Introduction
You bid the project at a 20% profit margin. But when you close the books six months later, you only made 5%.
This is called Profit Fade, and it is the silent killer of construction businesses.
Profit fade happens when you manage a project using your bank balance instead of Job Costing. You see cash in the bank (from the deposit) and assume you are rich, forgetting that $50,000 of that cash is already committed to lumber and subcontractors.
In this guide, we break down the three pillars of professional construction accounting: Job Costing, Progress Billing (AIA), and Retainage.
1. What is Job Costing? (Vs. General Ledger)
Most small businesses use General Ledger accounting. They track Fuel as one big expense category.
Contractors must use Job Costing. This means assigning every single nail, labor hour, and fuel gallon to a specific project.
The 3 Cost Categories:
- Direct Costs: Materials and labor used only on that job (e.g., the granite slab for the Smith Kitchen).
- Indirect Costs: Costs that support the job but are hard to trace (e.g., the site supervisor’s truck fuel). You must allocate these costs to jobs based on hours worked.
- Committed Costs: This is the most important one. These are costs you have promised to pay (Purchase Orders sent to suppliers) but haven’t been billed for yet.
- The Trap: If you don’t track Committed Costs, you will spend money you don’t actually have.
💡 The Fix: You need software that tracks Committed Costs in real-time. QuickBooks alone cannot do this well. You need an integration like Knowify or Buildertrend.
2. Progress Billing (The AIA Draw)
If you wait until the end of a 6-month project to get paid, you will go bankrupt. You must use Progress Billing.
This allows you to bill the client based on the % of work completed each month.
The G702 Standard:
Commercial clients often require an AIA G702 Application for Payment. This is a complex form where you must list:
- Original Contract Sum.
- Change Orders added to date.
- Total Stored Materials (materials on-site but not installed yet).
- % Complete for each line item (e.g., Framing is 50% done).
2026 Update:
New AI-driven billing tools can now auto-fill these AIA forms by scanning your daily site logs, saving hours of paperwork.
3. Retainage: The Holdback Trap
In commercial construction, the client almost always holds back 5% to 10% of every invoice until the job is 100% complete. This is called Retainage.
- The Problem: Your profit margin might only be 10%. If they hold back 10% retainage, you are effectively working for $0 profit until the very end of the job.
- The Accounting Rule: You must record Retainage as an Asset (Retainage Receivable), not an expense. It is money you earned, just haven’t received yet.
How to survive Retainage:
- Pass it down: If the owner holds 10% from you, you must hold 10% from your subcontractors. Do not finance their retainage with your own cash.
- Negotiate Terms: Try to negotiate a step-down clause (e.g., Retainage drops to 5% once the job is 50% complete).
4. WIP Reporting (Work In Progress)
If you need a bank loan or a surety bond, the bank will ask for a WIP Report.
This report tells the truth about whether you are Overbilled or Underbilled.
- Overbilled (Good): You have billed the client $50k, but only done $40k of work. (You are using their cash to fund the job).
- Underbilled (Bad): You have done $50k of work, but only billed $40k. (You are acting as the bank).
The Formula:
$$\text{Percent Complete} = \frac{\text{Actual Costs to Date}}{\text{Total Estimated Costs}}$$
If your Actual Costs are higher than estimated, your % complete goes up, and your profit fades.
Conclusion: Stop Guessing
Construction accounting is not about saving receipts. It is about Predicting the Future.
If you know your Committed Costs and your WIP status, you can fix a bleeding project before it kills your cash flow.
Your Action Plan:
- Stop using Excel for draws. It causes math errors.
- Start holding retainage on your subs.
- Upgrade your stack. Move to a system that handles WIP and AIA billing automatically.
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