Measure Your Construction Company’s Financial Health: Quiz Evaluation

Test the health of your construction company.

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Quiz Evaluation

1. Financial Analysis

Analytical ratios can be used to pinpoint weaknesses in a construction company’s financial position. Ratios generally fall into four major categories:

1. Liquidity ratios measure a company’s ability to meet its short-term obligations and commitments (e.g., current ratio).

2. Profitability ratios measure a company’s overall performance and returns (e.g., return on assets or equity).

3. Leverage ratios measure the extent a company has been financed by indebtedness (e.g., debt to equity).

4. Activity ratios measure how well a company has been using its resources (e.g., asset turnover).

Bottom line: The best response to No. 1 is “c,” but you need to do more than calculate ratios and file them away. Use the data to set improvement goals, and then monitor your progress.

2. Anti-Fraud Strategies

Be extremely cautious when protecting your revenue and assets, especially in the current economic climate. Experts estimate that fraud totals about 6 percent of revenues for a total average loss of $160,000 that goes 18 to 24 months before detection.

To conquer fraudsters, focus on three primary areas where fraud typically occurs at construction companies.

1. The Office – Although work occurs on the jobsite, the money is processed in the office, which presents fraud vulnerabilities. Does your construction company divide accounting and financial responsibilities among multiple employees? Some contractors implement this measure but then later have to cut staff. If your financial duties have been delegated to only one person or a select few, start including multiple people in the financial process. Force key financial personnel to take vacations, and invite your CPA to the office periodically.

Random, unannounced audits can help you identify dangerous controls and procedure gaps, and these audits put potential wrongdoers on notice. Also, consider having an anonymous tip hotline that employees can call when they detect fraud.

2. The Bank – Some employees misuse bank transactions for their own benefit. Use a bank’s positive pay check-matching services that match the account number, check number and dollar amount of each check presented for payment against a list of written checks. Do not use signature stamps, prohibit checks payable to cash, and set a dollar limit for checks clearing the bank without your authorization.

3. The Jobsite – Theft of cash, tools and equipment can occur, but fraudulent incentive arrangement claims can also occur. These plans can increase productivity, but a foreman or project manager might shift costs to create an illusion of savings. Prevent anyone who stands to earn extra pay from assigning job costs, and hold regular job status meetings.

Bottom line: The best answer to No. 2 is “c,” but the two-year timeline is a minimum. Fraudsters are usually the most trusted employees. If you suspect fraud, ask a CPA to conduct a fraud audit, which differs from a financial statement audit that only finds material weaknesses and errors in the financial reports and not necessarily fraud.

3. Construction Business Succession and Estate Planning

Succession planning should begin immediately. Focusing on daily operational demands instead of long-term succession planning can have serious consequences. Without a succession plan, you will not have a voice in the next management team and will miss out on tax savings. When death occurs without a succession plan, estate taxes start at 37 percent with only nine months for heirs to pay. Begin with a business valuation since estimating tax liabilities for those involved will be the first needed step.

Always be flexible. A customized succession plan may begin with the concept of selling outright but evolve to keeping the business within the family. These plans can be updated easily. Work with a CPA who understands your business.

Bottom line: Long-term stability depends on future planning, including methodically transferring ownership. Your answer to No. 3 might be “a,” but remember that time moves quickly—you should catch succession plan holes before it is too late to correct them.

4. Percentage-of-Completion

Although changes in revenue recognition requirements are under consideration, the percentage-of-completion method is still preferred by most who read contractors’ financial statements.

This method recognizes income as work progresses and is measured most often by cost incurred to-date divided by each project’s estimated total cost. Surety underwriters, lenders and other credit providers understand that actual profitability on individual contracts will change as the project progresses. It is important for the management team to re-evaluate the estimated cost to complete each contract at each interim reporting period.

This provides timely information to minimize problems and maximize profitability. Also, reviewing your historical accuracy rate ensures more accurate future estimates and timely, quality financial data.

Bottom line: Contractors must accurately estimate job profits. Examining actual performance compared to estimates helps contractors plan future work. If your answer to No. 4 was “b,” then analyzing and applying what you learn will improve the accuracy of future estimates.

5. Compliance in Construction

Requirements are ever-changing, with recent examples including:

• State Nexus laws that relate to the portion of income required to be reported in each state
• Worker classification regulations that determine whether a company worker is an independent contractor or employee
• Healthcare coverage requirements for employees under the multitude of new federal and state laws
• New W-2 reporting obligations for 2012 and 2013 by which the aggregate cost of employer-sponsored group health coverage must be reported for each employee on Form W-2

Bottom line: Compliance can make the difference between owning a thriving construction business focused on becoming more profitable or spending valuable time fighting with regulators over rules.