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The success of most construction businesses is built on not only quality work, but also positive relationships. Obviously, you’ve got to work well with project owners. But you need a solid rapport with other entities as well — including lenders, sureties and other stakeholders.
One way to enhance these relationships is to consistently generate complete, accurate and timely financial statements and other documentation. Here are some ways to up your financial reporting game.
This may seem obvious, but sloppy financial reporting is a big red flag for financial statement users. Regardless of your company’s financial health, lenders and sureties will hesitate to extend credit unless your statements are complete, accurate and timely. That also goes for additional documentation such as work-in-progress (WIP) schedules and owners’ personal financial statements.
Don’t view financial reporting as only a once-a-year activity. Dedicate yourself to preparing high-quality interim financial statements throughout the year — preferably those that adhere to generally accepted accounting principles. Lenders and sureties hate surprises; solid monthly or quarterly financial reporting will minimize the need for year-end adjustments.
Compare current financial statements to previous years’ statements as well as to industry data from comparable companies. Benchmarking against your own results can reveal trends in financial performance over the years — both positive and negative — and reveal potential reporting errors. You may discover opportunities to improve your financial reporting as well as to reduce debt, speed-up collections or correct a pattern of under- or overbilling.
Benchmarking against industry data lets you see how your financial statements and key performance indicators stack up against the competition. The Construction Financial Management Association produces an annual Financial Benchmarker report, which can be a useful tool for your company analysis. Through this benchmarking tool, you can compare key ratios — such as debt-to-equity, return on equity, working capital turnover and current ratio (current assets to current liabilities) — to those of construction businesses of similar type and size in your geographic region. Benchmarking can serve as an early warning system that enables you to address financial weaknesses before it’s too late.
It’s not enough to be profitable on paper or have a healthy net worth. Financial statement users also want to see solid working capital and a strong cash position, which reflects your ability to fund current operations.
Working capital is defined as current assets minus current liabilities. Current assets include cash and assets readily converted into cash — such as short-term receivables and certain inventory — in contrast to illiquid assets, such as buildings and equipment. In assessing working capital, lenders and sureties usually discount riskier assets, such as old or related-party receivables or prepaid expenses.
There are many strategies for improving working capital. Examples include accelerating the collection of receivables, negotiating more favorable payment terms with vendors and suppliers, and refinancing short-term debt with long-term debt.
Among the most important documents for lenders and sureties is the WIP schedule, which tracks contract price (adjusted for change orders), costs incurred to date, estimated job costs, estimated gross profits, revenues recognized, percentage of completion, billings to date and other information for ongoing jobs.
Preparing and analyzing periodic WIP schedules can help you spot problems and address them before they can escalate. For example, a WIP schedule may reveal jobs are underbilled, which could signal lax billing practices, cost overruns, management inefficiencies or an unhealthy number of unapproved change orders.
Reviewing and comparing WIP schedules and completed contract schedules over time can also uncover unhealthy trends such as profit fade — that is, gross profits that decline over the life of a project. Profit fade is a red flag for lenders and sureties, so it’s important to address it promptly. Potential strategies include improving estimating practices (or using more conservative estimates) and fine-tuning procedures for managing change orders.
Sound, trustworthy financial reporting can mean the difference in getting the funding and bonding you need to grow your construction business. Count on Doeren Mayhew’s construction CPAs to help you identify winning ways to raise your game to the highest level. Contact us today to obtain assistance.
This publication is distributed for informational purposes only, with the understanding that Doeren Mayhew is not rendering legal, accounting, or other professional opinions on specific facts for matters, and, accordingly, assumes no liability whatsoever in connection with its use. Should the reader have any questions regarding any of the news articles, it is recommended that a Doeren Mayhew representative be contacted.
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