Intro to Financial Management & Accounting Systems

Why is construction financial management different?

- Process vs. project orientation - Centralized vs. decentralized projects - Payment terms - Retention - Heavy usage of subs

What questions can be answered by good financial management?

1. Does the company have enough cash resources to perform this work or will the company need outside financing? 2. Should the company lease or purchase the additional equipment needed for this project? How should it be financed? 3. Can the company get bonded for this work? 4. What changes need to be made in the company's financial structure so the company can get additional bond coverage? 5. Should the company hire employees to do the work, or should they subcontract? 6. Will the project require the company to increase its main office overhead? 7. What profit and overhead markup should be added to a bid?

When talking about what makes construction financial management different, explain what goes into: Retention

- Modification required to accounting and other financial procedures

When talking about what makes construction financial management different, explain what goes into: Heavy usage of subs

+ Approximately 90%** of a project is performed through subcontracts + GC can "tap" into sub financial assets during the construction process - Greatly impacts a GC's finances

When talking about what makes construction financial management different, explain what goes into: Process vs. project orientation

+ Construction is a PROJECT DRIVEN industry + Each project is unique and usually wide in variety + Cost management strategies - Cost data from past projects must be carefully collected - Past project data used to forecast future project costs + Dealing with fluctuations in demand - What do you do if you overproduce 1000 microwaves? - What do you do if you have 1000 cy of excess dirt

When talking about managerial finances, what all goes into managing costs & profits?

+ Controlling project costs + Monitoring project and company profitability + Setting labor burden markups + Developing and tracking general overhead budgets + Setting minimum profit margin for use in bidding + Analyzing profitability of various "parts" of the organization and making necessary changes + Analyzing profitability of various "customers" and making necessary changes to improve

When talking about what makes construction financial management different, explain what goes into: Centralized vs. decentralized projects

+ Crews must be managed as a project center - Track job location, type of work performed, and productivity + Equipment must be managed as a project center + Site specific factors must be included in bid prices - Taxes, codes & their enforcement, worker availability, climate, and many others

When talking about managerial finances, what all goes into accounting for financial resources?

+ Ensure project and general overhead costs are accurately tracked + Set-up and maintain proper construction accounting systems + Project/forecast costs at completion + Determine if projects are over/under billed + Preparing and/or review needed financial statements

Explain more specifically what goes into the General Ledger.

+ Main accounting record of transactions (debits & credits) - Uses double-entry bookkeeping + Contains all accounts necessary to prepare: - Balance sheet - Income statement - Income taxes + Transactions will be handled differently depending on the ACCOUNTING METHOD selected by each company

When talking about managerial finances, what all goes into managing cash flows?

+ Matching the use of in-house labor and subs to the cash available + Ensuring that the company has sufficient cash to take on an additional project + Preparing an income tax projection for the company + Preparing and updating annual cash flow projections for the company + Arranging for financing to cover the needs of the construction company

When talking about what makes construction financial management different, explain what goes into: Payment terms

+ Most industries bill the buyer at the time the goods are shipped with payment terms in the "days" length period (i.e., 15 days net) + Construction companies have long-term contracts with monthly progress payments - Contracts generally extend beyond a year in length and can have great tax implications

Explain the following method of accounting: Percent of Completion

+ Recognize revenues, expenses, and ESTIMATED PROFITS on a construction project through the course of the project (best "picture" of company's financial status) + Revenue recognized when owner is billed - Note: retention is recognized ALONG WITH REVENUES from the bill + Expenses recognized when sub or vendor bill is received + Estimated profits must be EQUALLY DISTRIBUTED over project - AT COMPLETION OF PROJECT, company must review taxes paid to see if money is due or owed to IRS + Large companies must allocated general overhead to individual project over their project duration

When talking about managerial finances, what all goes into making financial decisions?

+ Selecting which equipment to purchase + Deciding to invest the company's limited resources in which area of business - What jobs to bid - What sector will maximize profits and minimize risk costs

Who is responsible for financial management?

+ Ultimately --> company owner or general manager + Majority of financial management tasks are delegated - Estimators, supers, and project managers + *Remember this!!!* - People who want to own their own business or move up the "corporate ladder" MUST have a strong financial background

When contractors fail, what falls into the following area of concern: Bank Lines of Credit Constantly Borrowed to Limit

- *All credit fully secured* - Lines not renewed

When contractors fail, what falls into the following area of concern: Accounting Issues

- *Inadequate cost tracking systems* - Estimating or procurement problems - Underinsured - *Improper accounting practices*

When contractors fail, what falls into the following area of concern: Poor Estimating & Job Cost Reporting

- *Revenue & margins decrease* - Continued operating losses - *Loss of bonding capacity* - *Bid jobs too low*

When contractors fail, what falls into the following area of concern: Ineffective Financial Management System

- *Tight cash flow* - *Slow receivables* - Past due bills - Vendors demanding cash - Poor project selection - Onerous owners - *Unsettled claims & change orders*

What are the four methods of accounting available to construction companies?

- Cash (Used by many other industries) - Accrual (Used by many other companies) - Percentage of Completion (Used by companies that enter long-term contracts) - Completed Contract (Used by companies that enter long-term contracts) Note: A company may use different methods of accounting when preparing financial statements than when filing taxes

Explain the following method of accounting: Cash

- Easiest accounting method to use - Revenue is recognized when payments are received - Expenses are recognized when bills are paid - Advantages: easy, defer income taxes - Disadvantages: little use for financial management (information is too late) - Note: a regular "C" corporation with average annual revenue over $5 million CANNOT use cash method of accounting

Explain the following method of accounting: Completed Contract

- Recognizes revenues and expenses at completion of the project - Advantages: revenues & expenses are completely known - Disadvantage: creates large swings in income

Explain the following method of accounting: Accrual

- Used to provide a more accurate "picture" - Revenue recognized when the company has the right to receive payment (sent bill to owner) - Expenses recognized when the company is obligated to pay for expenditures (receives a bill from a sub or vendor) - Retention not recognized until the end of the project - Disadvantages: may result in payment of taxes on revenues not received, and may be paying taxes on imaginary / unearned profits if project is "front-end loaded"

Why do contractors fail? (4 areas of concern)

1. Accounting Issues 2. Ineffective Financial Management System 3. Bank Lines of Credit Constantly Borrowed to Limit 4. Poor Estimating & Job Cost Reporting

What does a financial manager do?

1. Accounting for financial resources 2. Managing costs & profits 3. Managing cash flows 4. Making financial decisions

What are the 4 purposes of construction accounting systems?

1. Process cash receipts (collecting and paying bills) 2. Prepares needed for company financial statements 3. Collects and reports data needed for income taxes, employment taxes, and other required government documents 4. Collects and provides data needed to manage the company finances and project finances

What is financial management? (Straight from the slide)

Book definition - "the use of a company's financial resources" --> WORTHLESS!! A better way to understand financial management is looking at the questions that can be answered by good financial management

Why is the failure rate comparison of the various construction firms & all other industries graph important?

Construction companies are among the most likely to fail

What is the difference between cost reporting and cost control?

Cost Reporting - Accounting system provides management with data AFTER the opportunity has passed to respond to and correct problems - Extreme example: only looking at costs and profit for each project is done Cost Control - Accounting system that provides management with timely costs data to analyze and correct problems in a timely mannger - Crucial to PROACTIVE project management

What are the three main ledgers for construction cost control systems?

General ledger - Tracks financial data for the entire company - Used to prepare company financial statements and taxes Job cost ledger - Used to track the financial data for each of the construction projects Equipment ledger - Used to track financial data for heavy equipment and vehicles