Sunday, March 10, 2019

4 Reasons Contractors Fail

As things continue to go well in our market for the building economy and contractors are generally doing well, it's always good to avoid complacency and stay true to sound business practices.  This month we'll take a look at four key areas of running the business of a construction company.  I say it this way because, regardless of sector, owners and CEOs need to manage the overall business of whatever it is their company actually does to generate revenue.

In times where revenues are strong and margins are decent, inefficiencies throughout one's business can be "covered up".  Strong revenue is, to some extent, a "cure" for less than optimal business practices.  Even though your business may not be feeling the effects of not performing well in these areas today, when the market gets tougher you certainly will.  Now is the time to ensure you have these areas covered before you get into crisis mode.  The piece below puts a focus on the following four key business areas:

1. Insufficient cash flow/working capital

2. Poor estimating/job costing

3. Expanding too quickly

4. Lack of Succession Planning

Sunday, February 10, 2019

Construction Industry Financial Update and ABI Check

As we get to mid February many of our contractors 2018 numbers are rolling in, with results showing it was a good year for most.  Net profit margins are above average, with the majority reporting solid financial results for the year.  The challenge isn’t so much finding new work, it’s more finding qualified labor to execute on the abundance of work that is out there.

In construction, we get to see what is ahead in the short/intermediate term by virtue of the backlog as well as bid log, new contracts right around the corner.  Backlogs in our market today are strong, with work being scheduled filling out the balance of 2019 for many contractors with some work being slated for 2020 and even 2021 in some cases in our portfolio.  Prices used to bid new work today are generally designed to yield above average margins with the capacity being limited by already booked backlog.  Times are good for most right now and we should see positive results yet again for the whole of 2019.

The commercial construction market tends to lag the overall economy, which remains strong across the nation by most measures today.  A widely followed leading indicator for the industry is the Architecture Billing Index (ABI).  For more on that index click here… On a national level, the index for December 2018 was 50.4.  For the West region, the score was 49.2, trending up since October 2018.  In a nutshell, billings are reasonably steady, but not growing in the West in Q4 2018.  However activity, especially for those contractors with solid reputations and relationships, has been good in recent times so steady from that vantage point is not a bad thing.  It is interesting to note, however, that the trend line relating to architectural billings from the beginning of 2018 to the end in the West is down.

For 2019 it seems steady as we go with the relative strength we've been enjoying, with an always cautious eye for when the outlook doesn’t seem as rosy.  Always have that “what if the stuff hits the fan” budget ready for sharp revenue declines so you aren’t reactionary when things get tough.

Tax Depreciation Limits

I wanted to share this handy summary for any interested parties, I hope you find it useful…

Changes to Depreciation (2018 and Beyond)

Bonus Depreciation

Under new tax law, tangible personal property placed in service after 9/27/17 is eligible for 100% bonus depreciation.  Also, the property can be used.  Bonus depreciation drops to 50% in 2023.

Used property eligible for bonus does not include property received as a gift or inherited, or acquired from a related party or common control taxpayer.

Section 179 Depreciation
For tax years beginning after 12/31/17 maximum Section 179 depreciation increases from $500,000 to $1,000,000.  The maximum asset placed in service phase out increases from $2,000,000 to $2,500,000.  For assets placed in service after 12/31/17 Sec 179 is mostly redundant since Bonus Depreciation offers the same 100% depreciation without various limitations (exceptions for QIP and QRP).

Luxury Auto Limitations
These limits have been increased for passenger autos placed in service after 12/31/17 for tax years beginning after 12/31/17.  The depreciation has been increased from $3,160 to $10,000 in the 1st year, $5,100 to $16,000 in the 2nd year, $3,050 to $9,600 in the 3rd year, and $1,875 to $5,760 in the 4th and subsequent year.  For passenger autos eligible for bonus depreciation, the increase in 1st year depreciation remains at $8,000.

Heavy SUVs (Gross Vehicle Weight over 6,000 pounds)
The $25,000 Section 179 limit remains but is inflation indexed.

However, bonus depreciation for these vehicles acquired and placed in service after 9/27/17, new or used is 100%.

Pick-Up Trucks qualify as a Heavy SUV if they weigh 6,100 to 7,050 pounds and the truck bed interior length is under six feet.

Qualified Real Property – 4 Categories
Due to the PATH Act of 2015, there are four categories of qualified real property, each with its own set of requirements and limitations, effective 1/1/16.  Note that none of these apply to residential real estate. The four categories are discontinued after 12/31/17.

Leasehold Improvements, retail improvement, and restaurant improvement property are 39 years for California (for all years).

Qualified Improvement Property – (After 12/31/17) This is a new category of property This property is not subject to the limitations in #1, 2, and 3 below.  Instead, the improvement must be placed in service after the date the building was first placed in service (even the very next day is fine).

Conference Report changed life to 15 year property and allowed bonus.  
However actual new law states 39 years and does not allow bonus (but does include Section 179.) Technical correction is required to allow Bonus and change to 15 year property. 

Not to be confused with 15 year land improvements in which Bonus depreciation is allowed.

Qualified Leasehold Improvement Property(No longer exists for property placed in service after 12/31/17) This property is eligible for Sec 179 expensing, bonus depreciation, and 15-year depreciation.  This is an improvement to an interior portion of a building:
1.    Pursuant to a lease that is not between related parties, and used by either lessee or lessor.
2.    The improvement is placed in service more than three years after the building is first placed in service.
3.    Does not include common area of the building.
4.    Cannot include enlargement of the building, escalator or elevator, or internal structure of the building.

QRP (Qualified Real Property) also qualifies as QIP (after 12/31/17) and includes roofs, HVAC property, fire protection and alarm systems, and security systems.

After 1/1/18 a restaurant building does have a special 25 year life but is no longer eligible for Section 179.

Changes in Depreciation if electing out of Business Interest Deduction Limitations 163(j)

A real property trade or business electing out of the business interest limitation must depreciate
any nonresidential real property, residential real property and qualified improvement property in accordance with ADS (Alternative Depreciation System).

Nonresidential real property has an ADS class life of 40 years.  QIP property in this class is not eligible for bonus depreciation under ADS (this would be applicable if there is a technical correction in the law).  Residential real estate under ADS is 40 years if placed in service 2017 and earlier and 30 years if placed in service 2018 and later.

Existing residential real property that is required to be depreciated under ADS will have their depreciation lengthened from 27.5 to 30 years if originally placed in service 1/1/18 or later.  If originally placed in service 2017 or earlier the depreciation is lengthened from 27.5 to 40 years.  Nonresidential real property depreciation increases from 39 to 40 years.  This change to ADS depreciation will likely be the case for most of our real property trades or businesses that have interest expense.

An electing business must depreciate both existing property and new property under ADS in the election year and in subsequent years.  If this is properly done then a form 3115 for change in accounting method is not required because a change in computing depreciation for the election year for existing property is not a change in accounting method.

Sunday, October 7, 2018

2019 Construction Industry Outlook

Last month I went to a construction industry trade conference and attended a session presented by ITR Economics.  I enjoy listening to economic forecasts and do so a few times a year.  ITR is one of my favorite firms in this space as they not only look at the near term, they review longer macro trends and forecast several years out.

I’ve included a copy of their full presentation at the end of this post, however I’ll put the summary below for those that don’t have time to review it in full. 

ITR Summary as of Fall 2018

  •          Nonresidential construction lags; expect a strong year in 2019

  •         Expect fewer projects up for bid late next year to fill 2020 pipeline

  •          Multi-Family/Apartment market still throwing off warning signs, be cautious

  •        Wage and input cost pressure will be intense near-term; prioritize profitable work in 2019, accept leaner             margins looking into 2020

  •         Build cash reserves next year to ensure you can survive a later slowdown

  •         Do anything to avoid layoffs, labor market will be tight through 2020

  •         Follow the Leading Indicators

Although not as good as having an economist present the data to you, I will say clicking through the presentation embedded below is interesting nonetheless.  It provides data on the economy at the national level while also providing state by state economic/demographic data using easy to view maps.  The presentation also covered data on the various sectors of the construction industry including US office buildings, private commercial buildings, educational buildings, hospitals, etc.

One area highlighted was how government spending on healthcare, social security and interest continues to increase as a % of Gross Domestic Product.  In 2018 these areas accounted for just under 21% of total GDP.  That number is forecast to rise to 25% of GDP in the 2030s which will pose problems.  Right after this section there is a slide entitled “What to Tell the Kids” and it stated the following:

  •         Live below their means

  •         Learn a second language

  •         Each household should have multiple or diverse income streams

  •         Choose career(s) oriented toward the “opportunities”

  •         Pay off as much debt as possible by 2030

  •          Be ready to buy at the price cycle low in the depression 

  •          Be self-reliant

Sunday, September 9, 2018

Employment Practices Liability Insurance (EPLI) in the Era of the Me Too Movement (and a little HR function discussion)

EPLI is a type of insurance coverage addressing liabilities arising from wrongful acts involving employees.  These acts can range from sexual harassment to discrimination, wrongful termination, failure to promote, creating a hostile work environment, etc.  It has always been a good idea to at least seriously entertain this coverage, if not carry it. 

The main catalyst for me writing this post is that I’ve realized in recent months that many business owners not only don’t carry EPLI, they have never heard of it.  I have seen first-hand over the years where not having an EPLI policy in place has caused significant financial damage to businesses.  It’s a different time in our society where injustices are not tolerated as they may have been decades ago.  These changes have been occurring long before the “Me Too Movement”, however that movement has put a brighter spotlight particularly on sexual harassment in the American workplace (not just Hollywood and Harvey Weinstein) over the past year.  With these societal developments occurring, it has become increasingly important (it was always important) to train your workforce on a regular basis such that a person doesn’t have to be a victim to any of the circumstances which could give rise to a claim.  Secondarily, even if you have systems in place they could fail and that is when an EPLI policy could be effective in preventing significant financial harm to your business.

One area that has hurt many businesses are wage and hour claims.  The legal profession is aggressive in pursuing these claims and they can reach into the seven figures when they assemble a class of employees to join the lawsuit.  EPLI policies do not protect against wage and hour claims and you cannot bind coverage that would cover monetary judgments in this area.  You can, however, add coverage that will provide for the legal costs incurred against defending these claims.  Generally the amounts covered will be up to $100,000 and covers the defense costs only for wage and hour claims including meal, rest period and overtime.  As mentioned before, class action lawsuits are generally pursued and you must consult with your broker to determine whether there is a "multiple claim or class action exclusion" on the policy.  

Once you've made the decision to carry EPLI, making the best decisions surrounding deductible levels, amount of coverage, etc. are important as it is with any insurance policy.  One difference with EPLI coverage is that, with most standard policies, the amount of legal defense costs incurred goes against (i.e. reduces) the coverage amount.  With general liability policies this isn't the case, so that will be a factor and an important part of the discussion with your broker regarding coverage amounts.

In addition to reviewing EPLI options with your broker, I strongly recommend that if you don’t have a strong HR team in-house, you connect with an outsourced provider.  The maze of employment law rules and regulations is vast, and if you don’t pay attention to the details it could end up costing you and your business in a variety of ways.  Many small to medium sized businesses do not have in-house HR professionals but that doesn’t mean that function can be ignored.  There are providers out there who will take on all of your HR needs or if you have some functions covered internally, you can choose from a menu of services to complement what you already have in place.  Having the HR function properly covered by the right professional(s) can mitigate the risk of having an employment claim made.  As a backup, EPLI is a very good coverage to have in place.

An ounce of prevention is worth a pound of cure as the old saying goes.  Properly, and regularly, training your workforce with human resources professionals is vital in succeeding in today’s workplace environment.  With the right HR professionals on your team, you can not only potentially avoid having an employment claim made against your business, you can also learn how to get the most out of your workforce while your employees also get the most out of your organization in their journey to continuous professional growth and development.  It’s a win-win scenario when done correctly, and can also have many other positive effects on your business including cultivating built-in succession planning, for example, as employee retention (including key employee) increases within a good workplace.  Employees who are happy in their work environment will produce better quality results which should be evident in the bottom line.  At the end of the day we are all in the people business, be sure to treat your people well and have the right HR team in place to help with that initiative.

If you are interested in obtaining the right professional resources to help you with your business lines of insurance (including EPLI) or HR professionals, let me know.  

Tuesday, June 12, 2018

Technology and Your Business - Video Surveillance

Today we have an ever increasing number of technology tools to choose from to employ in our businesses.  The workforce has become more mobile with computing power held in our hands that was barely imaginable 30 years ago.  Productivity gains have been incredible and we can do more with less people.  That trend seems to be increasing as well with automation top of mind of many business leaders around the world.

There’s an old saying in business… “Employees don’t do what we expect, they do what we inspect.”  Well today we can inspect in better and different ways.  One such way is through video surveillance.  Security cameras can be utilized in many different aspects in business.  A business owner can place them on the manufacturing floor, in the warehouse and on the construction jobsite to name a few examples.  At our business we are considering placing cameras in the common areas of our building for added security for our professional staff and to better safeguard equipment.

You can see just in the examples above that cameras can be used for different purposes.  On the manufacturing floor, management can monitor equipment and people making sure processes are operating smoothly and all equipment is up and running effectively.  In a warehouse, cameras can be used to monitor inventory and serve as a deterrent to theft.  Additionally, any unsafe practices with forklifts, ladders or any other shortcut that an employee may take can be mitigated by the presence of surveillance cameras.  On a jobsite, you can again monitor the efficiency of processes as well as equipment usage practices, etc.  Safety can be increased as laborers will be less likely to take poor risks in the execution of the work.  What would it mean to your workers comp insurance premiums if your experience modification was improved in part due to this monitoring as well as keeping your employees safe and on the job?

In all of the above scenarios, having “eyes in the sky” can serve as essentially having another foreman on the site, in the warehouse or on the production floor.  Today’s cameras are high resolution and with certain makes/models, you can zoom in without losing any resolution providing clear pictures in the area of interest within the frame.  One can access these cameras anytime, day or night, from any device including your cellphone, tablet or desktop computer.  If you haven’t already added video capabilities to your business, now is the time to consider doing so.  If you are unsure where to find a technology provider, ask one of your business partners (banker, attorney, CPA, insurance/surety provider, friend in your industry).  This is an investment that should pay for itself in short order.

Sunday, April 15, 2018

Prevailing Wage, Benefits and Compliance Overview

by Mike Bottinelli, Fringe Insurance Services

Prevailing Wage Overview
The wage determination belongs to the contractor (not the employee) with the mandate that it be spent for the employee's benefit in some combination of wages and bonafide third party administered benefits (ie health insurance, qualified retirement plans, flexible spending accounts, vacation plans and severance pay plans).
In California, the base wage must be paid out as cash compensation. Contractors not governed by a collective bargaining agreement may re direct some or all of the fringe portion into the aforementioned plans at their discretion. The employee has no say in how the fringes are allocated. These monies are viewed by DOL and the IRS as employer contributions - not employee elective contributions.
A Merit Shop contractor has enormous flexibility in allocating fringe dollars (absent a Project Labor Agreement (PLA)) to include allocating some or all of the fringes as an add on to wages. In addition, these allocation choices can be made on a job by job and labor classification basis. As a result, if it is advantageous to pay additional cash wages to compete for labor or attract certain trades on a particular job, there is latitude to do that.
Because of the discretionary nature of fringe allocations, benefit plan designs can be
customized to meet a contractor's individual needs. This flexibility often allows benefit plans to operate off the same platform for work performed in both the private and public sector. Conversely, prevailing wage drive benefit plans can be established to operate concurrently with existing core benefit plans.
The ability to redirect fringe dollars into benefit plans affords a significant tax and cost savings to both the employer and employee. Since these dollars don't flow through payroll they are not subject to payroll taxes (FICA, Workers Compensation, FUTA, SUTA or General Liability Insurance (based on payroll) nor are they subject to income tax at any levelAdditionally, they can be used to directly offset medical insurance costs. These advantages level the playing field when bidding jobs.
How these savings are applied is at the total discretion of the contractorThey can be used to lower bids and/or increase profits and that decision can be made on a job by job basis.

Benefit Plans

Qualifed Retirement Plans:
Retirement plans in a wide range of platforms capable of addressing virtually any design requirements and/or demographics can be offered.
Plans are available on a bundled (administration and investment provider the same entity) or unbundled (administration firm independent from investment provider) with a wide range of investment and third party administration options.
Health and Welfare Plans:
Available programs include fully insured plans (HMO, PPO, HSA) from all major carriers, partially self insured plans, levefunding plans and actuarially designed stop loss self insured plans and can be designed to desired specifications.
If necessary, prevailing wage employee groups may be isolated and offered dedicated plan designs without impacting other employee classifications currently covered by existing core benefits,
Vacation Plans:
Merit Shop contractors are not required to provide vacation pay. If they choose to offer this benefit they can put additional monies on the check for that purpose or accrue it in a third party trust. If they accrue it, they can only offset their cost with fringes dollars based on the ratio of public to private work. An in-house sponsored accrual plan is not allowed in California, while it is allowed in a Federal Davis Bacon or Service Contract Act.  In either case there is no tax savings - if it goes on the check it's subject to tax, if it goes into an accrual plan it merely defers the tax until the employee is issued a vacation check.

Hour Bank Plans
Participants become eligible for coverage by accumulating a minimum required hours of work credit. For example, if eligibility for benefits is based on working 130 hours per month, each 130 hour increment of work credit provides a subsequent calendar month of benefit for the participant (and dependents if family coverage is elected).
The hourly equivalent for monthly premiums is determined by dividing the participant's
monthly premium by the hour bank level (ie. $390 monthly premium divided by 130 hour bank level equals a $3.00/hr equivalent).
Once the participant has completed the necessary 130 hours of work credit, they will be
covered effective the 1st day of the following month (ie. if contributions started September 1st coverage would begin October 1st). Participants accumulate hours of work credit for excess hours worked (ie. participant worked 160 hours in a month, the participant will accumulate an excess of 30 hours of work credit for the month (160 hours worked minus 130 hours required equals 30 hours excess credit toward future coverage).
If a participant falls below the required amount of hours of work credit, they or their employer can make up the difference. If not, then a COBRA notification will be issued. Once the minimum required hours have been reached again, benefits will resume the 1st of the following month.
Upon termination of employment the cash equivalent of any remaining hours may be used to offset COBRA premiums or refunded to the participantRefunds are subject to income tax and a 1099 will be issued to them at the end of the calendar year.

Hour Bank Plan Advantages
Hour Bank Plans solve the problem of contractors paying medical insurance premiums for employees as though they were working full time when they are often working less than full time.
Using this methodology, premiums are paid on a retrospective basis. The traditional method pays premiums at the beginning of each month with no way of knowing how many hours an employee will actually work that month. As a result, a contractor is either overpaying or underpaying. Hour Bank Plans remedy this situation with the added benefit of providing a method for reconciling monthly premiums to an hourly rate equivalent for compliance purposes.
Advantages from Employer's Perspective:
Employees learn coverage has to be earned
Addresses "lack of value" perception of benefits by employees
Aligns cost of benefits with bidding/job costing
Affords flexibility in amount of cost employee pays on private work
Advantages from Employee Perspective:
Helps cash flow issues when not working
Dollars vest immediately
Simple to understand - work an hour get paid a benefit for one hour
Earn extra benefits by working extra hours

Wage Determinations:
On Federal jobs, the fringe is expressed as a lump sum. On State and Municipal jobs the fringe is designated in a "line by line" format ( ie. pension, health & welfare etc).
The Unions' various collective bargaining agreements determine the hourly rates by labor classification and the fringes are allocated in their trusts based on the various job classifications and area jurisdictions.
Merit Shop contractors are not bound by collective bargaining agreements and can allocate fringe dollars at their discretion (with the exception of training or when performing work governed by a Project Labor Agreement) in any combination of cash or bonafide third party administered benefit programs (ie. retirement plans, group medical insurance, vacation plans, flexible spending accounts and severance pay plans).
Employer Obligation:
Wage determination dollars belong to the contractor, not the employee. This is the basis for them not being subject to payroll taxes.
The contractor's obligation is to spend the money for the benefit of the employee on a per hour/per employee basis in some combination of cash and/or bonafide benefit plans with the base rate required to be paid in cash.
In an audit, the contractor does not have to prove the employee received a benefit from fringe dollars allocated to bonafide third party administered benefit plans. It is assumed the employee received the benefit of dollars allocated to these plans.

In order to take full credit with the fringe to offset medical insurance plans, the contractor must pay on every hour an employee works in a pay period (both public and private). The rationale for this rule being since Union contractors must pay into their trusts on every hour worked, not requiring it of Merit Shop contractors would give the an unfair advantage by giving them the potential to subsidize benefits provided on private work with dollars accumulated from fringes on public works.
The only exception to this rule is contributions to a qualified retirement plan because they are 100 vested immediately and, as such, are viewed as a "cash in kind" benefit.
Credit Calculation:
Determining Hourly Rate:
Monthly premium divided by hours worked in previous month on per employee basis, or
Annualized premium divided by 2080 hours on a per employee basis
Ratio of public to private work:
Monthly premium = $260/130 hours worked = $2.00/hour 
80 hours worked on PV job - 80 hours worked on private job
80 hours x $2.00/hour = $130 credit


25                Number of Employees
$20 per hour     Fringe Rate
160 per month   Hours Worked
$80,000         Contribution per Month
20               Payroll Burden (FICA, FUTA, SS, Comp)
$16,000         Savings per Month

You Save:
FICA contributions
Workers Compensation premiums
General Liability premiums(if based on payroll)
                         - You become more competitive
You increase your contract volume
You generate higher profits