Growing Contractors: Your Financial Practices · © 2015 | All Rights Reserved | 805 King Farm...

Your Financial Practices

Growing Contractors:

blogs.aronsonllc.com

1. Growing too fast

2. Obtaining work in a new geographic region

3. Dramatic increase in single job size

4. Obtaining new types of work

5. High employee turnover

6. Inadequate capitalization

7. Buying unnecessary equipment

8. Poor estimating and job costing

9. Poor accounting system

10. Poor cash flow

Top 10 Reasons Contractors Fail

Presenters

Chavon Wilcox is a partner in Aronson LLC’s Construction and Real Estate Services Group. She has over 13 years of experience providing accounting and assurance, business/personal taxation, and business consulting services to construction and real estate companies. Her clients include general contractors, subcontractors, joint ventures, real estate developers, homebuilders, property managers, and design/AEC firms. 301.231.6288 | cwilcox@aronsonllc.com

Chris Vasquez is a senior manager in Aronson LLC’s Construction and Real Estate Services Group, where he provides accounting, assurance and tax services to construction contractors and also performs operational reviews and litigation support for emerging contractors. As an expert in the field, Chris has conducted presentations on the latest accounting trends to various sureties and bankers.301.231.6244 | cvasquez@aronsonllc.com

Michael Corcoran is a senior manager in Aronson LLC’s Construction and Real Estate Services Group. With more than 11 years of professional experience, he provides comprehensive assurance, tax and consulting services to general contractors, electrical contractors, mechanical contractors, heavy and highway contractors and masonry contractors with revenues ranging from $2.5 million to $4 billion. 301.231.6223 | mcorcoran@aronsonllc.com

Timothy Cummins leads Aronson LLC’s Construction and Real Estate Services Group. He joined the firm in 1982 and has spent over 20 years in the industry. Tim's clients include construction professionals, including general contractors and subcontractors, real estate developers, and property owners. Tim specializes in general accounting, tax, litigation support, strategic planning, and business consulting services. 301.231.6213 | tcummins@aronsonllc.com

GC Subcontractor

< $250M < $100M Fully Integrated Management Team

$50M – $250M $25M – $100M Increased Specialization

$15M – $50M $10M – $25M Professional Management

$1M – $15M $500,000 – $10M Estimator & Additional Superintendent

< $1M > $500,000 Entrepreneur

Construction Contractor Stages of Growth

“Mom & Pop” Focus

“Get Work, Do Work” Focus

Project Management Focus

Market, Client Focus

Total Quality Focus

Management StyleAnnual Sales

Where are you now? Where are you going?

Agenda

• Accounting Back Office

• Job Costing

• Change Order Management

• Cash Management

• Growth Management

Accounting Back Office

• Accounting System

• Accountant, Internal and External

• Internal Controls

• Financial Reporting

Organizational Structure Growth Projections

Accounting System

Collaboration & Participation Construction Specific Software

Accounting System

Accountant, Internal and External

What’s the difference?

• CPA

• Accountant

• Bookkeeper

Internal Controls

Basic Functions that Should Operate Separately:

1. Authorization

2. Recordkeeping

3. Custodianship

4. Reconciliation

Internal Controls

• Responsibility rests with the owner and top management

• Other factors that influence controls include:

• Size of Your Business• Management Style / Delegation• Cost of Procedure• Collection of Information

Financial Reporting and Analysis

Most important criteria….

USEFULNESSHow?

• Comparability• Historical records• Budget or projections• Decision making tool

Financial Reporting and Analysis

• Balance Sheet

• Income Statement

• Work In Process Schedule

• Gross Profit Analysis

• Cashflow Analysis

• Financial Ratio Analysis

Why is Job Cost so Important?

1. Revenue Recognition/Job Profitability

2. Billings and Cashflow

3. Cost Accumulation Support

4. 3rd Party Scrutiny

Example ComparisonNo Indirect Costs Allocated Indirect Costs Allocated

Year 1 Year 2 Year 3 Year 1 Year 2 Year 3

Contract Amount $ 500,000 $ 500,000 $ 500,000 $ 500,000 $ 500,000 $ 500,000 Direct Costs 425,000 425,000 425,000 425,000 425,000 425,000 Indirect Costs - - - 50,000 50,000 50,000 Gross Profit $ 75,000 $ 75,000 $ 75,000 $ 25,000 $ 25,000 $ 25,000

Gross Profit % 15% 15% 15% 5% 5% 5%Percent Complete 47% 94% 100% 51% 94% 100%

Contract Revenue Earned $ 235,500 $ 470,500 $ 500,000 $ 252,500 $ 468,500 $ 500,000 Contract Costs Incurred 200,000 400,000 425,000 240,000 445,000 475,000

Gross Profit 35,500 70,500 75,000 12,500 23,500 25,000 Indirect Costs Expensed 40,000 45,000 50,000 - - -

Net Income (Loss) Before G&A $ (4,500) $ 25,500 $ 25,000 $ 12,500 $ 23,500 $ 25,000

Direct Costs

• Actual labor charges and related payroll taxes, fringe benefits and insurance.

• Materials, including taxes, freight, storage costs, etc.

• Subcontractor costs

• Equipment (owned or rented)

• Other costs – bonds, permits, etc.

Indirect Costs

1. Does the cost relate to the performance of a particular job in process?

2. Does the cost relate directly to your construction activities?

If the answer is YES to either question, then the costs should generally be included as a direct or indirect cost.

Types of Indirect Costs• Project management• Estimating• Safety• Purchasing• Contract administration• Labor burden• General conditions • Small tools and supplies• Vehicle and communication costs• Insurance• Other costs

Types of Cost Pools

• Labor burden• Equipment• Shop and yard • Vehicle• Job overhead

Cost Pool ExamplePlumber Welder

Base Hourly Rate $ 18.00 $ 27.00

Burden Rates:Payroll Taxes

FICA & Medicare 7.65% 7.65%Unemployment - Federal 1.50% 2.75%Unemployment - State 1.00% 1.00%Total Payroll taxes 10.15% 11.40%

Fringe BenefitsHealth, Life and Disability Insurance 8.00% 10.50%401(k) Plan 6.00% 6.00%Other 2.00% 4.00%Total Fringe Benefits 16.00% 20.50%

InsuranceWorkers' Compensation 8.00% 12.50%Liability 2.00% 5.00%Other 0.50% 0.50%Total Insurance 10.50% 18.00%

Total Labor Burden Rate % 36.65% 49.90%

Total Cost per Hour $ 24.60 $ 40.47

Cost Allocation Objectives

1. Comparability between actual and estimated costs

2. Bill and collect for all your costs incurred

3. Compare to your industry segment

Change Order Basics

• What are change orders?– Assertion of a contractor’s right to

additional time to complete the work, and/or additional money.

• Some reasons why change orders arise:– Design errors– Changes in market conditions (new products)– Undisclosed existing conditions– Extra work

Most Types of Change Orders

• Owner-acknowledged changes– Changes initiated or approved by the owner

• Constructive changes– Owner caused additional work

• Not initiated by the owner– Rejection of conforming work, acceleration, problems with owner provided

equipment

• Consequential changes– Incurred as a result of another change on the project– Domino relationship cause and effect

Basic Cost Elements of Change Orders

• Direct costs: labor, materials, subcontractors

• Indirect costs: home office overhead, opportunity costs, lost profits

• Consequential costs (damages): interference, disruption, re-sequence

Major Components of Change Order Management

– Prospecting the change orders– Preparing the change orders– Pricing the change orders– Presenting the change orders– Performing the work– Payment on change orders

Change Order Management

Change Orders

Prospecting

Preparing

Pricing

Presenting

Performing

Payment

Clear identification of work that is beyond the scope of the original contract:

– Reviewing the design process to determine if properly completed– Investigating the contract to expose potential conflicts– Researching documents to identify any errors or omissions

Prospecting the Change Orders

Preparing the Change Orders

Establish a change order file to include:– Date of discovery– Company or personnel who discovered the change– All written documentation (change order form, contractor’s

change notice form, reports, invoices, minutes, emails, etc.).– Photos, plans, specifications, etc.– Notification letter to owner

• Dispute clauses generally indicate a specific time requirement for notification after discovery of the change

• Should include: time and cost estimates; owner is expected to make every effort to resolve the problems quickly; and contractor intends to be compensated for all effects of any change.

Contractor’s Change Notice Form Example

Pricing the Change Orders

Multiple complexities involve:– Use of forensic estimating– Use of delay analysis to allocate delay-days to various

responsible parties– “Measured-Mile” calculations– Use of industry-accepted inefficiency formulas– T&M for obvious direct and indirect costs

Presenting the Change Orders

Three basic elements:– Direct costs– Indirect costs (home

office overhead, delay costs, opportunity costs, lost profit)

– Consequential costs (damages, interference, disruption, resequencing)

Performing the Work

Tracking project effects:– Direct cost tracking is important– Indirect and consequential cost tracking is more important to

track• Must be tracked in explicit detail• Calculations must be accurate• Use of a robust cost accounting system and schedule documentation

Payment on Change Orders

Billing and payment will normally follow the same procedures and timing of base contract billing.

What is Cash Management?

Cash Management is the act of:

• Organizing,• Planning,• Collection of,• Investment, and• Disbursement……

of your Company’s CASH.

Markup Margin

Tells us how much we need to charge given an estimated cost

Useful for determining contract prices

Difference between the cost and the selling price

Ex. If Markup % is 30%, then the sales price is 30% above cost.

Tells us how effectively we are earning profit from sales

Useful for determining what percent of sales will be used to cover overhead and be turned into net income

Difference between the selling price and the gross profit

ex.. If Margin % is 40%, then 40% of the sales price is gross profit.

Markup vs. Margin: What’s the Difference?

Markup vs. Margin: Impact on PlanningDetermining Sales Price with

a Target MarkupDetermining Sales Price with

a Target GP Margin %

Job Costs $ 100,000Markup 1.4**Sales Price $ 140,000Gross Profit $ 40,000Gross Margin 28.6%

** Knowing your markup is because you created a budget!!!

The Wrong Way: Job Costs $ 100,000Markup 1.29Sales Price $ 129,000Gross Profit $ 29,000Gross Margin 22.5%

The Right Way: Job Costs $ 100,000GP Margin (1-.0.286 = 0.714)Sales Price $ 140,000Gross Profit 40,000Gross Margin 28.6%

Buy, Lease or Rent: Pros and Cons?BUY

PROS CONS

• Length of commitment/flexibility

• Tax Benefits (Depreciation, deductions of other related expenses)

• May have resale value down the road

• Use equipment at or near capacity

• High initial investment

• Must manage and pay for maintenance, insurance, storage, transportation etc.

• Equipment may become obsolete over time

• Use equipment below capacity

Buy, Lease or Rent: Pros and Cons?LEASE

PROS CONS

• Low initial investment

• Manage maintenance

• Lowers operating costs

• Interest rates generally higher

• Complex accounting rules

• Leases could be expensive to break

Buy, Lease or Rent: Pros and Cons?RENT

PROS CONS

• Low initial investment

• Access to broad range and latest equipment

• Maintenance, insurance, etc. handled by rental company

• High rental fees

• Needed equipment may be unavailable or already rented out

• If the project is delayed, you may be renting equipment that isn’t in use

GC Subcontractor

< $250M < $100M Fully Integrated Management Team

$50M – $250M $25M – $100M Increased Specialization

$15M – $50M $10M – $25M Professional Management

$1M – $15M $500,000 – $10M Estimator & Additional Superintendent

< $1M > $500,000 Entrepreneur

Construction Contractor Stages of Growth

Total Quality Focus

Management StyleAnnual Sales

Where are you now? Where are you going?

Stages of Growth Worksheet

Management Operations BD / Marketing / Estimation /

Bidding

Accounting / Finance

Total Quality Focus

Where is your business today? Where do you want to be?

Questions

Growing Contractors: Your Financial Practices · © 2015 | All Rights Reserved | 805 King Farm...

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