Building Success Key Practices for Small Construction Contractors

BY JAMES WIEDEMANN AND ALEXANDER LOMBARDI
For a smaller contractor or someone trying to break into the market, one of the most common issues is how to navigate an industry that has the second-largest failure rate. Too often, smaller companies simply focus on their bank account, and as long as they see the cash balances going up, the business is deemed to be running appropriately. The realization that something is going wrong doesn’t come until it’s too late in far too many instances. By the time the bank balance starts going down, it may be too late to recover. For many smaller contractors, keeping costs down and knowing when to ask for help is a delicate balancing act. Regardless of the entity’s size, everyone can follow certain best practices.

Cost Analysis
Contractors must understand the difference between direct and indirect costs. Direct costs are easy for most individuals to understand; these include the “hard,” more visible expenses such as the materials used, subcontracting costs, and labor. Conversely, indirect costs are the “soft” costs you do not always see on the job site. An example of an indirect cost is insurance expense. If a contractor has an insurance program for its overall book of work, the costs need to be allocated to each job.

Additionally, if equipment has been purchased for use on projects, the contractor needs to consider the depreciation expense, fuel expense, etc., which must also be included in each job. Small contractors run into problems when the indirect cost pool rises, and they have not accounted for those costs in their estimates and bids. For instance, when bidding a job for $50,000 with estimated direct costs of $35,000, smaller entities typically think they’ll make $15,000; but that does not account for indirect costs and general overhead expenses. When indirect costs unknowingly rise, that $15,000 of expected profit can quickly turn into only $5,000 or potentially even a loss. Without constantly analyzing costs, bids might be locked in at incorrect rates; and in the blink of an eye, a year of work can be lined up at margins that could put a small contractor out of business. It is essential to identify indirect costs and properly allocate them before small profit margins become a problem.

Accounting System
Having a proper accounting system and using it correctly can help identify financial problems, like rising indirect costs. This doesn’t mean a contractor doing $100,000 of revenue needs the same accounting system as a contractor doing $100,000,000. It is recommended that contractors research and see demos of the many different accounting software available to find their best fit. Most importantly, even if a contractor opts for the top-tier accounting system, it will only provide useful financial information when transactions are entered correctly. Properly coding as many expenses as possible directly to jobs will help contractors better identify their indirect cost pool, a common issue noted above. Simply entering payables and not distinguishing the relation to each job will not give you the proper lens on the work being performed. To get useful reports, businesses must know how to use their chosen software well and be disciplined and dedicated in entering detailed quality information. If the information entered is incorrect, then the information derived will not help drive your business.

Regular Meetings
The best-in-class contractors meet weekly or biweekly to discuss the status of jobs. These meetings can range in time and level of detail, but no matter how long they last, they provide valuable information about how a company is performing. Most importantly, having regular meetings means that any issues on a given job can be identified and rectified in real time rather than learning of a problem from an angry project owner. As previously mentioned, if there are issues with the indirect cost rates being used on jobs, you can discuss that in regular standing meetings so that the individuals estimating the remaining costs can become knowledgeable and adjust current estimates and future bids. These meetings are recommended to include the accounting department and the field personnel. Educating field personnel on over-and under-billings, as well as the impact that incorrect billings can have on the company’s performance, is essential. This does not mean that the field personnel should know every accounting function, but they should know why the accounting team is bothering them for additional information and what vital factor it plays in the overall business.

External Resources
The main goal for most contractors is to be a successful company and make money. To do that in the construction industry, contractors need strong banking and bonding. Bankers and bond agents will require certain reliable financial information, but more importantly, they will want to see consistency. If a company’s financial statement looks like a heart rate chart, it will find itself hard-pressed to succeed in the banking and bonding side of the business, which could cripple its operations. Working alongside the proper external resources cannot be discounted. Constantly fighting with a banker or bonding agent to take on new work may mean they are not the right partner.

Similarly, having a CPA who won’t pick up the phone other than once a year to ensure tax compliance is also likely a bad pairing. One thing we commonly stress to our clients is that we want to know when something is going on. When venturing into something new, a contractor may think they have it handled; but a quick phone call could lead to the question, “What about X?” It’s alarming how often simple issues, often with pricey solutions, can be avoided with a simple call to external resources that are all working together to ensure success for their clients.

We recommend contractors meet with their external resources as frequently as possible. The right attorney, banker, bonding agent, and CPA can help emerging contractors navigate a lot of the unknown. When contractors have the right team in place, these partners can also help with things such as finding good accounting software, understanding costs, and facilitating internal meetings. Unfortunately, a job will likely lose money at some point, but by following the best practices noted above, contractors can hopefully limit those instances. When things are going well, and the cash balance is rising, it is imperative contractors don’t get complacent and, instead, find ways to set themselves up for future success.

James Wiedemann, CPA, is a Director in CBIZ’s (https://www.cbiz.com/) New Haven, CT office. He has more than 14 years of experience providing compilation, review, and audit procedures in the construction, oil and gas, and manufacturing industries. Wiedemann has experience with reporting requirements, revenue recognition, and cost allocation techniques within the construction industry. He has in-depth knowledge of the accounting literature and is able to recommend changes to clients to increase productivity and overall output of information. He can be reached at [email protected] or 203.781.9721.

Alexander Lombardi, CPA, is a Manager in CBIZ’s New Haven, CT office. He has more than eight years of experience providing compilation, review, and audit procedures in the construction and oil and gas industries. Lombardi has experience with reporting requirements and revenue recognition in the construction and oil and gas industries. He can be reached at [email protected] or 203.781.9712.