Now that we’re through the late Thanksgiving holiday, the month of December is already in full-swing. In just a few short weeks another year will have come and gone.
In this edition, we’ll take a look at construction project risk factors and some financial reporting considerations that should be top-of-mind ahead of your year-end close process.
Construction Project Risk Factors
I recently wrapped-up two solid days of continuing education as part of the AICPA’s annual construction and real estate conference. While I’m obliged to attend a good portion of the technical sessions on audit and tax reporting, I always make a point to sit in on a few sessions specifically geared toward the issues facing construction owners and CFO’s. A very informative panel discussion was held discussing the development of a risk register in your construction project cost budget.
The biggest emphasis was on changing your overall mindset at the front-end of a project to focus on the risk first rather than the profit. For example, looking at how much you could lose versus how much you can make. A key takeaway was developing a circle of risk factors to consider things such as the owner or client, your internal team that will be involved, geography, contract type, and project type. The more of these items outside of your traditional “sweet spot” can ultimately mean a significant likelihood of losing money on the project.
Common unforeseen risks include environmental permits, hazardous materials, utility relocation, and design approval just to name a few. The intent was not to be completely risk adverse, but rather more cognizant of the typical risks your contracting business faces, but may overlook during the estimation process. Consider having multiple teams bid the same job and create a risk register that assigns corresponding dollar amounts to the most imminent risks to gain a better understanding of your potential loss exposure should the unforeseen occur. If the risk is too high, there is nothing wrong with declining to bid. One bad job could put a good company out of business.
Year-End Financial Reporting Considerations
The year-end close process is likely a pain point for most construction financial managers. A long list of checklists, adjustments, and to-do items creates additional work not normally needed on a month-to-month basis. We all know how difficult it is to impact the financial picture of a company when you wait until the month of December to see exactly where your projects stand. It’s even harder in January, February, or March when the year has come and gone. Take time now to address some simple issues with your work in process schedule before it is too late.
The work in process schedule is the lifeblood of a construction company’s financial statements. It paints the picture of not only what has already happened during the year, but more importantly the estimates of what is to come on your most significant projects. Best practice is to prepare a monthly work in process schedule versus waiting until the end of the year. You need this important information to run the business. Not having a WIP report is like playing a game without knowing the score until the end.
While the WIP schedule is a financial reporting mechanism, the input necessary will come from multiple levels within the organization. Project managers will need to be involved to provide information regarding how far along the project is compared to your estimated cost. It is a mistake to assume that your cost-to-date compared to your original budget is your actual percent complete. Cost to finish is more important, as there is a good chance that your original budget was wrong, and that you are not as far along as you think. If you are having job-cost meetings monthly, it is easier to decipher what changed from the previous month, as well as what the underlying causes were. Sitting down with project managers prior to year-end will enable you to hammer out your schedule of values and make sure everything gets billed, which will hopefully lead to fewer under-billings. A little up-front attention to your work in process schedule could result in a stronger financial position at the end of the year.
We hope you’ve enjoyed this edition of YHB’s construction industry quarterly update. We wish you a wonderful holiday season and a happy New Year. We look forward to speaking with you soon.