can cause mistakes in your financial reports.
A skilled bookkeeper who has experience with building bookkeeping can help you keep track of your costs of goods sold (COGS) and make sure your budgets are correct. We at Construction Cost Accounting are experts at customizing our accounting services for construction companies. We're here to help you make your accounting process easier, whether you need help with percentage of finish methods or how to figure out how much a job costs all together.
You can do these things yourself, but hiring a professional like Construction Cost Accounting to do your accounting for you can save you time, make sure the work is done correctly, and give you peace of mind that your money is safe.
Conclusion
Cost of Goods Sold (COGS) must be managed and calculated correctly in building in order to stay profitable and keep track of cash flow. You can keep your business financially healthy by knowing the direct costs of your projects, using good methods for figuring out COGS, and following best practices for keeping track of project costs. For long-term projects, the percentage of finish method is very useful, but you should be aware of the risks. If you want to handle your construction accounting more efficiently, you might want to get help from Construction Cost Accounting.
