Industry Insights

Great news:  You were just awarded the big contract you and your staff worked so hard to win. Now it’s time to schedule, mobilize and perform in accordance with the contract terms. Fixed fee quotes from subcontractors often are key to winning the contract.

While you probably know a lot about the subcontractor through previous work experience and reputation of their personnel, do you really have an accurate picture of the subcontractor’s current financial condition? Do you really know and understand the contractor’s ability to deliver on time and as expected if something goes wrong with your contract or others in which they are involved? These uncertainties can be very unsettling to you as the prime contractor, and you undoubtedly want to mitigate these uncertainties through your own financial due diligence process.

The following are examples of inquiries and analyses you can perform related to the financial due diligence on a subcontractor:

• Obtain a copy of the subcontractor’s most recent audited financial statements.
• Excerpt key financial data from the audited financial statements, such as:
• Available sources of credit
• Maturities of debt and other obligations
• Contract backlog
• Guarantees
• Joint ventures
• Changes to equity
•  Perform a variety of financial ratio analyses in areas, such as:
• Liquidity ratios—current ratio and cash to overbillings
• Profitability ratios—gross profit percentage and net earnings before taxes
• Leverage ratios—debt to equity and underbillings to equity
• Efficiency ratios—days in accounts receivable or days in accounts payable
• Obtain recent interim statements to check for significant changes from the audit date. Unusual changes, either positive or negative, should be analyzed.
• Obtain proof of insurance.
• Obtain proof of bonding.
• Consider contacting key suppliers about whether the subcontractor is current in its trade credit.
• If unionized, consider contacting union hall to see if fringe benefit contributions are up-to-date.

If a subcontractor is reluctant to provide financial information, you should address this matter in an open and straightforward manner. Though you may be able to gain some satisfaction if the subcontractor provides proof of bonding, we recommend you perform a comprehensive financial analysis as referenced above. Such analysis should be performed annually.

If the subcontractor’s financial condition is questionable but the company is critical to the project, consider obtaining an affidavit from the subcontractor allowing direct pay to significant material suppliers or payment via joint checks to both the subcontractor and supplier.

Subcontractors are key to completing projects and can significantly add to a project’s overall success, but everyone has heard horror stories about contractors that are unable to perform or complete a project. Critical evaluation of a subcontractor’s financial condition can significantly lessen the risk of such failures. 

For more information, contact your BKD advisor.