Tools For The Construction CFO

In this era of ever-tightening profits and expanding risks, accurate and timely discovery of project problems is essential. The sooner a problem is identified, the sooner the corrective actions can be taken. Unfortunately, factors leading to problems often occur before they are recognized for what they really are. Thus, monitoring how jobs are progressing is crucial to your company’s profitability and overall future.

The following are the main financial analysis tools that can be used to reveal and predict a job’s performance. While the tools will not reveal the “whys,” they generally will highlight those projects that need additional attention.

Job Cash Flow

The true lifeline of all businesses is cash flow. As a result, a good starting point is to perform a monthly review of the net positive or negative cash flows relating to each job. This can be accomplished by converting the job status report to a cash basis report. To create the cash basis report, subtract accounts receivable from contract revenue and accounts payable from contract costs. The cash basis job status report will identify the cash position of all jobs, and assist you in identifying negative cash flow jobs. Negative cash flow jobs can result from many items including, but not limited to, untimely billings, slow collections on accounts receivable, “paying before paid” on accounts payable, and unresolved change orders. If you have negative cash flow jobs, you may need to review additional reports and/or discuss appropriate corrective actions with the project managers.

Construction Cost Variance Analysis

Monthly, you should analyze construction cost variances between the revised job budgets and the anticipated costs-to-complete. The revised job budgets should include the original budget plus the costs related to all approved change orders. The anticipated costs-to-complete should include information gathered in preparing the original budget, the committed costs and all incurred costs. You should further separate this information into the significant values of services for a more meaningful analysis. To the extent unfavorable variances between the revised budgeted costs and the anticipated costs-to- complete result from operational problems you and the management team can address these issues immediately.

Work-in-Progress Schedules

Monthly or quarterly, depending on the size and complexity of the company, you should review complete job status reports which include the following basic information: the customer, contract amount, anticipated costs and gross margin, and the revenues and costs recognized and billings processed through the date the schedule was prepared. Though most companies have job costing systems that will automatically provide job status schedules, Excel is an excellent tool for those companies that do not have these systems because you can create custom job status reports. In addition to percentage-of-completion, you should focus your review on two critical areas: 1) significant overbillings and underbillings and 2) the anticipated gross margins.

Significant Overbillings / Underbillings — In a perfect world, contractors will have total net overbillings on their jobs in progress, because overbillings are “money in the bank” and they assure that the owner is financing the development. However, significant overbillings may be a sign of “job-borrow” if the overbillings are not represented in accounts receivable or cash accounts. Additionally, significant overbillings may indicate that all construction costs have not been recorded, which generally results from poor accounts payable cut-off procedures. As a result, significant overbillings need to be investigated to ensure that the costs on the job status schedules are complete and that adequate funds will be available to complete the jobs with significant overbillings.

Project managers should conduct a thorough review of all jobs with material underbillings and explain why incurred costs cannot be billed until a later date. This review will most likely accelerate future cash flows and identify jobs that are susceptible to profit fade or billing terms that need to be negotiated differently on future projects.

Anticipated Gross Margins — You should also investigate anticipated gross margins that are significantly less than budgeted amounts. These variances can result from many variables including estimating errors, variances in pricing on change orders, and unexpected inefficiencies and complexities. In addition, these differences can also indicate scope creep, which should be addressed immediately when change orders are issued. Occasionally, your initial review may not highlight the causes of profit fade, and a more in-depth study of the job status report will be necessary.

One way to gain a better insight on profit-fade in projects is to sort your job status schedule by the following variables: customer, contract size, job type, location, estimator and project manager. These varying sorts may indicate relationships that explain the profit fade, as well as those that are largely profitable. Companies should use this information strategically to improve the profitability on all jobs.

Internal Financial Statements

Quarterly, you should prepare internal financial statements on the same basis as the annual financials. You should compare the financials against the budgets and all significant variations should be investigated. In addition, you should review the backlog of contracted projects to assess staffing, scheduling and other operational needs and projected future revenues and expenses. When appropriate the annual budgets should be reviewed and adjusted to reflect the revised estimates if necessary.

Benchmarking

Annually, you should use ratio analysis to evaluate the strengths and weaknesses of your company against previous years and industry standards. The primary benefit of financial ratio analysis is determining the cause of changes in the ratios. Since bankers and sureties use these tools to evaluate your credit risk, it is imperative that you understand these tools to maximize your bonding and credit limits. The Construction Financial Management Association’s Construction Industry Annual Survey and Risk Management Association’s Annual Statement Studies are two useful publications that provide relevant ratios and industry standards.

Even the most profitable construction companies must adopt and adhere to a sound review process in order to continue profitable growth. Job cash flow, construction cost variance analysis, work-in-progress and completed job schedules, internal financial statements and benchmarking are just some examples of analyses that can be performed on your jobs to identify aberrations and implement corrective action to improve overall company results.

If you would like further information or assistance, please call the construction industry experts at Berntson Porter at (425) 454-7990 or (800) 876-6931.

Chris Newman, CPA, CMA
Construction & Real Estate Group Leader