By: Todd Feuerman
The current construction marketplace continues to challenge many firms. While job quality, job pricing, and job profit margins have improved, many jobs that were secured in previous years continue to linger on construction companies’ balance sheets and operations reports. Most construction activity completed during 2015 was bid on within the past five years, when companies struggled with substandard margins and other job-related issues.
In 2015, some construction companies will be reporting positive operating results; some will be reporting negative operating results; and some will be reporting a hybrid of the two. Generally positive operating results with a few significant loss jobs and major profit fade will not be unusual in the marketplace. When times are good, discussions with lenders, surety firms, and other financial partners are easy to prepare for and aren’t usually met with many questions or comments.
But when the operating results are negative, companies must evaluate how the news is delivered to the lenders, surety firms, and even municipal agencies that will address the company’s creditworthiness, prequalification capacities, surety programs, and reaffirmation of operating lines of credit.
Negative Financial Results
Let’s first look at delivering overall negative financial results. Once a contractor realizes that the year will be showing a loss, it is critical to communicate this information to its lenders and surety firm. Companies should have an open dialogue prior to year-end and accurately communicate the extent of the anticipated operating loss, the impact to the company’s balance sheet, an explanation of how the loss occurred, and most importantly, how the company is going to deal with the loss.
A loss does not have to be a bad thing if the contractor can assure the lender and surety firm that:
- the financial statement results are reported correctly,
- the loss captures all issues related to poorly performing jobs,
- no additional profit fade will occur on the jobs, and
- the company has a plan to address the financial implications of the loss.
In other words, the company should have developed a detailed operating plan, cash flow plan, personnel plan, and potential capital infusion plan to stabilize the company and restore equity from the loss.
Positive Financial Results
Now let’s look at delivering overall positive financial results with a work-in-progress (WIP) schedule with relatively few jobs that reflect significant loss and profit fade. While this situation seems like it would be a bit easier to discuss, the company’s credibility in managing and predicting job performance is challenged. The lender will most likely not pay much attention to the WIP schedule; however, an experienced surety underwriter will home in on the WIP schedule and require solutions to the poor performing jobs.
In this case, the approach should be to advise the surety prior to year-end regarding any significant job loss, explain the issues on the job, and provide a reasonable level of comfort that things are under control – meaning the contractor has conservatively estimated the job loss, identified and addressed the job issues, and (most importantly) has determined why this job was substandard and what protocol is going to be changed to avoid this situation in the future.
The Bottom Line
In both of these cases, the key to success is having transparent, upfront discussions with the lender and surety firm to try to avoid surprises at all costs. Financial partners are generally able to handle bad news if they are aware of the issues and have time to put an internal plan in place to address them. Don’t be afraid to put all of the bad news on the table, but make sure you have outlined a strategic course of action that addresses the issues and makes appropriate internal and external changes to avoid a repeat situation.
As chair of the firm’s Construction Services Group, Todd has over 25 years of experience providing audit, accounting, consulting and tax services to general contractors, specialty contractors, government contracting firms, as well as construction-focused banks and surety firms. His extensive expertise and inside knowledge of the construction industry enable him to provide the highest level of practical and technical financial consultation to entities which are construction industry centric.