July 1, 2019
Financial statements tell contractors, as well as sureties, bankers, and other stakeholders, how well a construction company is doing. A contractor’s character, capacity, and capital are determined by the numbers reported on the company’s financial statements. Commonly referred to as the “three C’s,” these indicators provide a foundation for sureties to form an opinion on a contractor’s past, current and future performance.
The four types of financial statements are the balance sheet, income statement, statement of retained earnings, and cash flow statement. Notes and disclosures to the financial statements are required to comply with generally accepted accounting principles (GAAP). Schedules are also included to provide additional information and explain certain numbers. Financial statements audited by a CPA who specializes in construction accounting are sometimes required for bonding.
The balance sheet reports the assets, liabilities, and owner's (stockholders') equity at a specific point in time, such as December 31. Sureties typically analyze a contractor’s mid-year and year-end balance sheet position to ensure that everything is going according to plan. Sureties will look to see that the assets and liabilities are properly classified. They will also analyze contracts, job cost efficiencies, billings (overbillings and under-billings), as well as other indicators that jobs may not be well managed, adequately financed, and being completed on or under budget. Items that sureties do not want to see on a balance sheet are cash overdrafts, loans to officers, loans to employees, certain current assets, increases in current liabilities, and negative equity.
The income statement is a summary of the results of a company’s operations for a specific period time. It presents a picture of a company’s revenues, expenses, gains, losses, net income, and earnings. Sureties will compare a contractor’s year-over-year and period-over-period financial statements. They look for significant changes in reported revenue and expenses. Key Performance Indicators (KPIs) will also be analyzed to determine if a contractor’s performance is in alignment with past periods, benchmarks on similar companies, and industry trends. Sureties want to see consistency in performance and that the contractor is operating as well as, or better than, other companies in the same market.
Statement of Retained Earnings
Retained earnings represent the amount of net income or profit left in the company after dividends are paid out to stockholders. The statement of retained earnings shows the changes in retained earnings from one point to another. Sureties look at the statement of retained earnings to determine if a contractor is over-extended. Although a contractor may have a positive amount of retained earnings, they may not have a large amount of cash if it was invested in buying property, materials and equipment, or used to reduce the corporation's liabilities.
Cash Flow Statement
The cash flow statement reports the sources and uses of cash and certain supplemental information for the period specified in the heading of the statement. Cash flows into and out of a company from a contractor’s business activities, investment activities ((sale of a property or payments, gross proceeds from selling certain assets or purchasing land, equipment, materials, etc.) and financing activities (borrowing money, paying off debt, issuing stock, purchasing stock or paying dividends, and making distributions to owners). Sureties analyze a contractor’s cash flow statement to see if they can pay bills in a timely fashion.
Notes to the Financial Statements and Schedules
The notes to the financial statements (footnote disclosures) provide information on a company's operations and financial position. The footnotes summarize significant accounting policies, business activities, the use of estimates, cash equivalents, method(s) of accounting used, and other key pieces of data. Notes to the financial statements are required by the full disclosure principle and are important to communicate relevant facts and explain certain numbers. Supplemental schedules give more detailed information. These include, but are not limited to the:
- Schedule of Contract Revenue
- Schedule of General & Administrative Expenses
- Schedule of Completed Contracts
- Schedule of Contracts in Progress
Sureties will analyze each footnote and schedule to determine the concentration of risks, costs, and estimated earnings on uncompleted contracts; if the contractor took out or used its line of credit, if there are long term notes payable, excessive overhead expenses; the collectability of accounts receivable, as well as any financial exposure due to retirement plan obligations, backlog, lease commitments, related party transactions, and commitments and contingencies. In addition, sureties want a breakdown of the cost of labor, materials, and subcontractors per job; the number and size of jobs in progress, gross profit per job, and job fade. Sureties want to see that the contractor is making money and that the gross profit is enough to cover 12 months of overhead expenses.
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Feel free to contact any member of our team with questions at 610-828-1900 (PA) or 732-341-3893 (NJ). You can contact Matthew Boland, CPA, director – accounting & assurance, at
or me at
. We are always here to answer your questions.
Martin C. McCarthy, CPA, CCIFP
McCarthy & Company, PC
Disclaimer: This alert is for informational purposes only and does not constitute professional advice. Information contained in this communication is not intended or written to be used as tax advice, and cannot be used by the recipient to avoid penalties that may be imposed under the Internal Revenue Code. We strongly advise you to seek professional assistance with respect to your specific issue(s).