Contractor Financial Statements – How to Identify Warning Signs Before It’s Too Late

By Deepa Bhat, CPA, Audit Principal
ASL Construction Group

It is not unusual for contractors to go through an entire fiscal year anticipating healthy profits only to end the year in a significant loss position. Here are some tips to identify and correct potential issues before they derail the Company’s financial performance:

  • Constantly question the accuracy of the estimated costs of contracts – as job conditions change, so can the estimated costs to complete a contract. Costs are the backbone of the Work-in-Progress (WIP) schedule maintained on the percentage of completion method and drive the percent complete, and determine revenues recognized for the year as well as the over- or under-billings at the end of the year. If the change in estimated costs is caused by a modification in the scope of the contract or unforeseen circumstances, be proactive in negotiating a change in the contract price. Waiting until project completion only reduces the likelihood of getting the change order approved by the customer.
  • Another reason estimated costs are important is they form the basis for the contract bid after factoring in the contractor’s desired profit margin. In arriving at the bid amount, consider all direct and indirect/overhead costs, which are often overlooked in the bid process. Direct material, sub-contractor, and labor are obvious, but don’t forget to factor in indirect costs related to contract performance, such as indirect labor, fringe benefits and selling, and general and administrative costs, all of which affect the Company’s bottom line. Be sure to negotiate the contract to allow for a healthy profit margin.
  • Just as costs need to be monitored, billing and collecting revenues should be the topmost priority for a contractor. Where possible, include project managers to understand how to optimize billings and solicit their help in collecting past due amounts.
  • Every so often, a contractor will pay expenses on behalf of a related entity, an affiliate, the owners or shareholders and not think to track such expenses. Not only does this dilute the Company’s earnings and affect cash flows, it raises a red flag for potential lenders and sureties who watch closely for unrelated business expenses that impact the Company’s ability to manage cash flows and fulfill its contract obligations.

These are but a few ideas to ensure more accurate and reliable financial performance metrics for your company and will go a long way in reducing unpleasant and unwanted surprises at the end of the fiscal year.