Construction Financial Management in the COVID Economy
As the nation races to vaccinate more than 320 million citizens, construction firms have been busy catching up on backlog, keeping workers safe and grappling with the complexities of construction finance during a pandemic.
The economy has bounced back much quicker than expected; however, there are still plenty of reasons for construction firms to remain vigilant and continue to implement strict financial controls as the recovery unfolds. The challenges of the past year have sharpened the business habits of contractors and financial professionals alike across the United States—proving that consistent success is achievable—if contractors are committed to seeing past the boom and taking adequate measures to streamline their bidding, contract and finance practices. Resisting bidding on unprofitable work, keeping careful records through automation and paying attention to new tax laws are just some of the methods that can ensure a contractor remains profitable for years to come.
To gain insights into the lessons learned from operating in the COVID-19 economy, CE reached out to contractors and experts in construction financial management for their observations and advice.
BEWARE OF OVER BIDDING
In the U.S. Chamber of Commerce’s Q1 Commercial Construction Index released in mid-March, contractors saw little change in obtaining financing compared to the last quarter, but 60% of contractors believe that access to financing will get easier or remain the same over the next six months. A decrease in backlog combined with a healthy expectation of new business and access to funding is a positive outlook for the industry, but contractors must be careful to avoid bidding unprofitable jobs or taking on too much work while maintaining strict financial procedures and controls.
Despite unemployment rates creeping down to 6% in March—lower than April of 2020 but still not below pre-pandemic levels—the industry continues to experience a shortage of skilled labor.
“Talent acquisition and retention continue to be a major issue,” notes Bill Cerney, principal of construction and surety for Gibson Insurance. “Understanding labor capacity is critical, especially with a multitude of delayed projects starting in 2021 that will be competing with newly acquired projects.”
The ongoing labor shortage and high prices for lumber, steel and other building materials are reasons for contractors to carefully consider bid ding opportunities. The Producer Price Index reports lumber recently topped more than $1,000 per thousand board feet and has not dropped below $800 since the end of January. These prices highlight the need to cultivate critically important supplier relationships whether there is a crisis or not.
Joel Hoffman, senior product manager at Acumatica, advises locking in pricing agreements whenever possible. “In today’s environment, material costs are impacting project success,” he says. “Having established vendor pricing, visibility into historical cost data and insight into future forecasts all play a critical role in profitability.”
Access to labor varies by region, but the high cost of materials remains a concern, regardless of location. Cadence McShane Construction, a Texas-based general contractor, recently conducted a survey of subcontractors that included insights into labor and material costs. More than 91% of the nearly 100 respondents indicated they expect construction prices to continue to rise over the next six months; furthermore, more than 30% expect an increase in excess of 20%.
“The market is still very competitive and there is plenty of labor, so supply has not yet outstripped demand,” says Will Hodges, president of the firm. “Supply-side disruptions and the trickle down of cost impacts will likely continue to influence pricing in the near-term.”
When bidding, the more information you have from your previous jobs, the better prepared you will be to price new work. “It's incredibly beneficial for you to be able to learn from previous data of similar project work,” says Mike Milligan, global head of marketing at GCPay. “Data pulled from payment technology, ERP solutions and estimating solutions will allow you to forecast and bid more accurately.”
Showing prospective clients that your company has a firm grasp of return on investment also prevents the temptation to bid low. “Do your homework, break down your bid and explain ROI. Be prepared to back up your information with hard data,” says Jeff Weiss, chief revenue officer for CMiC. “Breaking down the data through case studies stored in your technology platform is a helpful method.”
IMPLEMENT COST CODES
Tracking project costs requires thorough and efficient job costing methodology to avoid putting profits at risk. While spreadsheets may be suitable for a small contractor, they become inaccessible when information needs to flow between larger field and office teams.
“Spreadsheets or standalone applications generate silos of data that are hard for other employees to access,” notes Acumatica’s Hoffman. “When legacy systems don’t connect, construction businesses fall into an information void. A connected cloud application streamlines the exchange of information between teams in the office and on jobsites. As mobile applications collect information and synchronize data, the entire workforce has access to the same information at the same time,” he explains.
Implementing cost codes has a positive and lasting effect on a firm’s financial health. In addition to helping contractors streamline bidding and estimating, proper and consistent codes help battle fraud and profit fade.
“It’s important to have an established set of cost codes and cost types,” advises Geoff Arnold, general manager at Built Technologies. “It might take extra work, but it’s highly beneficial in the long run. Eventually, the business can begin presenting contracts or purchase agreements using that same set of information. As invoices are coming in, they can be associated with the proper codes and types for accuracy, enabling firms to tell where they are profitable and where they need improvement.”
Mike Ode, chief executive officer of Foundation, agrees. “Technology helps improve job costing in two main ways, organization and reporting. When it comes down to it, a job-costing system is only as good as the diligence to adhere to it. By pre-determining a list of all cost codes associated with a job, and making sure to assign any costs appropriately, technology can help contractors accurately track costs. With reports readily available, especially those that can break down all costs into further details, contractors can start to see where the majority of their spending occurs. This can help lead to more precise bids and ultimately, greater profit,” Ode says.
“The technology used to manage project scope and schedules needs to connect to the technology used to manage cost,” says Tooey Courtemanche, founder and CEO of Procore. “This can only be enabled by a platform that brings teams into a connected, collaborative space enabling cost data to continually flow throughout the project lifecycle and providing real-time, comprehensive insight into the financial health of your project,” he notes. “This is invaluable in connecting office and field teams with accurate information, resulting in data-driven decision making.”
AUTOMATE STANDARD BUSINESS PROCESSES
Incorporating automation can improve efficiency and remove the need for manual entry—the leading cause of accounting mistakes. Payroll, accounts payable and receivable, invoicing and tax compliance are among the business processes that can benefit from automation.
“Automating financial processes saves construction firms time and resources while eliminating error-prone manual entry,” says Dustin Anderson, vice president of construction and real estate at Sage. “This ensures that teams always have an accurate, up-to-date snapshot of their financials. Adding machine learning to this process can also up the error-free data game by using algorithms to interpret patterns and flag errors. Combining both automation and staff training to use provided technology tools will increase productivity, allowing employees to use their energy in other parts of the business that need it,” he says.
John Rosch, regional sales manager for Explorer Software, points out that automating field time tracking is one way to see an immediate noticeable improvement in efficiency.
“Automating field time eliminates the double entry of payroll data, avoids invalid job and cost codes, as well as mitigates missing or unreadable timesheets that otherwise must be manually dealt with,” Rosch says. “Through automation, time is entered once by the employee, electronically routed for approval and integrated with the accounting system when fully approved. Only valid data can be entered and the payroll department is now a data reviewer and not a data entry center.”
“It is critical to embrace tools and best practices for back office and field operations management,” CMiC’s Weiss says. He recommends that contractors look for a scalable construction software platform that provides automation to enhance profit and increase productivity.
One process that can be automated is payroll, which is especially beneficial to employers who are still operating remotely. “This allows employees to work from any location and have access to the same information that they’d have access to from their office,” Weiss says. “It also ensures safe payroll transactions and data maintenance with fine-grained security protocols, preventing a data breach or unauthorized access. Contractors that deploy cloud-based payroll with a self-service mobile time and production entry will benefit the most, ensuring that the data is entered at the source, only once and captured in almost real time.”
KEEPING TRACK OF ASSETS
Being able to track what tools are needed on the job in real time—and getting expensive equipment off the job when it is no longer needed—can also improve the profitability of a project. “Typically, there's an executive-level or project-level person being incentivized financially to bring the project in on time, at a profitable rate,” says Don Kafka, founder of ToolWatch. “Using a platform that allows the team in the field to collaborate with warehouse and yard personnel in order to get what’s needed to and from the jobsite cuts down on delays, reduces cost and gets the project completed faster,” he says.
Cloud-based tool and asset management systems allow contractors to access data regarding maintenance schedules, tool usage and manpower, as well as ghost equipment, both digitally and in real time, which eliminates the back-and-forth exchange of information that can lead to profit loss. Running regular audits on your assets can also help contractors to plan efficiently for the next project and reveal the true costs of tools and equipment.
WORKING REMOTELY IS CRITICAL
Over the past year, with a majority of employees working from home instead of coming into the office, the question of productivity was answered as data on working remotely clearly demonstrates that when employees are provided the right technology, productivity increases.
“For our office employees, the move to working from home was daunting due to a preconceived idea we were going to lose some productivity and momentum,” Hodges of Cadence McShane Construction says. “In reality, it forced our teams to communicate better through new platforms. In the end, productivity remained high and teams have found ways to successfully work from home and maintain a work product that is as good—and in some cases better—than what was produced in the office environment,” he says.
Even technology providers, such as ToolWatch, benefit from working remotely. “We’ve been using the virtual aspect of communication for many years (even pre-pandemic), and we’ve learned that it’s an effective way to help clients,” Kafka says. “Whether for tech implementation or training, it’s more productive to set up virtual meetings and provide the information over time instead of meeting for just one day and hoping clients can digest all the information at once.”
CYBERSECURITY & FRAUD
The highly mobile construction industry has always had a need to communicate time-sensitive financial information securely and effectively. The pandemic accelerated adoption of technology for contactless payroll, lien waivers, contracts and more, but keeping financial information secure has its own unique set of challenges in the age of the connected web.
According to IBM’s recently released 2021 X-Force Threat Intelligence Index, cyberattacks doubled in 2020. That was primarily owing to many businesses moving to the cloud to facilitate remote workers during lockdowns. Staff working from home often did not have access to the same security protocols that had been in place at the office. This makes it vital for construction firms to train staff on proper device use.
“Construction firms must continually review and audit their security methods and risks and adjust as needed. While users are the most significant security risk, they can also be the most powerful protection. User education is essential to any successful protection strategy,” Explorer’s Rosch says.
Cadence McShane Construction was aware of the potential for cyber fraud even before the pandemic and saw these threats worsen during the height of the crisis.
“We have a robust set of cybersecurity measures in place including two-factor authentication, a firewall infrastructure and encryption on all of our internal password protection documents to minimize damage if a file is exposed outside of the organization,” Hodges says. “We used training throughout the pandemic to reinforce discipline on correct procedures for handling financial information and payments.” Even before the pandemic, Hodges saw a number of fraudulent payment schemes in which criminals would create a fake invoice or purchase order that looked nearly identical to the original.
“During the pandemic, this scheme intensified,” he says. “As a result, we reinforced our procedures to release funds that involve multi-party reviews and sign-off. We worked with clients to ensure that they were intimately familiar with our protocols so they were not victimized.”
A construction firm can never be complacent in protecting sensitive financial information. “Cybersecurity is similar to the protection of any valuable item. Identify the data you want to protect, list egress and ingress routes, then leverage tools and processes that balance usability and security,” Rosch says.
Acumatica’s Hoffman stresses the importance of adding additional measures if your staff is working away from the office. “Cyberattacks are real and can cause significant disruption to your business. Companies should look at the threat on multiple fronts, not just external to the organization, but within. Utilizing two-factor authentication and implementing password policies that include periodic changes and complexity requirements can help keep up the diligence against attack,” he says. To protect against internal threats Hoffman suggests implementing application security by user role, row-level security, active directory integration and single sign-on capabilities.
“When construction companies shift from manual processes such as paper checks to ACH digital payments, things can slip through the cracks or become inefficient, causing them to revert to what they know for the sake of safety. The storage and collection of ACH information and bank account protection can be locked down by technology for verification and protection,” Built Technologies’ Arnold says.
AVOIDING PROFIT FADE
Profit fade occurs for a variety of reasons, including poor estimating, sloppy accounting practices and the changing costs of materials and labor. Facing weaknesses in organizational management and implementing technology to use data in real time can both help to prevent loss of project profits.
“Construction projects are not linear projects and changes are inevitable,” GCPay’s Milligan says. ”The right technology allows you to take action on those changes quickly so that there are no surprises at the end of the project.”
“Managing change orders, productivity and forecasting costs are areas that can be enhanced with technology to prevent profit fade. Automated alerts when certain thresholds are hit or when tolerance levels are exceeded allow a company to get ahead of possible issues,” Hoffman says.
Remaining keenly aware of where field employees are at all times can also strengthen a firm’s resistance to profit fade. Proactively producing labor cost reports during each phase of a project helps to more effectively manage the workforce and prevent labor costs from spiraling out of control.
Closing out a job and quickly reassigning manpower and equipment to other projects can improve bottom-line profitability. “Good resource planning software can assist in effectively reassigning your workforce,” Rosch advises.
Having an effective document control solution is another important discipline to protect profits. “Addressing change order requests, time and material billings, as well as subcontractor claims in a timely fashion will ensure projects can get closed out,” Rosch says.
Once you’ve implemented these tools, you must use them. “Data is worthless if it is not examined and used,” Arnold says. “Contractors should strive to be in a situation where they have ongoing access to accurate data that can be regularly reviewed to understand job-by-job profitability.”
Contractual risk transfer continues to play a big role in protecting profits. General contractors must be cognizant of the amount of risk they are willing to accept and which risks should be passed along to owners and subcontractors.
“With pricing and access to materials being variable in many sectors, contractors must be aware of these risks and assess how to protect themselves. Owners are often reasonable if the conversation is had upfront,” Gibson Insurance’s Cerney says.
Prequalification of subcontractors and suppliers remains crucial to the preconstruction phase of any project. “History has shown that most contractor failures occur after an economic downturn, not during it,” Cerney says. “Many contractors that managed through a downturn may find themselves understaffed from shedding overhead or find they were too willing to accept risk in pricing and timing on new projects. Robust prequalification procedures that potentially require subcontractors or suppliers to ‘bond back’ to the upstream contractor should be key elements in every contractor’s planning process.”
The Payroll Protection Program that allowed many construction firms to keep people employed and cash flowing also had a surety bonding benefit. “Well-managed PPP funds should help many contractors to maintain and even increase their bonding capacity,” Cerney says. He advises working with a team of trusted professionals to maintain a good relationship with the surety.
“Align your company with a CPA, legal counsel and an insurance agent that really understand construction. Accounting principles, tax laws, financial management and risk transfer techniques don’t always align with surety expectations. Open communication, with assistance from your surety broker, will help manage conflicting priorities.”
Having financial information at your fingertips is also invaluable in the event of an audit or legal action. Informal record keeping and uncontrolled document practices are not reliable, credible records.
“Using a payment management platform, in addition to a document management solution, acts like a repository of information,” says Milligan. “They contain compliance documents that would be required in the event of an audit. Being able to record, manage and report payments is critical in any audit or legal situation.”
ANTICIPATING TAX INCREASES
The new administration unveiled its American Jobs Plan at the end of March which calls for two trillion dollars to repair the nation’s infrastructure and also includes a federal corporate tax increase from 21% to 28% as well as a 15% minimum tax on corporate book income.
“For contractors that are regular C-corporations, that would be a significant federal increase. Currently, for S-corporations there is a 20% qualified business income deduction that is slated to be phased out at $400,00 of personal income which would have an effect on those entities,” says Ken Hedlund, principal for Somerset CPAs.
In addition, anyone who has income over a million dollars could see their capital gain rate go up to ordinary income rates or even double. While that income benchmark sounds high, Hedlund points out that if you are planning on selling your business or just happen to make a decent income for that year, you will fall into that higher capital gain rate.
“There's also a proposal on bonus depreciation which could be disincentivizing for companies who invest in equipment,” says Hedlund, referring to the proposed 15% minimum tax on book income, which could make it difficult for companies to fully utilize bonus depreciation.
Companies should also pay close attention to the proposal to eliminate the 1031 exchange program for real estate investors, which allows companies making $400,000 or more to repeatedly rollover any gain from real estate investments without penalty. If eliminated, property investors might hold off on selling and reinvesting in new property.
“Many of our clients are contractors and have their own clients who are involved in real estate development. If the exchange program is eliminated it could have a ripple effect on the industry,” notes Hedlund.
Despite all the challenges thrown at the industry, construction remains known for its resilience in weathering recessions, labor shortages, economic setbacks, rising labor and materials costs, as well as a global pandemic. Through diligence and reliance upon the professionals and vendors dedicated to the construction sector, firms can rebound from the COVID-19 economy even stronger and look forward to reaping the rewards of careful planning.
“I believe the biggest issue we will face in the coming one-to-two years is going to revolve around the anticipated growth of the economy and new project starts—and how companies manage that growth in the middle of extreme volatility of resources, such as commodity pricing, labor availability, and professional staff shortages in the AEC industries. If you can navigate those challenges successfully, you will be well positioned for large growth in the new ‘roaring 20s,’” Hodges says.