Construction accounting goes wrong quietly. Construction businesses fail with full order books more often than empty ones. The work comes in, the invoices go out, and the bank balance still will not stretch to Friday’s wages. It is rarely a sales problem. Usually the money is sitting in retentions nobody is chasing, in CIS deducted at the wrong rate, or in jobs priced on a feeling rather than a figure.
Key facts
- CIS deductions are 20% for registered subcontractors, 30% for those HMRC cannot verify, and 0% with gross payment status.
- Monthly CIS returns are due by the 19th of the month after the tax month, which runs from the 6th to the 5th.
- The VAT domestic reverse charge has applied to most construction services between VAT-registered businesses since 1 March 2021.
- Retentions are typically 3% to 5% of contract value, held for months after practical completion.
- Profit on paper and cash in the bank move at different speeds, and that gap is where most construction firms get into trouble.
What makes construction accounting different?
Construction accounting differs from other sectors because the money arrives long after you finish the work, and usually in pieces. A retailer sells something and gets paid that day. A contractor completes a phase, applies for payment, waits for certification, and is paid net of CIS. The retention then follows months later, if it follows at all. You earned the profit in March. Your cash turns up in October.
Construction also carries a tax scheme no other industry deals with. The Construction Industry Scheme governs how contractors pay subcontractors, and it removes money from the payment chain before anyone sees it. Add the VAT reverse charge and a construction business is running two tax mechanisms that accountants outside the sector rarely touch.
How do retentions affect construction accounting?
Retentions quietly become the largest unpaid debt most construction businesses carry. A main contractor typically holds 3% to 5% of each payment. The contractor releases half at practical completion and the balance at the end of the defects period, which can be twelve months later. On £500,000 of work at 5%, that is £25,000 sitting somewhere other than your bank account.
The damage from retentions is rarely the amount itself. It is that retentions fall out of sight. They do not appear on the sales ledger as an overdue invoice, so nobody chases them. The defects period then expires without anyone applying for release. A simple retentions schedule turns invisible money into a list someone can work through: contract, amount held, release dates, and whether anyone applied for it.
What is job costing in construction accounting?
Job costing means tracking the cost of each contract separately rather than only the business as a whole. In construction it is the difference between knowing and guessing. A profit and loss account tells you the business made 8% last year. It will not tell you that three jobs made 20% while two lost money, and that is the only figure that helps you price the next one.
Without job costing, construction firms repeat mistakes at scale. You quote the loss-making job type again, because nobody noticed it lost money. Crews carry out variations that nobody invoices, because no one reconciled the work done against the work priced. Materials bought for one site end up on another and the costing never catches up. None of this shows in the annual accounts, which is why it can run for years.
How does CIS affect your cash flow?
CIS takes money out of your business months before you get it back, and the rate depends on your registration status. A subcontractor registered with HMRC has 20% deducted from the labour element of every payment. One HMRC cannot verify has 30% deducted. A business with gross payment status has nothing deducted at all.
The gap between those CIS rates is substantial. Take £200,000 of labour income in a year. Standard registration means £40,000 is held by HMRC across the year. Gross payment status keeps that money in your account, and you settle the tax through your return instead. It does not change what you owe. It changes when you have it. Our guide to gross payment status covers how HMRC grants it and how firms lose it.
On the contractor side the obligation runs the other way. You verify each subcontractor with HMRC before paying them, deduct at the rate HMRC gives you, file a monthly return by the 19th, and issue payment and deduction statements within 14 days of the end of the tax month. Verification is the common failure point. Pay someone at 20% when HMRC says 30% and the shortfall is yours to find, not theirs. The full rules are on GOV.UK’s Construction Industry Scheme guidance.
What is the VAT reverse charge and who does it affect?
The VAT domestic reverse charge means the customer accounts for the VAT on most construction services between VAT-registered businesses, rather than the supplier charging it. It has applied since 1 March 2021. A subcontractor invoicing a VAT-registered contractor no longer adds VAT to the invoice. The invoice states that the reverse charge applies and the contractor handles it.
Two things go wrong with the construction reverse charge regularly. Subcontractors keep charging VAT out of habit, which leaves the contractor holding VAT they cannot reclaim on an invoice they should reject. And businesses used to holding VAT between collecting it and paying it over find that cushion gone, because they never collect it. That second one is not a compliance error. It has still caught out plenty of firms that had quietly been living on their VAT.
Are your subcontractors really self-employed?
Paying someone through CIS does not make them self-employed, and this misunderstanding is the most expensive one in the industry. CIS is a deduction scheme, not a status test. Take a worker who turns up when you say, uses your tools, works only for you and carries no real financial risk. HMRC may well treat that person as an employee however they are paid.
Getting employment status wrong lands on the business rather than the worker. That means years of back PAYE and National Insurance, plus interest and potentially penalties. It is worth asking which of your regular subcontractors would survive that question, before HMRC asks it.
How often should you review your construction accounting figures?
You should review your construction accounting figures monthly, and sooner than most firms manage. Annual accounts in construction are a post-mortem. They tell you what happened to jobs that finished eight months ago. By then the pricing that caused a loss has gone into three more contracts.
Useful construction accounting reporting is short and regular. Where each live job sits against its budget. What is held in retentions and when it falls due. How much CIS you have suffered and reclaimed. What is going out over the next four weeks against what is realistically coming in. That takes an hour a month once the bookkeeping is in order. It is also the difference between catching a problem on a job and finding it in the accounts a year later.
Frequently asked questions
When are CIS returns due?
CIS returns are due by the 19th of the month following the tax month they cover. Tax months run from the 6th to the 5th, so a return covering payments between 6 May and 5 June is due by 19 June. You still file a return in months where you paid no subcontractors, either as a nil return or by asking HMRC to make the scheme inactive. Filing and paying run to different deadlines. The return is due by the 19th, while the deductions themselves are due by the 22nd if you pay electronically.
Can you reclaim CIS deductions?
Yes, you can reclaim CIS deductions in full. CIS deducted from you counts towards your tax bill rather than being an extra cost. A limited company reclaims it through its payroll scheme against PAYE and National Insurance due. A sole trader or partnership claims it through the Self Assessment return. The real problem is not whether it comes back but how long HMRC holds it first.
Do sole traders need to register for CIS?
A sole trader doing construction work for a contractor should register as a subcontractor. Registering means deductions at 20% rather than 30%. It is not compulsory, but not registering simply means more of your money sits with HMRC during the year.
Does CIS apply to materials?
No, CIS does not apply to materials. Deductions are taken from the labour element of a payment, not from materials the subcontractor supplies. This is why invoices should separate labour and materials clearly. Where they do not, the contractor may apply the deduction to the whole amount.
What records does construction accounting require?
Construction accounting needs more records than standard bookkeeping. Keep subcontractor verification references and deduction statements. Keep a retentions schedule with release dates. Allocate costs to the job they belong to rather than the month they were paid. Record each variation when you agree it, rather than reconstructing them at the end.
If you want someone to look at where the money is actually sitting in your business, our construction accounting team works with contractors across Hertfordshire. Send us a message with your last accounts and your current job list.
