Construction Financial Statements 101: Bonding Agency Considerations
In the construction world, very little gets done without bonding agencies. Such agencies protect contractors and their customers against disruptions or financial loss.
Construction projects are expensive, and bonding agencies won’t give contractors the green light to join a project without proof of solid business practices and financial stability. As an accounting and advisory firm, Grimbleby Coleman prepares the financial statements of contractors for submission to bonding agencies. Well-prepared financial statements help contractors prove they have the track record and resources to complete jobs.
Types of prepared financial statements
In general, three types of financial statements are prepared for bonding agencies:
- A compiled financial statement involves compiling data provided by a client without reviewing or auditing the data.
- A reviewed financial statement involves applying analytical procedures and making inquiries of management. These procedures assist us in obtaining limited assurance as to whether any material modifications should be made to the financial statements. A review engagement provides a higher level of assurance than a compiled engagement.
- An audited financial statement provides an opinion with reasonable assurance as to whether the financial statements, as a whole, are free from material misstatement. This process could include on-site visits and examination of supporting documentation to verify the financial statements are materially accurate. An audit engagement provides the highest level of assurance.
All financial statements include the common components listed below, but a bonding agency’s requirements may vary based on the size of the project.
Cash flow statements and current ratios
Cash flow and profit are often confused. It’s good to remember that cash is not always profit. Cash flow shows cash received and spent, while profit is the difference between income and expenses.
The cash flow statement shows where the company’s cash originates and how the money is spent. The cash flow statement will help determine if the company’s operations are generating enough cash to sustain the company and cover expenditures, including debt service.
The current ratio, also known as the working capital ratio, measures a contractor’s ability to pay short-term obligations with its current assets. Bonding agents often look at this ratio, and a rate of more than 1 is desirable and indicates the financial well-being of the company.
The cash flow statement and current ratio are useful indicators but looking deeper can be essential. For example, two companies might have $1 million in the bank; however, if Company A has a $500,000 loan and Company B has no debt, Company B is in a better financial position, and bonding agencies will take note of this when making their assessments.
Costs in excess of billings and billings in excess of costs
Analyzing billing practices reveals much about a company’s cash and project management. Costs in excess of billings and billings in excess of costs are common components of contractors’ financial statements.
Costs in excess of billings occur when job costs have been incurred but not billed. These costs in excess of billings are recorded as receivables. While this can be a positive attribute on the financial statement, sureties may wonder about billing practices. Are these costs in excess of billings due to the normal course of business, unapproved change orders, or a lack of timely billing?
Billings in excess of costs occur when customers are billed in advance before the revenue is actually earned and is recorded as a liability. Sureties may wonder about the advance billings. While it’s advantageous to use the customer’s money to finance the job versus using debt, there is a danger if the funds are used on expenditures unrelated to the jobs.
Backlog represents future contracted work. Bonding agencies typically look at backlog as either Cost to Complete or Left to Bill.
Lag time between projects can lead to a dip in cash flow, sometimes leading contractors to take on more debt, leading to a poorer overall financial picture. You can manage and mitigate your backlog by doing the following to measure your backlog accurately:
- Use construction-specific accounting and management tools to maintain an accurate WIP.
- Clearly communicate with your clients throughout all phases of a project.
- Consider backlog when making decisions regarding your workforce.
- Track and compare yourself to industry benchmarks, which the economy can impact.
Of course, you should always have work in the pipeline — but ensuring that you’re profitable and that your customers are happy is equally important.
Work in progress schedule
A work-in-progress (WIP) schedule, also known as a job schedule, tracks where you are with active projects in conjunction with the job estimate. Contractors should have a track record of estimating projects accurately. For example, if the projected profit was 15 percent, but it came in at 10 percent, you will want to know why.
Some job fade is fairly common because the construction industry works on a long timeline — often two years between initial design and paperwork for a project and its completion. The pandemic has affected supply chains, including material availability, timing, pricing, and labor, sometimes making the timelines even longer. However, the job fade should still be examined to determine whether the problem is chronic or temporary.
Get in touch
Grimbleby Coleman’s Construction Team has served our clients by providing financial statements, cash flow projections, and business advisory for decades. We would love to learn how we can help your construction company set solid foundations for success. Reach out to our team by emailing us at email@example.com or calling our office at (209) 527-4220.