Accounting in the Construction Industry

Transcription

1 Accounting in the Construction Industry How your CPA can hep you be among the 80 percent of contractors expected to survive the next year, rather than the 20 percent expected to fai. This whitepaper wi have specia interest to: Contractors concerned about their abiity to secure future financing. Advisors to construction contractors. Contractors who reaize they need to make permanent changes to their business, but are unsure of the best path to foow. Entrepreneurs ooking to start a new company buit on their construction skis. Sma contractors whose surviva depends on maintaining a strong baance sheet. Large contractors ooking for CPAs knowedgeabe in construction markets to undertake specia assignments. Insight. Oversight. Foresight.

2 Construction-reated businesses have ong been a haven for some of the most sef-reiant and successfu peope in America. The owners of these companies are used to waking a tightrope over crocodie-infested waters as they navigate compex ong-term contracts, ow-margins and constant demands on their avaiabe cash reserves. Their businesses are so different from others that a totay separate section of the IRS tax code is dedicated to their accounting methods. Even the economy treats contractors differenty, affecting them much more deepy and in different ways than other businesses. This whitepaper is dedicated to heping these unique American businesspeope survive an economic andscape that has dramaticay changed their industry. When writing this whitepaper, we considered that many contractors have ong-standing reationships with their CPA, whether that CPA started with construction experience or not. However, this is a unique time in the construction business that demands a CPA who not ony has construction experience, but aso stays current with the rapid-fire changes taking pace in construction accounting procedures and the construction business. For exampe, under IRC 460, contractors working on home construction projects can use either the cash method or competed contract method of accounting, to gain tax fexibiity. At the same time, a severe recession has forced many contractors to radicay restructure their businesses. CPAs with deep industry ties are abe to hep these businesses navigate the new andscape whie preparing for the inevitabe upturn. 1

3 The Tie Between Procedures and Advice Knowedge of rapidy changing procedures is crucia for success in construction. As the market continues to tighten, many contractors find themseves taking work we beow their target margins, and with profits tight, new work often strains their remaining capabiities and resources. Bidding on such tight margins requires a reiabe understanding of costs. For exampe, if a contractor figures insurance covering office contents as an indirect cost, the costs of a job he is bidding on wi be too high. At the same time, if he doesn t factor in buider s risk insurance as an indirect cost, anticipated costs for that job wi be too ow. In this economic environment, a financia misstep or poor business decision can spe the end of a business that has been operating for decades. Never has it been more critica to work with a CPA who is on top of changes in procedure, understands your business and is respected by your ending sources and surety agents. How a CPA with Construction Experience Can Make a Difference A CPA with industry expertise is a must for a business rued by compex accounting and tax procedures. When you aso consider the need for aggressive cash management, reiabe financing and expert business advice, the seection of a CPA who combines industry knowedge with business knowedge becomes one of the most important business decisions any contractor can make. However, there are at east two other considerations for a contractor when searching for accounting and audit services: 1. Reationships: Certainy it s good to work with peope you are comfortabe with. However, it is more important for your CPA to know and work we with your bankers and surety agents. Since financing is the ifebood of the construction industry, knowedge of how a surety or bank needs to see financia statements is vita. Time after time we have heard from both that they can te if a contractor is being advised by a CPA knowedgeabe about the construction industry just by ooking at how the financias were presented. 2. Business Consuting Expertise: Financia, reguatory, safety and management demands are mounting on every type of contractor. For this reason, we have seen greater use of our consuting services to hep contractors keep their businesses running smoothy. This is especiay true at a time when the need to right-size presents a whoe new set of chaenges to contractors. How do you get payro and overhead in ine with business whie sti maintaining the capabiities required to bid on new business? A good CPA steeped in the contracting business can hep a contractor find the right path forward. doeren.com 2

4 Be Prepared for Permanent Changes in the Business Engineering News Record Magazine recenty named the federa government Owner of the Year in recognition of the increasing roe it pays in the contracting business. Is this temporary or permanent? We don t pretend to know, but government work requires some speciaized knowedge and contractors who want to continue to grow are we advised to master the intricacies of government work. The credit environment has aso changed dramaticay. Not ony have baance sheets been affected by the recent recession, but we are seeing surety agents and credit sources more hesitant to extend credit to contractors who aren t getting the right advice. They pay attention to who is doing the financia statements, auditing the books and providing business consuting services. It has been said that we are in a reset economy. This means contractors have to ook at what they are doing from an operationa point of view. Instead of focusing on cutting overhead immediatey, find ways to make changes in estimating or fied production. If the target is a 15 percent cost reduction, 12 percent can be reaized through these changes eaving another 2 percent to 3 percent to be reaized through cutting overhead. However, contractors have to constanty monitor the situation and be prepared to make other, more dramatic changes. They must adapt. In this entirey new environment, 20 percent of the industry wi fai by the end of any given year. However, 80 percent wi succeed. How cosey contractors stay on top of costs and day-today operations wi determine which group they fa into. doeren.com 3

5 How a CPA Can Hep Contractors Navigate This New Environment There are three basic things an experienced CPA can bring to any contractor s team: 1. Knowedge of the incrediby compex accounting and tax issues facing contractors. Section 4020 of the IRS Code is among the argest and most compex in the entire code. An experienced CPA shoud understand a the intricacies. In addition, contractors tend to operate many corporate entities in order to spread risk. As CPAs, we are often caed upon to hep contractors determine the type of entity best suited to a particuar roe. 2. The abiity to propery prepare financia statements required to secure funding sources. A contractor s access to funding depends on the abiity of their CPA to prepare materias in the way funders and sureties need to see them. Since construction funding is very different than other types of financing arrangements, a CPA needs to have experience in the market to do the job propery. 3. Consuting support to hep them make good decisions at a time when there is itte margin for error. As a contractor once tod us, It woud be impossibe for me to keep up with a the changes taking pace in my business. A CPA with business consuting experience can hep a contractor get above the daiy grind and understand the ramifications of any decision he or she makes. They can hep a contractor understand the proper reationship between direct costs for abor, materia and subcontracting and indirect costs for abor, supervision, toos, equipment, suppies, insurance and support costs. This, aone, can be an invauabe service to any contractor caught in the maestrom of a business where a singe misstep can cause ruin. doeren.com 4

6 How Contracting Businesses Are Different Knowedge of rapidy changing procedures is crucia for success in construction. No two contractors are aike because of the nature of the construction business and the peope invoved. A contracting business demands a high toerance for risk; it wi not attract peope who enjoy painstaking anaysis of financia statements. It is easy to understand why contractors tend to be expert at estimating, winning contracts and getting things buit, yet ess sophisticated about the financia side of their business. As one contractor commented, I don t know if I know the business of business. Thinking and Working Long Term Long-term contracts are the norm in amost every type of construction. This makes it difficut to understand when profits are reaized. A manufacturer who makes and ses a thousand widgets knows how much income he receives from his investment and when he wi reaize it. Contractors working on ong-term contracts don t have this uxury. As one contractor summarized, This is the reason contractors fa under a totay separate section of the IRS tax code, the singe argest and most compex section. I don t know if I Even within their own code section, contractors are treated know the business differenty depending on their size. This change occurred in 1986 of business. when a number of arge defense contractors were found to be using the competed contract method of accounting, pushing off any income reaization and consequent tax iabiities unti the fina jet or batteship was buit. At this point, a ine was drawn between those contractors with gross receipts over and under $10 miion, adding further compexity to construction accounting procedures. Safety makes good business sense In the contracting business, today s probems often have repercussions for many years to come. This is most evident in the costs a contractor has to pay for worker s compensation coverage. To a arge extent, the cost As one contractor summarized, of this coverage is based on a contracting company s safety record. If there have been numerous caims, the higher costs coud prevent a contractor from winning enough contracts to I stay don t in business. know Therefore if I a construction-savvy CPA wi hep a contractor understand the financia ramifications of taking short-cuts with safety. know the business of business doeren.com 5

7 Cash is King Even in the midst of a recession that has decimated arge segments of some construction markets, more contractors go out of business because the money ran out before the work did. In a business where payro is paid out every week or two, yet payment isn t received unti 60 to 90 days ater, there is a strong demand to manage cash. Equipment and materia costs are high. Margins for most contractors are tight. Disaster ooms for any contractor who isn t on top of their business every day. The need to understand their cash position is aso important when a contractor is trying to determine how to cut budgets or add capabiities as business ebbs and fows. Equipment and materia costs are high. Margins for most contractors are tight. Disaster ooms for any contactor who isn t on top of their business everyday For this reason, right-sizing the business has become a major concern for today s contractors. This is often a difficut job for contractors who tend to be an optimistic group; a necessary character trait in a business where one poory executed contract can force a company out of business. The construction industry is one of the few industries that demand at east three parties to any financing agreement. The construction industry is one of the few industries that demands at east three parties to any financing agreement. Besides the contractor, a surety agent is necessary in addition to banks and other financing sources. Without good surety and banking reationships, it is virtuay impossibe for any contractor to compete in today s marketpace. As guarantors of performance, surety agents have a compeing interest in a contractor s business performance. They want their contractors to work with financia peope who understand construction. As one surety agent expains, Just by ooking at a contractor s financia statement, I can te whether it was prepared by someone knowedgeabe about the construction industry. If the statement doesn t have the right numbers in the right pace, that contractor is going to have a tough time getting financing and performing to the contract. doeren.com 6

8 The Demands Paced on Construction CPAs Recenty, we taked to a commercia HVAC contractor who tod us point bank, I m not smart enough to keep up with a the changes affecting my business. That s why I hire professionas. In today s construction environment, a CPA needs to do more than determine whether to use the Competed Contract Method and Percentage of Competion Method to recognize revenue. We beieve they must be abe to work as a true partner with contracting cients, and understand the critica reationship between direct costs and indirect, seing, genera and administrative costs. A construction-proven CPA must aso smooth the reationship between contractors and their financing sources rather than throw up needess barriers. Construction has become a business with very itte toerance for error. A construction-speciaized CPA can hep contractors safey navigate this new environment. doeren.com 7

9 Concusion We wrote this whitepaper to hep crystaize some of the financia issues confronting construction contractors today. Few other businesses face the same compex chaenges and need for financia carity. Few pace such a premium on industry experience to do the job propery. Contractor s spend their ives waking a tightrope between high costs and demands on cash. An experienced CPA adds an important safety net to hep ensure that contractor cients fa into the 80 percent group expected to survive the next year, rather than the 20 percent expected to fai. For more information on contact us at: Michigan Office infotroy@doeren.com Houston Office infohouston@doeren.com doeren.com 8

10 This pubication is distributed for informationa purposes ony, with the understanding that Doeren Mayhew is not rendering ega, accounting, or other professiona advice or opinions on specific facts or matters, and accordingy assumes no iabiity in connection with its use. Shoud the reader have any questions regarding any of the information, it is recommended that Doeren Mayhew be contacted Doeren Mayhew. A Rights Reserved. Michigan Texas Forida doeren.com