Make More, Save More With Project-Based Accounting

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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You may sense that profits are lower than they should be, despite full slates of projects and timely collections. Providers of creative, technology, consulting, and even project-management services have joined construction businesses to benefit from project-based accounting or job-cost accounting. Getting a handle on what constitutes a project and the resources required to develop, sustain, execute, and complete project-oriented assignments can mean the difference between barely getting by and showing strong profits.

Predict findings and benefits of project-based accounting

Until you see project totals and cost breakdowns, you may not know precisely what you'll do with the financial intelligence that project-based accounting delivers.

Instinct may be telling you that projects are underpriced, especially if demand is high but profits are low. The benefit in this scenario is that you'll have a foundation for justifying and negotiating higher prices. You may be able to pinpoint project details that are critical to clients' successes as well as those that are expendable because they increase cost but add little value.

Discoveries that you may make based on compilation of total project costs:

• project types that are most profitable;
• client profiles that tend to engage your business in high-profit projects;
• inconsistent pricing among similar projects; and
• problems with pricing that occur only when scopes of projects are broadened.

Drilling deeper into costs by category may lead to revelations such as:

• inexpensive per-unit costs on project materials through bulk purchases (but accompanied by the need to dispose of excess inventory);
• higher efficiencies among in-house labor compared to contract labor;
• use of materials with specifications not appropriate to project requirements; and
• failure to assign certain costs to projects.

Cataloging benefits can provide inspiration and direction for pursuing, shaping, and implementing project-based accounting and financial reporting.

Decide that you're going to adopt project-based accounting

This approach will require your full support and commitment from nearly everyone in the business. Your accountant can produce reports but the raw information will come from your team. They'll need to track resources (labor hours, professional services, inventory, etc.) dedicated to each project.

Create boundaries for what constitutes a project

Much emphasis is rightly placed on defining the scope of projects. Clients and service providers should agree on project deliverables along with features to be included and those available for additional fees. Uncertainties can still exist in regard to scope, such as the cost of preliminary research prior to the project start or routine maintenance and upgrades scheduled just prior to completion. Set guidelines for charging expenses to projects for consistency in comparing and scrutinizing costs.

Design processes for capturing project information

Ideally, financial data relevant to projects can be recorded at the same time that accounting information is being captured for the general ledger. Billable (or labor) hours and materials used for projects should be included; other line items may include equipment rental, professional services, insurance, and supplies pulled from inventory for specific projects.

Employees or their supervisors can provide breakdowns on hours expended by project when completing timesheets. Managers can designate project names and authorize payment approvals when they review vendor invoices. Depending on the size and complexity of your projects, find software solutions that will capture and keep project information integrated with your accounting system.

Start tracking all information

To get project reports that are meaningful, allocate all resources among active projects. Otherwise, some expenses may be omitted altogether or charged to the wrong project, canceling out reasons for setting up project-based accounting.

If time constraints prevent assigning all related expenses to projects, then start by recording one category, such as payroll. Implement processes for assigning billable hours to projects. Reconcile project hours with payroll hours to confirm that information is being captured and recorded properly. Research and resolve discrepancies, and redesign processes or reeducate team members on methods of assigning expenses to projects. You may uncover questions about the difference between overhead and project hours; decide how you'd like to treat these issues so that information among projects stays consistent.

Create project-based financial reports

Compile numbers and produce project financial reports with total revenues and expenses. Seeing project profits (or losses) is the first step in gaining insight into methods of improving results. Compare pricing and expense ratios among projects to discover ways to enhance efficiencies, find cost-savings techniques, or eliminate certain tasks not relevant to project successes.

Looking at project financials can be startling. The projects that you love may not be the ones that are the most profitable. The clients who are the most endearing may be the ones who continually ask for extras and expand project scopes to the point that profits plummet. Get a true understanding of costs so that you can negotiate pricing and earn the profits you deserve.