Cash flow is a critical reality in the construction business. How much do you have? Who do you owe and who owes you? Thanks to new tax regulations, contractors’ books may get a bit cleaner and clearer.

Recent tax reform will open doors for many in the construction industry to grow their businesses throughout 2020 and beyond. While the cash basis method of accounting has generally been available for small businesses grossing $10 million or less per year, that threshold has now more than doubled. Today, if a business generates revenue of up to $26 million, it can take advantage of this accounting strategy.

What is the cash basis method of accounting?

According to the American Institute of CPAs, the cash basis method of accounting “records revenue when cash is received, and records expenses when cash is paid.” It’s regarded as being a simpler and more straightforward method of accounting. But is it right for all contractors?

What’s important to note, especially for owners in the construction industry, is the cash basis method of accounting enables businesses to defer paying taxes on income until that revenue is actually in hand. In the past, contractors were required to pay taxes on dollars accrued from the time a job exceeded 10% completion, even if payment wasn’t received in full until months later.

That type of accounting, known as Percentage of Completion (POC) accounting, is often problematic in the construction industry. Projects have long timeframes and up-front costs are large; add to that a required tax bill that must be paid before cash hits the bank account and it becomes very challenging for business owners to get ahead.

To blunt that reality, owners in construction often tap large lines of credit to purchase material and pay for labor when a project commences. The result is significant interest charges and debt that needs to be serviced. Now, with more capital available because of the cash basis method of accounting (i.e. no immediate tax burden), businesses don’t have to operate on credit, which can save thousands and thousands of dollars.

The cash basis method of accounting also provides flexibility not offered by the POC-based method. For example, a $20 million-dollar job might require $18 million in costs in terms of labor and material. By being 90 to 100 days in front of the money tax wise, contractors now have some breathing room in the budget. Perhaps most importantly, deferring a substantial amount of income, and therefore delaying the tax payment, business owners now have the ability to free up the funds necessary to invest in their businesses and bid on bigger projects rather than borrow from the bank.

Full disclosure: there is one negative that exists when it comes to the cash basis method of accounting. At any given moment in time, a company can be viewed as being in better or worse shape than it really is, depending on what is owed to the business or what the business owes. The calendar or company fiscal year can also cause some confusion when receivables and payables straddle two years. In addition, non C-corporation entities need to be mindful of the alternative minimum tax (AMT), as there could be a situation where AMT rules eliminate some of the benefits. That said, these issues are easily addressed, especially if a contractor works with a CPA who understands construction finance.

Overall, the positives far outweigh the negatives for businesses that qualify for the cash basis method of accounting. Business owners can elevate the size, type and quality of jobs they bid on, ultimately growing their businesses. To that end, business owners should talk to their accountants about whether or not the cash basis method of accounting makes sense for them. With good planning, it can be used to their advantage.