Construction contractors need to work with a CPA who knows their industry to help ensure their financial performance is in line with healthy benchmarks and to remedy any signs of financial trouble, says Julian Xavier, CPA and managing principal of CliftonLarsonAllen, LLP's Walnut Creek, CA office.
Xavier serves on the NASBP CPA Advisory Council
CPAs can help contractors understand finances and plan accordingly, allowing them to win business as well as being more financially prepared. Xavier says healthy benchmarks for contractors include:
• Cash greater than 5% of annual revenue
• A line of credit of at least 5% of annual revenue
• Tangible equity (which excludes goodwill prepaid expenses) greater than 10% of annual revenue
• A current ratio (current assets divided by current liabilities) that is at least greater than 1.0
• Tangible working capital of at least 7.5% of annual revenue
• Minimal underbillings on their projects
• Minimal bad debt or aged accounts receivable (past-due more than 90 days)
• No significant gross-profit-margin fade on projects
Meanwhile, some of the strongest indicators that a contractor could be in a precarious financial position include:
• Overall underbillings greater than 10% of equity
• Significant claims or unapproved change orders outstanding on construction projects
• Interest-bearing debt greater than 100% of equity — that is, if a company owes more money to banks and lenders than what the company's owners have invested in it
• Total liabilities exceeding 300% of equity
• Significant gross-profit-margin fade on projects
In severe cases, these financial shortcomings can put contractors at risk of failure. One such example is large past-due accrued liabilities related to payroll taxes or union-benefit liabilities, which is a sign of cash-flow problems and can lead to significant penalties and fines, Xavier says.
Another problematic sign is significant turnover, particularly in key management roles, Xavier says. When project managers and operational managers leave, “that tells you there's danger, and jobs remaining to be completed might have some problems,” because those managers would take their knowledge of the projects with them when they go, he says.
Another sign of trouble can be when revenue is decreasing but general, administrative, and overhead expenses are not under control, Xavier says. For example, many contractors “continued to spend like when times were good” in terms of bonuses or headcount instead of cutting expenses during a financial downturn, he says.
A severe sign of turmoil is when a contractor loses a line of credit or other financial arrangement with its bank, Xavier says. “That's kind of like your safety net when times are tough,” he says.
To ensure they are in a strong position with regard to benchmarks, contractors should work with a CPA who has thorough knowledge of the construction industry, Xavier says. Such a CPA can benchmark the contractor's performance against the industry's best practices, as well as address areas of weakness and paths to improvement, he says.
A construction-oriented CPA “can help look at billing and collections processes and analyze what to do better to improve cash flow on projects,” which “will go a long way to help with unhealthy benchmarks,” he says.