Somehow it is that time of the year, again, when the leaves have fallen, the temperature drops, and we watch the calendar tick down towards December 31. And with Andy Williams crooning, “It’s the most wonderful time of the year,” there is a lot of noise in the world today that detours business owners from charting a confident course into the new year.
For construction contractors, who are now feeling the COVID-19 impact that most other industries experienced in 2020, that noise revolves around replacement of dwindling backlogs, material price increases, continued labor concerns, and the impact of interest rate hikes on capital expenditures. With no plans for additional governmental assistance programs, the potential to see a wave of contractor failures is real.
And while it is easy in the doom and gloom that comes with the shorter days and longer nights of winter to discuss inflationary concerns or debate if a recession is looming or already here, it feels more appropriate within the holiday season to focus on the strategic planning techniques contractors can employ to capitalize on the opportunities we believe will emerge during 2023, like the first flowers of spring.
1. Purchasing & Procurement. Take inventory regarding how you have been dealing with the price fluctuation of construction materials. To mitigate price fluctuation, consider purchasing and storing stock items in advance or secure a purchasing agreement for stock items in an effort to lock in prices. Review if change orders are being accepted for increased costs of construction materials or altered lead times for purchasing materials.
2. Revisit Your Prequalification Process. With so much talk in the industry around other construction contractors in distress and fear of failures, this is a good time to revisit and update your subcontractor prequalification process. When the contractor’s prequalification program relies on year-end information, the issue becomes the reliability of outdated financial statements on which you are making award decisions. In addition, 2021 saw the end of the government grant programs, such as PPP and ERC, so results may have been skewed. Asking for updated financial information, whether CPA-prepared or not, could give the qualifying contractor greater insight into the current financial health of a subcontractor before it is too late.
3. Operations & Disaster Planning. Take note of increased costs this year due to inflation. If you implement new innovations to streamline operations, you may be eligible for R&D credits. In the event of future disasters or slowdowns, have a plan in place and make sure your team knows the proper procedures to execute during a business crisis.
4. Project Performance Management. This is an ongoing review of the efficiency of your projects. It is essential to have a formal policy in place for communicating, reviewing, and documenting actual job performance in relation to the budget. Management should review job costing and profitability on a regular basis.
5. Internal Controls & Auditing. Reflect on whether your business has sufficient internal controls in place to deter the opportunity for someone to commit fraud, including your remote employees. Ensure job costs are being posted to the correct project. Also review how journal entries are originated, approved, and posted within your accounting environment.
6. Cybersecurity. Cybercrime is the industry that never sleeps. Hackers love the construction industry as they perceive it to be one with a high proliferation of companies within the middle market that are either unsophisticated when it comes to investments in technology or view these types of investments as having little to no return. Mix in times of financial and general uncertainty, and cybercriminals have the perfect setup to prey on already vulnerable and fearful companies. While the construction industry may be a late adopter of cyber and information security protocols, it is never too late to promote awareness throughout the organization and foster an environment where it is ok to be skeptical of an email, a request from a new face on the construction site, or a new vendor payment process. Ensure that you and your management team know what to do if your company experiences a cyberattack. Have formal policies and procedures in place to monitor cyber risk, including exercises such as penetration testing. Utilize a third-party provider to run crisis management and have a designated cyber expert on staff.
7. Cash Flow Forecasting & Operating Budgets. This makes the list every year, but is even more important in today’s economic climate. We all know that contractors fail in good times due to cash flow constraints, let alone in tough financial times. Each construction project has is its own cash flow eco-system. By implementing and employing a project-centric cash flow forecast and operating budget process, the contractor can identify where projects, and the company, will experience cash surpluses/deficits and understand how this will impact the entire business. These reports should be fluid, cover a 6–24-month outlook, and provide the construction financial manager with a deeper insight into the company. Ensure you make changes in real time to address potential cash shortfalls and project profitability matters. The power of this strategy is, when a constrained period is identified, management will be able to take the necessary steps to identify other sources of cash flow that will carry operations.
8. Financial Reporting & Key Performance Indicators. For the construction contractor, financial reporting on the company-wide and project level must be the foundation of every business decision upper management makes. Real-time and accurate financial reporting will help the contractor identify issues early and remediate them contemporaneously. After all, yesterday’s issue is today’s loss. But financial reporting should not stop at the job or corporate level. Identifying and benchmarking your company to construction industry key performance indicators (“KPI”) can help the contractor identify if a certain metric is above/below industry average and where the contractor is excelling or needs help, as compared to the rest of the industry. While these are powerful and insightful techniques, they do require the construction financial management team to capture that data in real time.
9. Income Tax Planning. Nobody likes tax surprises, and the construction industry is certainly not an exception to this rule. In an industry where “cash is king,” a proactive income tax deferral strategy becomes an effective means to maintain corporate capital. Based on the types of contracts a construction company performs under, there are opportunities to employ an accepted income tax reporting method as the basis of a deferral strategy. For example, while a construction company’s overall method may be accrual, to the extent any projects are completed within a single tax year, that project could qualify for cash basis. Further, a residential contractor (not a homebuilder) could employ a 70-30 accrual-cash basis split on reporting a qualifying project for tax. In terms of tax reform, assuming nothing changes, we know the current income tax rates will sunset by the close of 2025. If a contractor is already employing an accepted deferral methodology, the strategy could shift to accelerating the recognition of income for tax advantage at the lower rates, which is a real dollar savings. These are powerful techniques that should always be revisited, especially since cash flow is vital to a project’s success. Siphoning off cash unexpectedly due to an April 14 phone call can be extremely detrimental to the construction contractor.
10. Succession & Estate Planning. This is one of the more overlooked topics for many construction company owners/executives, not because it is unimportant but because it demands time, and where does the contractor want to be – at the project site or in her/his office? On the succession side, having a plan in place to identify, engage and create success for the next executive is imperative. In an industry where there is a skilled labor shortage, not to mention the Great Resignation, a formalized and practiced succession plan acts as a differentiator for future-facing contractors. In terms of wealth preservation, owners of construction companies still have the opportunity to transfer highly valuable/appreciable assets out of their estates, tax free. By utilizing the lifetime gift tax exemption, which is $12,060,000 per individual for 2022, an owner can move the ownership of the company to the next generation while controlling the tax implications. Like current income tax rates, this exemption is subject to potential change in 2023 and is scheduled to sunset in 2025. To the extent the owner of a construction company has not done this type of planning yet, 2023 is the time to get strategic on this point.
Every market condition presents opportunities, and this one is no different. So keep your eyes open. These may come in the form of labor or other talent, new customers as you step up and fill a market void, or accelerated investments in technology. Whatever it is, be open to it.
Your service providers and advisors are key sources of innovative ideas and strategies. Stay engaged in a continuous dialogue with them to understand what they are seeing across the industry. For example, a conversation with your bonding agent could reveal problems other contractors are experiencing and help you avoid them through proper planning. Keep in close contact with your audit and tax professionals, as their unique insights into your financial condition can yield valuable recommendations for greater efficiencies and cost savings. This discussion should extend to the bank and surety, making sure they are on board with any upcoming requests that will require your credit providers’ backing. In other words, leave no room for surprises.
While not an all-inclusive list, these items are certain to continue to impact the construction contractor in the office and on the job site. Success for the upcoming year can be achieved through continued dialogue with your people and professionals as the operating landscape continues to evolve; better access to real-time project data (financial and non-financial) that will enable you to make critical job decisions in the moment; and an emphasis on conserving corporate capital while being open to new opportunities and the right type of growth. As we close the books on 2022, a year which saw some reactive decisions, the construction industry has the opportunity to proactively script and plan 2023.