Sponsored Content from Old Republic Surety
Posted by Darrel Lamb, CPCU, AFSB
If there is one thing I learned in grade school, it is that some days are more important than others. Most notably, in the life of a grade schooler, picture day was of great importance. This was the day you should look your best. It’s that one snapshot in time when you would be captured for your student body card and the yearbook. This snapshot is how you will be judged. The ramifications were powerful for the whole year, if not for a lifetime.
It is not that different for construction companies. One day of the year is more important than all the rest. For most companies that day is December 31. It is important that a construction company look its best at its fiscal year end. This one day of the year, this one snapshot of its success and worth, is how it will be judged for surety and bank credit. As a surety underwriter, my advice is that a construction company should always look its best for its “picture day” in order to maximize its bond credit.
That said, there are competing forces that would have construction companies not look their best for picture day. The reality is that fiscal year end of the contractor is not just picture day, it is also the day on which the contractor bases its annual tax obligation. The construction-oriented CPA that was hired may feel his or her first job is to, within the bounds of the law, appease the construction company owner’s desire to pay less tax and make the construction company look as poor and tattered as possible and mute the year’s success to minimize the company’s tax obligation.
Therefore, it is sometimes the job of the surety underwriter to look past the tattered clothes, the cowlick, the braces, and the crooked glasses to find the beauty in each snapshot we examine. We learn how bottom lines are “managed.” We familiarize ourselves with tax incentives that beg companies to invest cash at year end into heavy equipment they can fully depreciate in the first year, which to the untrained eye makes it appear that a lot of cash just disappears. Likewise, it is important that the contractor work with a construction-oriented CPA who understands the value of surety credit and the balance the contractor must strike in the image it presents on picture day.
We have seen where contractors have attempted to present a picture that is perhaps better than it actually is. Overestimating job profits on work-in-progress can lead to a lovely year end picture, but it can result in the disappointing negative result of profit fade when the jobs close out. Sureties do not like profit fade. It is better that the contractor take a more conservative approach to its estimates. I spoke with a senior tax manager from one of the leading construction-oriented CPA firms in my area.
These are the questions a construction-oriented CPA asks for picture day:
- Did the contractor have a big year? If so, are we being conservative enough on open jobs?
- If it had a big year, should we accrue distributions to pay taxes? It looks odd to have a down year followed with distributions way in excess of net income.
- Is the balance sheet getting too big so the next generation has trouble buying in?
- Are we doing all we can to minimize and smooth out taxable income to maximize after-tax cash flow over the long haul?
A good surety underwriter desires and will get to the real picture. We are not looking for a glamour shot that shows a fake representation (all hat and no cattle, as they say in Texas). Nor do we want to see an overly aggressive tax-motivated picture that wipes out your construction company’s equity and working capital. Choosing your CPA and surety partners carefully will help you find the right balance you need to minimize your tax bill and maximize your company’s surety credit – and have a fantastic picture day!
For more information on contract bonds, construction-oriented CPAs, work-in-progress reports, and how Old Republic Surety can help you prepare for picture day, please contact your insurance agent and ask to work with Old Republic Surety. For a list of insurance agencies that represent Old Republic Surety, refer to our branch locator and it can assist.
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- Darrel Lamb leads Old Republic Surety’s West Region surety operation in all facets of contract surety including business development, underwriting, marketing, agency management, strategic vision, operations, compliance, and employee development. Territory includes Washington, Oregon, Montana, Idaho, Hawaii, Alaska, California, and Utah. Darrel has over 30 years of proven success and is skilled in developing relationships with internal and external stakeholders to drive superior business results.