Sunday, December 14, 2008
Many contractors are owned and operated by one key individual, the owner. Further, usually the vast majority of the owner’s net worth is tied up in the stock of the company he or she owns. It is imperative, for many reasons some of which I’ll outline here, for every contractor to have an operational succession plan in place to ensure fluid continuity of the business operations.
Let’s say for example that Jane Contractor employs 150 people between the field and the office. On average, for every employee I would suggest that another 1.5 people are dependent/affected by that employee’s livelihood within Jane Contractor’s company. Some employees are married, some aren’t, some have kids, while others don’t. So I’m suggesting that, including the employee, for each person employed perhaps 2.5 total people are affected by the success of Jane Contractor’s business. That’s a total of 375 people dependent on whether Jane Contractor has a plan in place to ensure the continuity of business whether Jane, the primary driver of success in the company, shows up to work or not. There are many business reasons to have an operational succession plan, but perhaps none more important than the financial security of all of the construction companies employees and their dependents. Most, if not all, of the owners I know are great and compassionate people and this issue might be the highest priority. The knowledge that their own families, their employees and the families of their employees, will be able to have a secure financial future should something happen to the “Top Dog” should be a primary driver in the desire to develop an operational succession plan.
Management should prepare an operational succession plan to also serve as an “insurance policy” which can be shown to creditors. Surety companies and banks are generally two very interested parties wishing to ensure that a construction company can perform on its backlog without total reliance on the Owner/President being involved. I’ve witnessed countless times where a bond company requests a succession plan document only to be met with either lack of a meaningful response, “we’ll get it to you”, “it’s in process”, etc. One main concept that usually occurs to me is that the bond company, bank, etc. are only asking for items the contractor should want to have for his/her own purposes in managing the company and ensuring its success more than anyone else! The bond company is not asking for this document to be a pain in the neck, they just wants reasonable assurance (a written plan) that management has a strategy for performing on its backlog in case of unforeseen circumstances. The bond company’s goals are not inconsistent with what the contractor should want/need for him or herself. If Joe Contractor asks a bond company to vouch for him and his construction company that he has the necessary components in his business (relevant experience, capital, personnel, capacity, etc.) to successfully perform the work, Joe Contractor should ensure he has all the pieces in place to back up that promise to perform on the backlog including a contingency plan in case he isn’t able to show up to work for whatever reason.
Another benefit to the creation of an Operational Succession Plan is that it requires the contractor to think about his or her replacements, as well as replacements for them as they vacate their positions. Further, it calls for cross training those individuals now and actually provides for the beginnings of a natural (not getting hit by a truck, etc.) succession plan. Many contractors think about how to get into the business and build the business, but few think about how they will get out of it. For many contractors a viable exit is to sell to the next level of management. Often times that structure necessitates the owner to take back a note (debt) from the new ownership. The chances that the debt will be successfully paid on schedule (or ahead of schedule) are greatly tied to the success of the ongoing business. The new owners/management will fare much better if they are properly trained and groomed for the roles. By having an operational succession plan in place “in case of emergency” you are also building your future possible exit strategy. It is not lost on me that some may think you could be training your future competition, however I am a firm believer that if you create a fair, fun and successful work environment and treat your employees well you will not face that scenario. As long as those future stars have the knowledge that “your” business will someday be “their” business or in the event of sale or other windfall they will share equitably, they most likely will not leave.
It is clear for many reasons the creation of an Operational Succession Plan is an important, fluid document which should be updated as circumstances warrant. There are many important reasons to have the document in place as discussed above. It may seem a daunting task to create such a plan. If you need help getting started we have created a template you can use (and our clients have successfully done so) as a solid starting point, just email me for your copy. I encourage all owners of construction companies to create an operational succession plan to help ensure a bright future for themselves, their employees and all their families. It could be a key component in the perpetuation of the business they worked so hard to start and build.
By Steve Antill, Foundation Software, Inc.
When contractors decide they need new accounting software, the Internet is usually the first place they begin their search. But do a Google search on “construction accounting software” and hundreds of options will appear—accounting software that does estimating; accounting systems that do estimating, accounting, and project management; and project management systems that do estimating and accounting. The construction software industry has reached a point where many vendors are trying to be everything to everyone.
Theoretically, this is ideal. After all, who wouldn’t want a onestop shop for all technology tools? Realistically, though, every construction business is unique, and an all-in-one product may not be flexible enough. An estimating module built into an accounting system, for example, may not work for a specialty trade contractor since the estimating tool is too general. The real question is: When looking to replace an accounting system because it is too generic to meet the
required needs, why consider an all-in-one system that was not designed with the specific business or trade in mind?
Preparation Is Key
So what is the best advice for new technology shoppers? Before taking any other steps, the company should develop a plan and stick to it. The best plans, by the way, are those that include input from all employees who will use the software or who may require information from the system. When shopping for new accounting software, contractors need to prioritize their wish lists. The “must-have” list includes features and functions the company cannot do without. Depending on the company, this list may include American Institute of Architects (AIA) billings, work in process (WIP) reports, certified payrolls, customizable report writers, and so on. Beyond must-have items, shoppers should identify items they could live without and, finally, those they simply do not need.
Companies often overlook functionality when shopping for construction accounting solutions. For example, why purchase an accounting system that includes a built-in, canned estimating module if the estimating module is too generic and may never get implemented? Wouldn’t it make more sense to buy an industry-specific, third-party estimating software product that will integrate with the new accounting system, so the contractor can benefit from the best of both worlds? On top of needing to be prepared for a conversion, companies need to make sure the feature sets of the new system will work for them. Wowed by cool, yet impractical features. Failure to plan. Unrealistic expectations. These are just some of the reasons companies end up with a construction accounting application that offers them limited benefits. Overbuying is something companies often regret, and yet it happens because they get in over their heads and fail to focus on their true needs. It all comes down to one basic purchasing principle: Don’t get sidetracked. Buy only what is really needed and what can realistically be used and implemented.
Sunday, November 16, 2008
In February of this year President Bush signed the Economic Stimulus Act of 2008. Although this may be older news for some, it's important to revisit it now as time is running out for those contractors wishing to take advantage of its provisions as they relate to capital asset expenditures.
A significant piece of this Act deals with 50% Bonus Depreciation on qualified depreciable property (contact us if you have any questions regarding what qualifies). The Bonus Depreciation has no cap on it and the qualifying property cannot be ''previously owned'' (must be new and the taxpaying entity must be the original purchaser). As long as the property was purchased and put in service in calendar year 2008 and is qualifying property, half of it can be deducted immediately (the immediate expensing provisions discussed below applies first) with the balance subject to normal depreciation rules.
The allowance for immediate deductibility of qualifying equipment and other capital assets was raised to $250,000 for tax years beginning in 2008. If the total of the additions exceed $800,000, this allowance begins to be reduced. Also the luxury auto limitation was increased from $4,600 to $8,000.
While it's never a good idea to purchase capital assets merely to take advantage of these tax changes, it may make sense to accelerate purchases slated for the first part of 2009 into 2008 in order to do so. The cash flow required to make significant additions is greatly reduced by these provisions therefore making an earlier acquisition potentially attractive.
By Don Fornes, CEO - Software Advice
Project managers and accounting staff are often a world apart. They differ in personality, computer skills and the type of work they do. While many contractors are content to let these two worlds remain separate, the best companies are integrating what’s managed in the field with what’s accounted for in the office. Importantly, these industry leaders are finding that opposites do attract.
Project managers need accurate, up-to-date job cost data. How much has been spent so far? How does that match to the budget? However, they probably don’t know what invoices have come in and what’s been paid. Accounting takes care of that. What they do know is what’s been done in the field, what’s late and who’s performing (or not).
Accounting has the job cost data. But they can’t put that information in the context of project status. Accounting folks often have a hard time answering critical questions: How do costs-to-date match to our percent-complete? What is our cost-to-complete estimate? Has this sub performed or should payment be withheld?
Forward-thinking contractors are getting a handle on their project profitability by implementing integrated project management and construction accounting software systems. By deploying an integrated system to share data between accounting and the field, they know their profits at each point in time. Even better, they can correct course before it’s too late to get a tough project back on track.
Below we highlight six principal benefits of integrating accounting and construction project management software in a single construction management software suite.
Accurate Revenue Recognition
Accountants play by the book, which in construction usually means recognizing revenue on a percentage of completion basis. Yet while they are charged with recognizing revenue, accountants aren’t the ones with the most up-to-date percentage of completion data. The project managers have that information. Publicly traded contractors, and even most private companies, will want to smoothly match their revenues to their expenses so as to avoid reporting losses, not to mention that doing so achieves a basic premise in accounting, the “matching principle”.
By integrating project management and construction accounting software, the office can understand exactly where each project stands and recognize revenue accordingly. This is especially important in light of the steady stream of invoices and payables processed by accounting.
Accurate Cost-to-Complete Estimates
Managing a project to profit is critical, but too many firms find out in retrospect that they lost money on a job. They may already be half way into the next job when they figure out why. To maintain profitability, the contractor needs to identify cost over-runs on each job and at each phase of the project.
What’s over budget? Is it a sub, labor or materials? Did we blow the estimate? Maybe we should be using different equipment... Regardless, contractors need to identify overruns early and take action.
The best contractors know their cost-complete on each job, every week or month. They identify cost over-runs immediately and have adequate time to change course towards profitability. However, to achieve this goal, they need to integrate job costs with performance data from the field. By combining project status with job costs, an integrated system can identify what’s left to be done with what it’s going to cost.
Control Expenses and Avoid Errors
What if accounting is paying a sub far more than that partner is producing in the field? A sub may be behind schedule on pouring concrete, but that doesn’t mean they’re not up-to-date on invoicing. Meanwhile a Payables Clerk may not realize that a given material is $61/yard, not the $67 deciphered from a scribbled nvoice. Operations could have caught that mistake. Accounts payable needs Operations’ input on what invoices to pay, what to modify and what to withhold.
Leading contractors are implementing a highly structured, electronic process for handling expenses. Within 24 hours of getting an invoice, it’s keyed into the system with an accompanying electronic image of the paper invoice. It is then routed to the project manager to approve, disapprove, comment on or modify. Payments are made in accordance with contract terms to improve accountability and carefully manage cash flow. This disciplined process provides easy access to up-to-date invoice data so that managers can generate accurate cost-to-complete estimates.
Maintain Profits on Change Orders
Change orders can be a great source of above-average profits on a job. However, too often they go unbilled or end up in dispute. Even if you end up negotiating a resolution to a change order dispute, you’ll probably end up making far less than you should have. It’s therefore critical that any change that has a cost or procurement impact must be tracked, approved and billed.
By integrating operations and accounting, leading contractors can manage a
tight change order process. RFIs, submittals and change orders that originate in the field are documented and tracked through a disciplined approval process that reaches back to the office, the client and any subs. In the end, these contractors are able to present a detailed cost impact analysis and the associated paper trail to their client. As a result, they are able to bill in full for the change in work.
Ultimately, productivity leads to profitability. The costs of labor and materials each day are fairly certain. What’s less certain is how much progress you’ll make by employing these resources. Hit your metrics for “soil-moved” or “pipe-laid,” and you’ve got a profit. Fall short of those metrics and you won’t recognize enough revenue to cover costs. Smart contractors realize that key productivity metrics are a leading indicator of job profitability. Where possible, they gather detailed metrics that measure their cost per unit of work.
Achieving this level of detailed measurement requires collaboration between operations and accounting. The superintendent contributes the quantities of work completed each day. These quantities when combined with the related cost information yield unit costs. An integrated system for construction management can provide the environment to collect, analyze and report this information. The resulting unit cost information is a powerful tool for gauging and improving productivity in the field.
While the personalities in operations and financial management may not necessarily match, their view on the business can. Bridging these two worlds requires a well-designed, integrated construction management program. The good news is that the technology is available to automate the ideal scenarios presented above. The challenge is to gain consensus throughout the organization that communicating, sharing data and automating those processes will make everyone’s life a lot easier.
Tuesday, November 4, 2008
We have all heard much about fraud in recent years as it relates to business. In the early 2000s, the news was filled with scandals involving fraud of various types. The mere mention of Enron and Worldcom, for example, is now virtually synonymous with the word fraud. Although these scandals involved very large, publicly traded companies, the fact remains that fraud occurs most often in smaller businesses. Further, according to the Association of Certified Fraud Examiners, the losses incurred due to fraud in the smallest businesses are 100 times greater than those incurred by the largest companies. According to the 2006 Report to the Nation on Occupational Fraud and Abuse by the Association of Certified Fraud Examiners, "The median [fraud] loss suffered by organizations with fewer than 100 employees was $190,000 per scheme…higher than the median loss in even the largest organizations. Small businesses continue to suffer disproportionate fraud losses."
In my almost twenty years in business, I have never seen the frequency of detected fraud and embezzlement as great as it is at this time in our business community. It's tough to know exactly why the frequency with which fraud is committed has increased. It may be due to tougher economic times or specific personal circumstances causing more people to steal. Whatever the case, this abundance of fraud-related activity has only shone a brighter light on the issue.
Let's first understand what fraud and embezzlement are by definition. According to Wikipedia, fraud is "in the broadest sense…a deception made for personal gain." Wikipedia defines embezzlement as "the act of dishonestly appropriating goods, usually money, by one to whom they have been entrusted." One of the key reasons fraud can occur, and why it is more frequent and severe in the small business environment, is the root of a word in the embezzlement definition… trust. In the smaller business office we often entrust employees with more responsibility and greater authority because the financial resources do not exist to hire many people over which to spread the responsibility and authority. This situation leads to the classic "lack of segregation of duties" which is a critical internal control concept. This scenario is inherent in small businesses and small business owners are highly susceptible to fraud and more specifically embezzlement as a result. Also, this trust is earned over many years in some cases. It seems that in many of the cases we see, the person committing the fraud has been working for the owners for 10 years or longer. It is precisely in these relationships where the trust and authority is given far more than it should be because the comfort is so great with the familiar individual and any and all guards are let down. It is an unfortunate observation that these most trusted individuals are, in many cases, the ones who are stealing with both frequency and in large amounts over long periods of time.
In my career, I have uncovered fraud and seen its effects both financially and emotionally on the principals of the business. The cost to small business is greater than the hard dollar cost of the monies misappropriated. The distraction to the business, its employees, owners and others involved with the business is costly in terms of lost productivity as well as the cost to replace a once trusted and valued employee. There is the cost of recruitment and training of a new person as well as, in many cases, the cost of aggregating information to provide to authorities for prosecution. It has been my experience that in many of these instances of fraud, the perpetrator is not prosecuted.
I've heard many reasons for why prosecution is not pursued. These reasons include: remaining loyalty to the individual due to what used to be a strong relationship, not wanting to hurt the person beyond the loss of their job, or embarrassment in being the victim of such a crime, among others. I would suggest that in certain scenarios, one has a duty to prosecute. When you are involved in a situation where there are multiple shareholders, you have a fiduciary responsibility to prosecute and file related reports in an attempt to recover corporate assets. In many of the situations I've seen, the embezzlement occurred in a company owned by one individual. In those cases, the decision comes down to a personal choice as there is no responsibility to other shareholders. However, the rights of creditors should also be considered if there is any question that the embezzlement could place the company in a position where repayment of debt becomes questionable. It is also important to note that prosecution is a good idea so that the record of the individual committing the crime becomes public record. This public record will be discoverable by future employers performing background checks.
Some Ways that Fraud is Committed
There are many ways fraud can be committed. Embezzling cash is most common, however misappropriating goods or engaging in kickback schemes also occur with regularity. Let's begin with a few methods used to steal cash from the company.
If you Google "signature stamp for checks", you will find approximately 276,000 links in less than a quarter second. Many of those links are attempts to sell signature stamps for convenience while other links discuss the fraud associated with the use of signature stamps. I'm of the opinion that using signature stamps is a bad practice. We have seen many accounting personnel use the signature stamp to commit fraud. In fact, before the turn of this century, I had suspected a Controller of embezzling cash. I strongly recommended to the owner to get rid of the signature stamp. I had also led an effort to do work to determine whether fraud was, in fact, occurring.
Later that year, we had built a file such that the Controller, who had been there for over 15 years, ended up confessing. This person called me in to the conference room and actually thanked me for taking away the signature stamp months earlier. As it turned out, despite loyalty to the family who owned the business, this person's personal financial woes (which included a spouse who had been out of work for 18 months) simply made the temptation to steal too great. This person did not want to steal from the business (and the family) however, they felt as if they had little choice. The Controller stole in a number of ways, but most notable was the use of a signature stamp in preparing unauthorized checks.
We have also seen straight forgeries on unauthorized checks.. In a more recent case, an accounting person was allegedly forging checks to fictitious companies they had established, as well as checks written to their own business. In this case the accounting person had been employed with the company for over 15 years; another trusted employee.
In another case, the Controller, who had been in that role since the Company's inception over 10 years ago (and with the management 4 years prior, for a total relationship of over the cost of recruitment and training of a new person as well as, in many cases, the cost of aggregating information to provide to authorities for prosecution. It has been my experience that in many of these instances of fraud, the perpetrator is not prosecuted. That being said, there are many ways you can mitigate fraud and the chances that it will occur in your business. Here are just a few items to consider...
1. Consider obtaining a bond on certain employees
The cost of a bond is possibly cheap insurance should embezzlement or other fraud occur. Also, if you let prospective employees know that you will be bonding them and as part of the bond application the bond company will conduct thorough background checks including criminal, etc. you may find that the candidate decides that another opportunity he/she has is better for them. With this practice, you may prevent a possible bad apple from preying upon your company in the future.
2. Perform Criminal and Credit Background Checks
Employees to whom you will entrust financial assets should be checked; perhaps even conducting a check on a receptionist who may open the mail and list out the checks -- we had one situation, where over 6 weeks an employee was stealing checks straight from the mail. Be sure to get the appropriate legal permissions to conduct these checks from the prospective employees. Asking for this permission could also have a similar effect as discussed above regarding the prospect deciding that perhaps they should try their luck with a different employer.
3. Make these employees take at least two weeks of vacation per year
Do not let employees forego vacations and get paid out unused vacation or carry over unused vacation. The idea here is that most of the embezzlers work very hard to cover up their trail. If you take them out of that job for a few weeks a year, that trail will most likely surface and any wrongdoing will be uncovered.
4. Look for changes in employees lifestyles, circumstances and/or behaviors
As noted in one example above, a change in a spouse's employment situation could be a catalyst. Look for a brand new luxury car in your company's parking lot that you might suspect could be outside the expected financial ability of your employee. In a few of the cases we're aware of right now, gambling addictions are a common thread. Authorities have traced a few of the Controllers to Southern California Casinos. There are many indicators, if one is alert, which could lead to the identification of fraudulent activity.
5. Monitor your financial statements and management reports for unusual fluctuations
As discussed in one example above, we noticed a spike in the cost of materials relative to earned revenue. That fluctuation in a simple metric alerted us to the possibility of a kickback scheme. Monitoring financial reports can provide clues as to the possibility of fraud occurring. When cash leaves the building, often times the general ledger will reflect that activity. Paying close attention to your company's financial metrics will allow you to understand what a "normal" range is and if the numbers stray outside the norm, it could potentially be an indicator of fraud.
6. Prosecute and Communicate
As noted in one example above, the creation of a culture of zero tolerance is important. In another case discussed above, the owner was able to recover approximately $60,000 almost immediately by letting the individual know that the authorities were going to be brought in. That individual thought that making partial restitution would prevent the prosecution process from occurring, but they were wrong. The situation was communicated to all the employees as it was happening. The owner was careful to stick to only the facts as he knew them. The underlying message was that this activity was not acceptable, would not be tolerated and would be prosecuted to the fullest extent of the law.
7. Always have an invoice or other support attached to the back of any check you sign
Oftentimes due to the large volume of checks owners will sign, they only will handle the checks themselves and sign in short order, without taking the time to review supporting documentation to ensure the expenditure is justified. A Controller may run into the owner's office with only the check and ask for a signature. The payee may be familiar -- let's say "American Express." But is it the owner's American Express account or someone else's account? You don't know unless you have the backup for the check agreeing to the check amount. Take the time to review the backup, as it is a common sense practice that is worthwhile.
8. Run a vendor history showing invoice numbers and amounts
You may find an interesting trend by simply running a vendor history. Would you agree that it would be peculiar if the history showed a sequential order of invoice numbers (e.g. 1001, 1002, 1003, 1004, etc.)? I would find that very odd as this would indicate you are the only customer of this vendor which is highly unlikely. This type of invoice number pattern could indicate a fictitious vendor was established by someone in your office.
9. Conduct Seminars about Workplace Fraud
Creating an awareness in your business about fraud is important. Educating your employees about fraud, letting them know how prevalent it is, what the consequences are, and that it is not tolerated is a step towards prevention. Coordinate with your HR Department and your labor law attorney to ensure you are communicating the issue appropriately.
10. Be sure to communicate the need to issue a 1099 to the embezzler
In Wikipedia's discussion on embezzlement there is discussion, based on case law, that the proceeds from the embezzlement are to be included in taxable income. This should be communicated to the person who embezzled funds and explained that if they make remuneration in the same year, then those amounts
would not need to be included in taxable income. That could be one of the factors motivating an individual to make restitution.
11. Provide instructions to your bank
In many of the cases I've seen over the years, the embezzler will write checks out of the operating account directly to him/herself. Instruct your bank to never honor a check from your operating account written to an individual. It is also a good policy to provide your bank with a list of your approved vendors to whom checks written may be honored. Of course you'll need to continuously update that list as you add vendors but that isn't as onerous as it may sound. Your Accounts Payable clerk will need to add a new vendor to your accounting system to write the check in the first place. Make communicating these vendor updates with your bank a part of that same process as setting up the new vendor in your accounting system.
Also, be sure to provide your bank with a list of your employees. Instruct the bank to only honor payroll checks written to names on that list. As with the new vendor procedure listed above, have your HR Manager or Controller regularly communicate new employee names to the bank to add to that list and delete names of those employees who are no longer associated with the company. Have a copy of the bank statements, or the originals, mailed to your home. Review each statement for appropriate employee and vendor names.
12. Hand out employee pay checks at least once a year
Require each employee to provide identification when picking up their paycheck. The paychecks you may have left over will be for those employees who are on PTO (vacation, sick, etc.) that day or perhaps those "employees" don't exist. These checks are for fictitious employees established by someone in your office. There are rules and regulations, certainly in the construction industry, regarding where you must hand out the checks. You may have to go to each job site to physically hand out the checks. In that case you may want to, on a monthly or quarterly basis, rotate which job sites you or your designee will visit.
13. Participate in a limited scope fraud program
Your CPA firm may have a program in place to perform spot checks for unusual activity in certain areas of your business and therefore decrease the chances of it happening in the first place. After the first time or two that your Controller and other accounting personnel note that you are bringing in people to perform procedures specifically designed to help lessen the chances your company will be victimized by fraud, the greater the chance that they themselves may not engage in that activity to begin with. There is an old saying "Employees do not do what we expect, they do what we inspect". If you are inspecting for possible fraudulent activity, the chances of employees engaging in that practice should decrease.
Fraud has been part of our society for thousands of years. It is driven in part by greed and sometimes by fear. Preventing it in absolute terms is most likely a losing proposition.
Implementing controls like having an outside party come in periodically to perform procedures to help identify unusual activity, being alert to changes in your employees behavior and circumstances are all ways to help prevent fraud. Do not tolerate fraud if you experience it in your company…prosecute. If these criminals are not prosecuted, the chances of one of them landing in your company and doing the same to you is increased.
Lastly, be aware that the chances of you becoming a victim are very real. This type of activity happens every day, everywhere. Position yourself by being proactive and be alert so that you lessen the chances it happens to you and your company.
Sunday, October 26, 2008
By Daniel Huckabay, President – Commercial Surety Bond Agency
With the halt in residential construction many contractors are moving into, or expanding their presence in, public works. As a result, competition has increased, bid lists have gotten longer, gross profits are declining and it’s harder to get work at any price. For these reasons, the ability of a contractor to get surety bonds has become even more critical; the question is, “What can contractors do to maintain or even increase their bonding capacity in this tough construction market?”
The first and most important thing contractors can do is keep in touch with their surety agent and bond company. Meet with them periodically to let them know what is going on in your company. Tell them about the things you’ve done to be proactive and deal with the slowdown. Inform them of any problem jobs, assure them of the ways you are keeping it under control, and above all, avoid surprises.
One way in which surety companies will try to stay in closer contact with their contractors is to require more frequent internal financial information. Contractors can expect to see some sureties request quarterly financial reports including a balance sheet, income statement, contracts in progress schedules, completed contract schedules and aging accounts receivable schedules. With this information, sureties will look for how gross profits are holding on contracts in progress, how completed jobs are finishing up, they will try to identify any jobs that are having problems and how the company is doing financially overall.
Sureties will also be looking be taking a hard look at old receivables, because there is generally a rise in slow payments during hard economic times due to disputes and / or owners and general contractors trying to manage cash flow. Sureties typically discount receivables over 90 days under the assumption there is a problem with collection. For this reason, it is important when contractors provide these schedules that they let their agent and bond company know those over 90 day receivables that have been collected since the report date, those where payment is expected in the next 30 days and those where there is a legitimate reason for delay (such as an inability to receive payment until material is on site, etc.).
Contractors can take advantage of the slower times by working to improve their internal accounting systems and ability to produce those reports mentioned above. This will benefit not only the company’s operations, but enhance the contractor’s ability to communicate with their surety. As a result, the surety will be more comfortable and in tune with the contractor’s operation increasing their likelihood to extend bond credit. Furthermore, they may even waive the need for a CPA six-month financial statement, which would be a cost savings.
Almost all contractors are facing lower revenues and gross profits from prior years, and consequently, more and more contractors will have trouble generating enough gross profit to cover their fixed expenses – primarily overhead and equipment debt. For those contractors in this situation, sureties will want to know what overhead expenses have been cut, and there will also be a strong emphasis on reducing debt, particularly debt on idle equipment.
Typically surety companies look for a Debt to Equity Ratio of less than 3 to 1 (calculated by taking total liabilities and dividing it by net worth as analyzed by the surety) and an Interest Bearing Debt to Equity Ratio of less than 0.75 to 1 (calculated by taking the total bank debt or other interest bearing debt and dividing it by net worth as analyzed by the surety company).
The rental for equipment has become very competitive making it a good time to analyze whether it makes sense to sell encumbered idle equipment and rent instead, which will cut expenses and generally improve working capital and these debt ratios. Outline your plan to your surety for generating revenues, managing costs and producing a profit for the company.
Last, but just as important as all of the above, there is no more important time to retain all the money you possibly can in the company. With thin profits or even losses, many companies will face a deterioration of their balance sheet. Since a contractor’s balance sheet is one of the main factors sureties use to grant credit, it can lead to a spiraling cycle: losses lead to lower working capital and net worth, which could lead to lower bonding capacity, which limits the contractors ability to bid work, which then affects their ability to earn the revenue necessary to be profitable. To combat any possible deterioration, contractors should defer nonessential fixed asset purchases and personal expenditures. Also, consider lowering officer salaries if possible and temporarily eliminating any distributions from the corporation to the owners.
If you do have a loss and erosion of your company balance sheet, the best way to convince the surety to maintain your bond program is to communicate the problem early, outline a plan to resolve it, and show a commitment to your business. Discuss with your agent and CPA the possibility of making a personal loan to the company and subordinating it to the surety. This can provide a temporary fix, because the surety will treat this subordinated shareholder loan as capital, but it can eventually be repaid without any potentially negative tax consequences as characterizing the contributed amounts as capital.
Whether it comes to trying to maintain or increase your bonding capacity during this down cycle, the key point in all of this is to communicate with your surety agent and bond company. Treat them like a partner in your business and use them as a resource. After all, their success depends on yours.
Daniel Huckabay is President of Commercial Surety Bond Agency, which has specialized in providing surety bonds to contractors since 1984.
As CPAs who work in the construction industry, we have developed many positions and strategies to help our contractors become best of class and manage successful businesses. No matter what industry you are in, communication will be a cornerstone in your success. Many of our contractors regularly use their surety line while others obtain a bond once in a while. Still other contractors working in the private sector are rarely, if ever, asked to provide a bond. My advice to contractors falling in any of these categories is all the same…be sure to regularly provide financial reports and communicate with your agent!
It seems obvious for contractors who regularly use their bond program to be in regular contact with their bond agent and providing financial information, however it isn’t always the case that they do so. If your company gets bonds less frequently or rarely to never, you probably aren’t too concerned about proactively keeping your agent in the loop. This is a mistake for many reasons. The contractor must continuously, in all aspects of business, strive to position their companies as best of class. This basically means doing things better than most, if not all, of their competitors. There are few areas easier to do this in than in keeping the lines of communication open with your bond company. If your company rarely or never is asked for a bond, it is still a good idea to develop a relationship with a quality bond agent to prepare for the moment when an opportunity arises. I have seen many times over the years where a contractor is awarded a job and needs a bond. The problem is the contractor doesn’t have a relationship in place and has to scramble to convince a bond agent (who then needs to find the right market and convince a bond company) that their company is worthy of a surety program. It is so easy, without any time pressures involved, to ask your CPA or other business advisor to connect you with a good bond agent. They will ask for basic corporate data and have a market on standby for when you land that great opportunity requiring a bond. Have the relationship in place before you have the need!
My recommendation is basically twofold in terms of a proactive communication plan with your bond company. The first is to provide, without being asked, quarterly financial statements and job schedules (which obviously reconcile) to your agent. It is always prudent to have your outside CPA review your internal financial reports before you send them on to the bond agent. I have seen cases where financial reports, with errors, were sent to the bond agent (and the bond company) and this is counterproductive as credibility (one of the 3 “Cs” in the surety world, character, capacity, credibility) is diminished. Providing accurate, timely financial information to your bond agent should be very easy as you are producing this type of information monthly (or at least you should be) in order to effectively manage your business. Since you are sending this package to your bond agent, you should also send this same package to your banker. There is a chance that the parties to whom you send this information may not spend a lot of time analyzing it but that is unimportant. The mere fact that you provide timely and accurate financial information speaks volumes about the type of organization you manage. The second part of my recommendation for your proactive communication plan is to call, at least once a year, an all hands meeting to communicate the state of your company’s financial and operational affairs to the surety underwriter and agent. You should also invite your CPA and perhaps your banker as well. Relationships drive business and there is no better way, especially in today’s world of email, phones, scanners, etc., than to do so in a face to face meeting. One way to do it is to schedule it at 11AM and have lunch brought into your office. If you don’t have a conference room suitable for this size of a gathering you might ask your CPA for use of his/her conference room resources.
The benefits of this communication strategy are numerous. First, no one likes surprises and this method of regular, proactive communication avoids surprises. Second, how many times have you bid on a job requiring a bond and then scrambled to provide financial information to your bond company? This method avoids that crisis and uncertainty as the bond company needs to get up to speed on your account. Also, I’ve heard people in the surety industry say “Oh, guess they need me now…now we’re important.” No one likes to feel like they are only a means to an end…it gets back to the relationship; the two-way mutual respect being shown by both parties.
Communication is a cornerstone for your business’s success. Communication is important inside your organization within your management team, office and field personnel. It is equally important with your outside business partners. As a business owner, you should regularly be reviewing various financial information including your financial statements. Other dashboard type reports should be monitored on a daily or weekly basis. These reports are also referred to as Key Performance Indicators. Providing quarterly financial statements and job schedules to your bond agent should be a very easy task as they are already being done monthly. The benefits are significant and there are no costs associated with doing so. Following this program will help place you in that “Best of Class” position with your bond agent and bond company.
Wednesday, October 1, 2008
Most owners of construction companies came up through the operations side. They were the ones in the field early in their careers, learning their trade from the ground up. Today, many contractors find themselves owning a business that has grown significantly from where it started. They generally aren’t experts in organization structure and therefore aren’t aware of the need to assess the organization they have in place to handle the current and future volume of the business. This is certainly not unique to business owners in the construction industry. Most business owners, no matter the industry, weren’t trained to run a business…any business. I would suggest that the core principles and skillsets involved in running a construction business are the same as those needed to run a manufacturing business, a professional services firm, a retail store, etc. Most of the skillsets involved in managing a business efficiently and effectively revolve around how one deals with the issue of people. One has to put the right team in place and then it’s important to keep the team together all working towards the same goals. It’s imperative to have the right people in our organization and have those people in the right places within the business. This article introduces you to a process which aids the business owner in identifying both the position slots needed, and gaps which may exist, on his or her team. The Gap Analysis is an effective way to accomplish that objective.
Keeping Up With Your Growing Business
We all tend to work within our comfort zones. If the construction business owner came up through the field operations, he or she will tend to run the business from that perspective. The office may be viewed as overhead and the number of people allocated towards office functions may not be appropriate. The accounting department may find itself short-staffed and the owner may find him or herself spending little on the accounting function. At the same time the owner is probably not getting adequate financial and management reporting resulting in poor and/or untimely decisions being made or not made costing the business far more than the savings in short spending on the accounting and reporting function.
The same scenario could be painted for the operations side of the house; not having enough people in a certain function or missing a function altogether. Most contractors started out doing a few million dollars in revenue (sometimes less) in their first few years and today finding themselves doing twenty, thirty, fifty or more million dollars annually in revenues. The organization structure for a five million dollar a year contractor is very different from that of a contractor doing fifty million dollars a year. Often times as a contractor moves through various revenue levels, he or she does not keep up with those revenue changes with the appropriate changes in the infrastructure of the business.
Over my career I’ve made an observation that many contractors can grow reasonably successfully up to approximately 40 or 50 million dollars in annual revenue without significant changes to their executive management infrastructure. That’s not to say that changes should not have been made during that growth period, I’m just noting that many of these businesses tend to perform at least at an average level. When the business grows past approximately 40 to 50 million or so in annual revenues few contractors can successfully navigate those volume levels without significant mistakes and financial pain with their incumbent management team. The reasons usually trace back to not having the appropriate personnel in place in key management positions to be able to deal with the issues which invariably arise in organizations of that size. There are significant “gaps” in management which, in best case scenarios, would have been filled as the contractor was approaching the fifty million dollar revenue levels to begin with. It is important to put the management team infrastructure in place before crises develop.
Many owners refuse to allow other top level management personnel do their jobs without some micromanagement or they don’t acquire top level management to help professionally run the business as many contractors are “overhead” averse. Those actions by an owner can ultimately cripple a business that otherwise has solid prospects as long as the right team was put in place each fulfilling the correct areas of responsibility. A Gap Analysis engagement can be a very useful tool for the business owner who lacks the time and/or perspective to be able to see and understand all aspects and requirements of the business at a high, professional and objective level.
Benefits of a Gap Analysis
Our firm has performed many Gap Analysis projects for contractors and they are always an interesting assignment because we are taking a holistic view of the contractor and his/her business. The business owner generally is not very sure of what his or her team is specifically doing on a daily basis, nor should s/he be. S/he should, however, have a good understanding of what those who directly report to him/her are doing, however this isn’t always the case. This knowledge of what team members are doing is generally the responsibility of a person’s direct supervisor. Throughout the organization supervisors are not precisely sure what their team members are doing and sometimes there are no supervisors for a team when there should be. The problems arise when the reality of the day to day world set in and people starting moving in different directions and assumptions are made about who is doing what. Often times no one is performing a critical function while other times the same functions are being performed unnecessarily by multiple people or in some cases the wrong people. Sometimes a task is being performed with little or no commensurate value and no one is questioning why they are doing the task relying on the knowledge that “this is what we’ve always done”. It is at these times where profitability is eroded and frustrations, mistakes and breakdowns in quality and service are maximized. The team is not pulling in the same direction or they are pulling but their hands may not be on the rope so to speak.
The Gap Analysis helps to identify gaps in areas of responsibility or overlaps within a company. The gaps are created over time through lack of attention to process evaluation and improvement or growth in the company’s business which gives rise to new needs which are never addressed. In order to perform a successful Gap Analysis it is important to first understand the business as it currently exists and operates and fully document the needs of the business. In doing so, one can create an organization chart outlining all the roles and responsibilities of all the positions that should exist within the organization. Once the organization chart and position descriptions are created, we can then evaluate the existing infrastructure, including current roles and responsibilities, and compare them to an ideal organization structure. At this point gaps and overlaps are identified and either re-assignment of responsibilities between existing team members can be suggested and/or the need for new positions are identified. Further, it is possible that the existing organization structure is so far divergent from what the current business needs call for that a complete overhaul is the most efficient solution assuring the needs of the business, its customers and team members are being met.
As mentioned above, it’s imperative to have a good general understanding of the business including its nature (what does it do and how?), scale, market(s) served and existing structure. One of the best ways to gain an understanding in these areas is to interview key employees. Once the interviews are done, a findings and observation memo is created and presented to the management team. The memo often gives management a different perspective of what is going on in their business versus what they think is going on. The interviews will yield both positive and negative results, each of which are equally important in the process. Many of the comments and feedback are based in tangible events and observations occurring in the business while other comments may be based more in perception and feelings. Both types of feedback are also equally important as the organization is built on both tangible (policies, procedures, methodologies, etc.) and intangible (primarily core values, mission, vision, corporate culture, etc.) fundamentals.
After input and discussion from the management team, with the Gap Analysis Project Manager serving as facilitator, a customized Gap Analysis questionnaire is developed. The Gap Analysis questionnaire is given to all key employees and addresses how each views his or her role. For each task listed, the employee notes whether s/he manages, performs, or assists in that task. Once the results in this area are analyzed, it becomes evident who is doing what and whether the right person is performing the function. Also this analysis will identify whether no one is performing a function or if certain functions are being performed but no longer need to be due to changes in the business and/or its processes.
A Responsibility Delegation Summary is also created in chart format. All of the company’s key operational tasks are outlined by responsibility codes for different departments and displays in chart form who should be delegating which duties, tasks and responsibilities to whom.
A Functional Organization Chart is developed which outlines the departments and the roles and functions of each department. Think of this chart as one level up from a traditional Organization Chart which outlines positions. This Functional Organization Chart shows a broader view of the overall company and serves as a good basis from which to create the more traditional Position Organization Chart.
When we build a Position Organization Chart for a construction company, we are sure to include the roles and responsibilities of each position right on the chart. We find titles are simply not enough to convey what that team member means within an organization. A CFO in one company will not operate in the same exact way as a CFO in another company. Many other variables are in play that affect roles and responsibilities and it is also best not to leave it up to subjective opinion as to what is expected from each position. Clearly defining the roles are the best way for the expectations we have for each team member to be met. Position Guides are also created for each role. We also provide a Position Guide Development Procedure to ensure consistency when they are developed in the future as the organization grows and its needs change. Each Position Guide is reviewed with each employee and s/he, as well as management, sign off on the document.
One of the keys to success in business is having the right people in the right places doing the right things. A Gap Analysis project can be of great use to the construction business owner. This project will provide insight and perspective as to the current state of the organization structure as well as provide the road map that will assure the needs of the business, its customers and team members will be met.
Tuesday, September 2, 2008
The credit crisis, energy prices, the residential real estate market, consumer spending, food prices…all of these are contributing factors to our struggling economy. Certain sectors within the construction industry are feeling it more than others, however virtually all sectors go through cycles of outperformance and underperformance relative to their baselines. Many business advisors talk about preparing annual budgets, forecasts, plans (pick your favorite word choice) and talk about their importance in the success of your business. Many also agree that these plans are not static, they must be continuously adjusted based on current conditions. I agree with these assertions wholeheartedly. It is important to measure actual results against a plan in a timely fashion and make management decisions to ensure the organization reaches its financial objectives. There is another plan which is the focus of this article, the plan for “when business goes in the tank”.
The best business decisions are made when there is no time pressure and dispassionate, thoughtful and analytical thinking prevail. The problem many businesses face is that they often times make decisions that are reactive, emotional and in a rush. One such scenario is when business begins to suffer, normally defined by revenue declines. Take a look around the residential construction sector and you’ll see drastic declines in new housing starts, top line revenues and head counts in the field. We’re all well aware of it, whether you are a homeowner, looking to buy a home, or simply watch the business news or read the papers. The best of class businesses in this space reacted swiftly, had a plan in place and avoided the financial bloodbath others endured, many of which are no longer in business. There are many sectors under the umbrella of “construction contractor” and from my own observations it seems that commercial construction, although margins are not quite as high as perhaps a few years ago, is still chugging along. There is more competition, more contractors on the bid lists (we’ve heard of 30, 40 and more) but the work is still out there albeit with perhaps a few delays here and there. Contractors in the public works sector appear to be going strong at this time. Although it is clearly late for those in the residential sector to plan for the downturn they are currently facing, it is not too late for the other categories of contractors just discussed.
What does it mean for business to “go in the tank?” Different people will have different definitions. The fact is it is somewhat subjective and not very important. What is important is to create a plan for when business gets bad. You could use a 20% decline in revenues for Case A, 50% for Case B and perhaps an 80% decline for Case C. Some of those in the residential construction space saw declines in the latter range, so it is not unreasonable to create a plan for that scenario. Think of these plans as insurance…you have them but hope you never have to use them.
The plans should contain financial metrics, forecasted income statements and balance sheets, etc. with the revenue line in the income statement adjusted for each down scenario. Further, operation decisions should be contemplated and outlined in the plan. For example, if revenue decreases 20% how many of your field people would you let go? Are there any office personnel you would consider releasing? Which ones? What type of capital expenditures would you reduce or put a hold on? Would you sublease space? Would you consider moving into other types of projects? Is that really a good idea? What other types of general and administrative expenses would you cut? Could you re assess your insurance premiums based on sales and modify your insurance payments? You get the picture…ask all sorts of “What if?” questions about your business and document your best answers. This exercise, although not having a “due date”, is best done in the next month or two at the most while your business is not declining by 20%, 50% or more. You can be more effective when you are not in the midst of declining business, concerned management and employees, mounting expenses and accounts receivable not being collected in a timely fashion, etc.
Businesses are generally good about filing their corporate tax returns (or extension) by March 15th, owners meet the April 15th filing deadline, etc. When it comes to estate planning, succession planning and planning for poor business conditions most companies fail to make the grade because these are not due, no one is pounding the table asking for these plans by a certain date with failure to comply meaning negative consequences. In addition to death and taxes, it is certain that business at some point will significantly deteriorate. It is important to be prepared for the day when your contract revenues start declining and backlogs start delaying, cancelling and dwindling. Having a plan in place can help mitigate losses and even mean the continuation of your business will little negative financial impact. When the time comes, will you be ready with your plan already prepared and ready to execute?