Why High-Quality Financial Statements Are Important for Contractors
Author: Ben Stone
Are you caught off-guard when cash flow gets tight? Do you miss opportunities for new work because of difficulty securing bonding quickly or at a feasible cost? Do you have trouble obtaining financing, even though you believe your company is healthy? High-quality financial statements can be an effective weapon in the fight to overcome these threats.
Accounting software makes it easy to generate a variety of attractive reports, but what constitutes high-quality financial statements? Although it varies depending on the situation, high-quality financial statements consist of a balance sheet, income statement and statement of cash flows prepared in accordance with generally accepted accounting principles (GAAP). These should include the required footnote disclosures with the appropriate level of detail, reflecting proper application of the percentage of completion method of revenue recognition, along with accurate work-in-progress and completed contract schedules.
In the current economic environment, more and more available work requires bonding, and underwriting has tightened as sureties expect greater losses during a slow economic recovery. High-quality financial statements are essential for any firm striving to secure and perform work that must be bonded. The bonding process is relationship-driven, and your relationship with your bonding agent and surety (or sureties) will be enhanced if they are confident in the reliability of your financial statements. To this end, having your annual financial statements audited or reviewed by a CPA who is knowledgeable about the specific business and accounting issues contractors face will add credibility to those statements. In addition, interim (monthly or quarterly) financial statements prepared internally should be prepared consistently with the annual financial statements.
Some sureties may consider it a “red flag” if a contractor uses a CPA who does not specialize in construction, and there also are other benefits of working closely with a construction-oriented CPA. By being familiar with your business and the industry, a construction-savvy CPA is better positioned to offer effective tax planning advice. With some jobs bid at very thin margins, the estimated profit must be accurate; the right CPA can assist in reviewing burden and overhead rates so bidding decisions are considered using complete and accurate data. CPAs also can help you check your company’s internal controls over accounting cycles and cash flows to make sure those controls are as strong as possible with the resources available.
The point of the surety underwriting process is to determine the reward the surety must receive to take on the perceived risk of your company and the proposed project. That perceived risk can be mitigated if the surety is confident the financial information you provide is accurate and complete. Reducing the project’s perceived risk will result in cost savings, both through better bond pricing and less time required of you and your staff to pull together information for the surety. These cost savings—and the quicker, smoother bonding process—can help you win more bids with less stress.
Available financing options also are affected by the quality of your financial statements. While sureties are interested in your ability to perform on a contract, lenders are concerned with your ability to repay, in accordance with loan terms, the money they are considering loaning to you. If the lender is assured the financial information you have provided is accurate, you could receive better interest rates and payment terms, as well as more cooperation from the lender if the potential for default rears its ugly head.
Even if you do not plan to do any bonded work or obtain financing from third-party lenders or investors, high-quality financial statements can be important to the success of your company. With the increased prequalification efforts in recent years by many project owners and prime contractors, the ability to provide high-quality financial statements on time can lead to more opportunities for new work. From a management perspective, accurate and complete financial statements can assist with the early identification of losses or potential cash shortages. Good work-in-progress schedules allow for early recognition and oversight of jobs going bad, and completed job schedules aid in evaluating the profitability of different types of work, work for each customer and jobs of each project manager. High-quality financial statements allow for the development of an appropriate mix of ratios to monitor the company’s progress and benchmark against peers.
The benefits of high-quality financial statements can be considerable. While there are many hindrances in today’s economic environment, strong financial reporting is a tool for survival that is within your reach. To discuss the financial reporting process in detail, contact a BKD advisor.