State of the Construction Financial Industry

Executive Insights from Construction Industry Leaders

Construction Business Owner interviewed top executives and CPAs at accounting firms, as well as leaders in the surety and insurance industries who concentrate their practice on construction. In addition to providing insight into best practices, they comment on the most pressing issues affecting contractors in today’s climate and how to successfully navigate challenges.

What recent accounting changes will impact contractors’ financial statements? 

Senior Audit Manager

Hartman Leito & Bolt, LLP

One of the most impactful changes coming soon is the standard that is currently in exposure draft that will significantly change lease accounting. The changes that are being proposed will most likely create a less attractive balance sheet. As a result of the requirement to record both an asset and a liability on all leased property, a rising debt-to-equity ratio could potentially make it more difficult to obtain bonding and financing. 

Will international accounting standards be implemented in the United States? 

Partner

Carr, Riggs & Ingram, LLC

To date, there has been a significant amount of “convergence” of United States GAAP and International Financial Reporting Standards (IFRS). A lot of progress has been made to bring the two sets of standards together, but many major issues are still up for debate. Areas that have not been settled include revenue recognition, financial instruments, leases and the use of LIFO (last in, first out) for inventories. A majority of accountants and financial statement users have indicated that having one set of global accounting standards should be the goal. At this point, my opinion is that the two sets of standards will continue to converge to mirror one another much more closely over the next few years. However, the complete adoption of IFRS is not likely to take place anytime soon.

How do tax rules differ from GAAP accounting? 

CPA

CliftonLarsonAllen

Tax rules for contractors are widely divergent from GAAP accounting rules for construction. Generally, for tax purposes, most non-residential contractors’ revenue reporting falls within IRS Code 460, which has its own definitions for long-term construction contracts. The reporting for taxable income for long-term construction contracts may differ tremendously from reporting revenue and income on financial statements for GAAP. There are also allowable income reporting regulations for tax purposes related to cash basis, completed contract method and other variations of revenue recognition that are not generally recommended for GAAP financial reporting. 

What other accounting issues do you think are important for contractors to consider? 

CPA and Partner

Citrin Cooperman

Communication between contractors and their creditors is critical. Don’t hold onto bad news—it doesn’t age well. We recommend speaking with significant creditors—typically the sureties and bankers—about changes in the business, not all of which may be good news. These creditors are your business partners and have placed trust in your organization and judgment. They become wary when they find out about changes they are not aware of.

Partner, Construction and Real Estate Group

Dixon Hughes Goodman, LLP

Strategic planning that involves market analysis, operational competencies and ownership and management development and transition plans will separate the survivors from the thrivers as the various segments of the market return to the post recession “normal.”

What should a contractor do if he or she receives a notice from the IRS?

CPA and Construction Practice Leader

Elliot Davis, LLC

Any person or business that receives an IRS notice should contact their CPA or tax professional as soon as possible because most notices are time-sensitive and response dates can often be very short. … Generally, it is best that the taxpayer not have direct communication with the IRS. A CPA or tax professional that handles tax matters and correspondence with the IRS on a daily basis is far more capable of resolving the notice in a timely and cost effective manner.

What issues should a contractor consider when planning for business succession? 

CPA and Partner in Charge of Corporate Finance Consulting

Blackman Kallick

You need to start planning years in advance to maximize what you will receive and to increase the likelihood that the business you spent years building will survive. … If you are the owner of a closely-held business and want to be able to retire, you need to have a management team in place that runs the business and functions without your day-to-day involvement. Otherwise, the value of the business is dependent on you, and the value you receive in a sale will be lower because a buyer is afraid the business will not function without you. However, if you have a solid management team in place that has demonstrated an ability to run the business profitably over a period of time, you will have increased the value you will receive.

National Construction Practice Leader

Grant Thornton

In addition to timing, it is critically important to identify the goals of the owner(s) at the start of the succession planning process. When and how the owner(s) will either monetize their investment in their business or transition it to family or employees who will drive the succession process.

What is a “fade analysis,” and why is it important?

Executive Director

Construction Industry CPAS/Consultants Association (CICPAC)

A fade analysis looks at projected profit on jobs and actual results. This exercise is extremely important since it can give the contractor a critique of the estimating and project management functions. The surety companies do this analysis when reviewing bond applications to make sure the financial statements are realistic.

What recent (or potential) changes in the surety and bonding industry will impact a construction business owner?

Executive Vice President

HUB Northwest 

Preliminary surety results for 2011 indicate loss ratios in the 40 to 50 percent range for many sureties on the portion of their books of business with contractors in the $0 to 50 million annual revenue size range. For the smaller and regional sureties, higher reinsurance loss attachment points than in the past result in these companies retaining a larger portion of resulting surety losses, which combined with operating expense ratios north of 40 percent render bottom line profits marginal at best. These results very likely will lead to further tightening of these sureties’ underwriting standards and requirements on contractors in this size range. 

What are the most important steps a contractor can take to protect and bolster his/her balance sheet?  

Vice President and Managing Director, Account and Wrap-Up Operations

Turner Surety and Insurance Brokerage

Execution, execution, execution—in all aspects of your operation. Every contractor should challenge their business models, identify areas of inefficiencies, and make the changes necessary for improvement. This approach should be done in every aspect of their business, including finance, IT, safety, risk management and operations. Luckily, there are more tools and procedures now that can really make a difference—this includes BIM and lean. Information technology that gives contractors the type of data needed to help manage their business has also improved.

What recent (or potential) changes in the construction insurance industry will impact construction companies? 

Producer

The Graham Company 

Courts across jurisdictions continue to challenge liability coverage provided for construction risks. Some cases are at odds with the traditional understanding of how policies are interpreted and how coverage is provided. Jurisdictions seemingly have a different viewpoint on how an occurrence is defined and how the primary versus excess limits apply. Similarly, state anti-indemnity statutes that limit the amount of contractual risk that can be transferred are being extended to also limit the additional insured coverage being required of subcontractors. 

The resulting lack of clarity and understanding you might have with respect to the risks you may be assuming or transferring for any given project can impact your business. It is no longer only important to make sure your contracts are well-written and combined with broad liability coverage, but now it is equally important to understand the jurisdictions in which you are working and their interpretations of insurance policies.

With the market on the verge of hardening, what strategies should be employed now to better manage what happens over the next two years? 

Construction Risk Management Practice Leader

Marsh Inc.’s U.S. Construction Practice

Some of the recommendations we are giving to clients to enable them to stay ahead of the curve in developing their risk management strategies are to:

• Initiate the renewal process at least 120 days prior to the policy’s or program’s effective date.
• Develop a communications strategy and presentation approach around all key risk exposures. 
• Provide quality data and analytics. In today’s environment, it is imperative that organizations provide underwriters with complete, accurate and thorough data in order to differentiate their risk profile.

Contractors may also consider negotiating multi-year programs for their casualty and property policies. In some cases, rates can be locked in subject to the expiring year’s loss activity under the policy. Another alternative would be to secure a project-specific insurance program on certain jobs establishing the cost up-front for the entire term of the project. Any rate increases to the contractor’s corporate insurance program at renewal wouldn’t apply to that particular contract. 

What subcontract document changes and/or risk management practice modifications should be considered as a result of problems surrounding additional insured endorsements?

President

XL Group’s North America Construction Unit

It is important that contractors understand which additional insured language to purchase and how to effectively manage contractual risk transfer. It is incumbent upon the carrier to also understand the laws in each jurisdiction so that tendering a claim to the negligent party is effective. As the contractor, you want to make sure that you protect yourself by maintaining proper subcontractor agreements in place each time you subcontract work to others. The proper verbiage in those documents is vital for the success of transferring a claim to the appropriate party. Monitoring and qualifying the subcontractors you hire, building the proper language in the agreements and making sure that proper safety techniques and procedures are in place are all forms of good risk management procedures. 

From a general contractor’s perspective, should we implement a contractor controlled insurance program (CCIP)?

Senior Vice President and Director of Construction Risk Services

McGriff, Seibels & Williams 

More and more general contractors will embrace the CIP concept, on both a project basis as well as on a rolling CIP basis. There are a number of reasons: 1) as the market hardens, this will manage costs by removing premium redundancy, 2)  this establishes consistency in coverage between GC and all subs, 3) this removes issues related to additional insured problems and 4) this provides a long-term solution of “known” coverage and limits for completed operations exposures.

How do we plan ahead for higher workers’ compensation costs?  

CPCU, RPLU, ARM, MLIS, President & Principal

Cavignac & Associates

Comp rates are going up and in some cases significantly. At the same time, changes in the Experience Modification formula can drive mods up as well. It is critical to estimate your new modification after the Unit Statistical Report has been filed. It is also important to discuss pricing with your underwriter three to four months out and, if appropriate, to market your program.