In construction, it’s not just the concrete that holds things together—it’s cost control. Managing expenses isn’t just a line item; it’s the backbone of a construction firm’s financial health and long-term profitability. The process of cost management requires the following:
- In-depth tracking
- Planning
- Cost controls from project initiation to completion
By managing costs effectively, construction companies can better anticipate project outcomes, optimize their resources, and reduce the chances of going over budget.
The cost-to-cost method is the current best choice for controlling costs. What is it? How is it done? What are the benefits? Are there any drawbacks?
Cost-to-Cost Method: Defined
The logic behind the C2C Method derives from needing to determine the percentage of a project’s completion, which will push more of the revenue ahead of the building project’s direct costs. Direct cost items, from such as materials (concrete, lumber, etc.), equipment, and labor specific to the project generally arrive at the job site sometime after the ribbon cutting and before the first real shovel of dirt turns over.
But before project accountants can apply the cost-to-cost calculation, they first need to use the percentage-of-completion method—recognizing revenue and expenses over time based on how much of the project is complete. This ties back to the earlier point: accurate tracking, careful planning, and strong cost controls are essential.
This approach allows the company to recognize a portion of the project’s profit or loss in each accounting period while the work is ongoing. Profits are evened out, as revenues and costs are more closely matched, avoiding the month-to-month variability that can harm long-term profitability and lead to unnecessary stress, as can happen with cost overruns mentioned above.
How Is Cost-to-Cost Done?
Construction company management and their stakeholders prefer that their accountants use the cost to cost method to smooth cash flows and ultimately boost profits. The steps are straightforward enough. When the project chugs along according to plan (when there no surprises, delays, or hiccups—which rarely happens) the steps are as follows. The first order of business is progress measurement, followed by progress billing.
Tracking Project Progress: Monitoring the advancement of individual project tasks is essential for understanding how much of the job has been completed at any given time. This step helps contractors quantify work performed and align it with billing items or milestones. Keeping tabs on progress ensures that invoicing reflects the real-time status of the job, supporting accurate financial reporting and transparency.
Milestone-Based Billing: Instead of billing the entire contract amount upfront, many contractors use a phased approach tied to project benchmarks. As each stage of work is finished—based on an agreed-upon schedule—an invoice is issued for that portion of the total cost. This method supports predictable cash flow and is especially effective for complex or multi-phase projects.
Proper planning requires a calculation where the accounting department divides all costs recorded to date on a project or job by the total estimated costs to be incurred for that project or job.
% of Completion =
Project’s Costs to Date
Project’s Total Estimated Costs
The resulting overall percentage of completion is used for billing and for revenue recognition.
To calculate revenue for the accounting period:
Multiply the % of completion figure (from above) by the (contract price minus the revenue recognized before this accounting period.)
Of course this is not a one and done. It’s continuous—figures are recalculated throughout the project’s life.
What Are The Benefits?
Higher Accuracy
To achieve the best results from the C2C method, accountants must monitor project progress with a bird-of-prey focus, keeping laser-sharp track of expenses. The result is overall improved accounting and better revenue recognition regardless of the length of the project—which can take years for more significant and complex undertakings. It forces the accounting department to stay on its toes, with rigorous devotion to GAAP (Generally Accepted Accounting Principles) for recordkeeping and cost accounting as the project unfolds. Discipline is baked into this method.
Faster Revenue Recognition
Even more exciting to investors and stakeholders is having revenue recognition be a matter of pushing a button. All the data has been gathered. No last-minute scrambling is needed to make that report for the Board of Directors meeting at noon.
Are There Any Drawbacks?
Not everything is perfect, so we would be remiss if we did not mention some instances where cost-to-cost does not work. Here are a few.
- Inaccurate cost estimation. This method’s power to affect profitability depends heavily on accurate cost estimates for the project in its entirety. If total costs are miscalculated (under or over), the reported income (revenue less expenses) will be misstated. Investors may be erroneously advised, not on purpose, but by faulty assumptions or values placed into the calculation. Certainly, today’s construction management software programs can run several scenarios instantly, but they are only as good as the data they’re fed.
- Indirect vs. direct cost misclassification: It’s not always easy, but determining which costs are directly attributable to the project (e.g., material and labor) versus indirect costs involves judgment and, most of all, consistency from accounting period to accounting period. These are related to inaccurate cost estimations but have a different flavor and impact. Huge, multi-million-dollar contracts cannot afford to be questioned because of a potential manipulation of revenue recognition resting on a flimsy foundation of direct vs. indirect shifting sands—especially if it’s intended, but sad indeed if it was an honest mistake and gets pulled into question.
- Scope creep. Nobody likes scope changes, but they are a way of life, especially for long-term projects where the market changes, technology has had two upgrades along the way, or zoning/government/natural disasters and other vagaries complicate the project. Any can increase costs beyond initial estimates. Unless flexibility has been embedded into the contract wording, these adjustments can require recalculations, complicating financial reporting, and potentially leading to revenue misstatements. Human beings must take charge of the reports, hone and polish their negotiating skills, and encourage a culture of collaboration and communication among the buyers, sellers, investors, and the hard-working people on the ground running the bulldozers.
Cost overruns crush our tidy percentage-of-completion formula. Unexpected cost overruns directly affect the denominator (Project’s Total Estimated Costs). Plug that result into the next formula, and the recognized revenue or profits figure changes, sometimes radically. `
Conclusion
Nothing’s perfect. The cost-to-cost accounting method for large construction projects does have drawbacks, but the benefits of higher accuracy and faster revenue recognition can outweigh the costs. This method demands vigilance in estimating expenses, classifying expenses as direct or indirect, and being accurate and timely with progress measurement and progress billing. The accounting department will be charged with in-depth tracking, strategic planning, and grip-tight control on all costs from project initiation to completion. It’s a method that lets the accounting department receive the kudos it deserves when it’s done well.
If you need counseling on how to incorporate this into your accounting workflow, contact LSL today!
