The construction industry came into 2023 with caution, uncertainty and many unanswered questions. Halfway through the year, do we have any clearer answers? As an adviser, student and practitioner of the construction industry, it felt only natural to reflect and share some observations and takeaways from what we have experienced over the last six months.

Financial Results Are Shaky

The renaissance the construction industry experienced in the years leading up to and through 2019 is well-documented: record levels of spending across all sectors and employment at its highest. And we all know what happened as we pushed into 2020, specifically March 2020.

When the COVID-19 pandemic hit, nearly every business, regardless of the industry, was impacted. But the construction industry had one thing others didn’t: committed backlog. Plus, most contractors qualified for the Paycheck Protection Program (PPP) and Employee Retention Credit (ERC) programs, so the financial pain of the pandemic was masked. Flash forward to 2022, and backlog had dwindled, replacement work was hard to find, government assistance programs had ended and the natural lag of the construction industry caught up to us. Not surprisingly, contractor financial performance in 2022 was meek. The 2022 financial results that surfaced during early 2023 show the construction industry is experiencing what most industries felt in 2020.

Adjusting to Inflation

Inflation has made its mark across most businesses and households. And while it continues, the construction industry has adjusted to the rising costs of materials, taken proactive steps to alleviate supply-chain issues and modified employee compensation packages accordingly. While the absorption of rising costs depends on the circumstances at hand, the primary tool to battle inflation—interest rates—has cost contractors real dollars in their bottom line as rates continue to rise. The private construction sector has experienced substantial fallout as spending has slowed due to the cost of borrowing. Not to mention, the common practice of utilizing a line of credit to mobilize projects while requisition funding is pending has become extremely costly. The best summation is what one industry executive shared with me: “It scares me when I see contractors bidding a project at a margin that is less than their line of credit rate.”

The Banking Shakeup

The United States hadn’t seen a banking crisis since 2008. Coming into this year, a banking crisis—or maybe this was more of a shakeup—was an event we didn’t expect to encounter. Seemingly emerging overnight in mid-March, Silicon Valley Bank and Signature Bank made headlines as a result of weak investments and cryptocurrencies. In an age of market perception becoming reality regardless of fact (thanks to social media and the 24-hour news cycles), confidence in both banks was shaken to a point where we saw depositors lining up to withdraw enough funds to cause the banks’ collapse. Like 2008, the federal government stepped in to assist by securing all deposits and, in Signature’s case, facilitated a soft landing for customers and personnel. Regardless, the damage was done as numerous contractors either moved or started the process of moving away from Signature. For the New York construction market, there is one less bank dedicated to the construction industry, and we will need to watch closely how Flagstar Bank navigates the market after acquiring Signature. If you missed our recent guidance on what your construction company should do to mitigate banking risks in this environment, click here to read the full article.

Infrastructure Spending

The need for infrastructure investment in the United States is dire. Washington has recognized and taken steps to address this by passing the Infrastructure Investment and Jobs Act, which will see $1.2 trillion authorized for transportation and other infrastructure spending, with $550 billion earmarked for new programs. Interestingly enough, a tradeoff in the passing of this legislation was the repeal of the ERC program for the fourth quarter of 2022, which most contractors qualified for in the first three quarters. Even as we hear about the billions of dollars being released and allocated to the states, the projects are MIA. Looking at where we are locally and the robust capital spending plans our public agencies have teed up, we cannot help but wonder: How much is reliant on federal dollars?

Looking back, it has been an eventful year, even though it’s only halfway through. The construction industry will look at the rest of 2023 to rebound from shaky 2022 financial results, stabilize their banking positions and hopefully start to see work in both sectors emerge. The industry continues to be a major driver of jobs and opportunities across the country.

As the year continues, Grassi’s construction team will continue to monitor industry trends and share proactive advice and insights to navigate the landscape.

The post 2023 Observations on the Construction Industry: Where Are We Now? first appeared on Construction Executive.

Now, more than a year after the pandemic began, the construction industry is still facing unprecedented situations. Contractors must continually refocus their collective vision toward the future—and on what will help them survive.

1. Develop a fluid cash flow model and operating budget covering the next 18 to 24 months. Contractors fail in good times due to cash flow constraints, let alone in times of financial and health crisis. Tried-and-true financial management planning tools, such as project-centric cash flows and budgets, can help a contractor identify where projects will experience cash surpluses/deficits and understand how this will impact the entire company. When a constrained period is identified, management can take the necessary steps to identify other sources of cash flow to carry operations.

2. Don’t take work to keep the field busy. As backlog is rapidly burning off, replacement work is not as readily available as it used to be. While there are needs for new projects, economic uncertainty has put a freeze on funding. More bidders are pricing aggressively, at slim to no margins, to win work. This is an unsustainable strategy that will have a negative impact on a contractor’s cash flow and could have a waterfall effect. To the fullest extent possible, a contractor should bid work to make money (even if at a lower profit), stay within their own expertise and identify where overhead can be reduced and corporate capital conserved.

3. Evaluate income tax options. While not immediate, there is an expectation that President Biden will look to reform the U.S. tax structure. This throws a twist into certain income tax planning strategies, such as proactive income tax deferrals, which enable the contractor to conserve cash that can be deployed into projects while requisitions are being funded. If rates are expected to go up in a subsequent year, however, the notion of accelerating income becomes a more viable tax strategy.

4. Treat Paycheck Protection Program loans as “wild cards.” The evolution of PPP loans has been a well-publicized odyssey. Even with many issues resolved, such as the deductibility of PPP-funded expenses, the Small Business Administration’s scrutiny over the need for these funds and the tightened requirements for second-round loans are causing continued uncertainty. Thus, questions arise, such as:

• Was the loan truly necessary, or should it be repaid?
• If forgiveness is sought, when does the loan drop to income for financial reporting purposes?
• Was I really eligible for a second loan?
• How will my bank and/or surety treat this income?

5. There is no better time to start estate planning. Estate planning is an important initiative for all contractors, but it is not always the highest priority. As a result of COVID-19, the construction company (often the most valuable asset in a contractor’s estate) could be valued at an all-time low. Coupled with the current high lifetime gift tax exemption ($11.7 million for 2021 or $23.4 million if married), ownership of the construction company, real estate and other assets can be moved out of the estate for significant tax savings. PPP borrowers should be aware of restrictions if the transfer involves more than 50% of the ownership interests or assets.

6. Refine and scenario-train response plans. Even in 2021, contractors should still look to implement and refine COVID-19 response plans. The plan should focus on proper hygiene training; how to handle positive cases in the office or on a jobsite; measures to understand the owner’s and other contractors’ jobsite protocols; and contact tracing.

As with any plan, the COVID-19 response plan is only as good as the execution. Start with staff training and awareness, and then engage in scenario training, ensuring people know their health is a priority and understand their functions and protocols if an outbreak occurs.

7. Cybercrime never sleeps. Hackers love the construction industry because they perceive it as a high proliferation of middle-market companies that are either unsophisticated when it comes to technology investments or view these investments as having little to no return. Mix in times of financial and general uncertainty, and cybercriminals have the perfect setup to prey on vulnerable and fearful companies by offering everything from “free” jobsite COVID-19 tests to financial grants in exchange for employees’ personal information.

It is never too late to promote awareness throughout the organization and foster an environment where it is okay to be skeptical of an email, a request from a new face on the construction site, or a new vendor payment process.

8. Get on board with technology. Most construction companies had to put their technologies to test rather quickly during the initial shutdown. Employees had to “lean into the curve” and learn how to work remotely; IT teams were stretched as they made sure VPNs had bandwidth to accommodate multiple users at once; and mobile meeting platforms became the norm not only for internal meetings, but also for project kickoff meetings and even project walkthroughs.

While a number of initial issues caused by this shift have resolved themselves, contractors continue to have opportunities to evaluate remote workplace strategies, assess whether technologies are efficient and explore new ways to build. While certain aspects of construction can never be virtual, the opportunity and need to adopt jobsite health and safety technologies has never been greater.

9. Huddle up with advisors. Contractors should be engaged in continuous dialogue with advisors to understand what they are seeing across the industry. For example, a conversation with a bonding agent could reveal other contractors’ challenges, which could be mitigated for your company through proper planning. Contractors should also ask accountants about possible financial reporting and the income tax implications of the pandemic. This conversation should extend to the bank and surety, making sure they are on board with any upcoming requests that would require a credit providers’ backing.

10. Stay alert for opportunities. Every market condition presents opportunities, and this is no different. These may come in the form of labor or other talent, new customers in a market void or accelerated investments in technology. Whatever arises, contractors should be open to the shift.
Success can be achieved through continued dialogue with advisors; better access to real-time project data (financial and non-
financial) to help make critical decisions; and an emphasis on conserving corporate capital while being open to new opportunities and the right type of growth. Following a year of many reactive decisions, contractors can proactively script and plan for a very different future.

The post Ready to Mobilize in 2021: 10 Things Every Contractor Should Consider first appeared on Construction Executive.

While each construction company is different in terms of its approach to building, one similarity exists at the core—an entrepreneurial nature. And the one thing all entrepreneurs want to know is: “How am I doing compared to my peers and competition?”

One of the best ways to answer this question is with benchmarks. And one of the most powerful benchmarks for a construction company is working capital. For a user of a contractor’s financial statement, such as a surety and a professional surety agent, working capital is a great indicator of a contractor’s immediate financial prowess.

Asset and Liabilities

Working capital is the difference between a company’s current assets and current liabilities. It is a measurement of the company’s operating efficiency and financial health for the next operating cycle (generally, the next 12 months but could be longer). For a construction company, quite simply put, working capital is the financial capacity to perform on the current backlog.

According to Greg Horne, assistant vice president at Liberty Mutual Surety, the base premise of working capital starts with the question: “How is the construction contractor going to fund the company until the payment requisitions come in?”

Kevin McCann, vice president—surety division, Philadelphia Insurance Companies, adds: “Sureties may look at some components of working capital differently, but ultimately we want to understand the liquidity of the company to keep operations funded for the next year.”

The composition of the balance sheet can start to answer these inquiries but, in practice, working capital is not a pure ratio, especially considering the recent changes in Generally Accepted Accounting Principles’ (GAAP) revenue recognition model (Accounting Standards Codification “ASC” 606: Revenues from Contracts with Customers). As part of those changes, upfront cash outflows (such as bond and mobilization costs), which in the past would have been considered job costs and generated book revenue, need to be analyzed for the potential reclassification as prepaid job costs. By definition, this method would increase working capital but, in reality, does it?

While it does depend on the specific contractor and circumstances surrounding those costs, generally, under ASC 606, if it is determined prepaid expenses are job-centric (that is, can be attributed to a specific job), working capital credit can be extended.

Certain assets, Horne says, are discounted while others are deeply scrutinized in his analysis. Items like inventory and general prepaid expenses are often written down by 50%, which may not be enough in some cases. As time passes between when the CPA completes procedures and analysis and when the surety receives the report, underbillings are “audited” again, this time by the surety.

“We typically want to understand what is causing an underbilling and why the contractor has not been able to bill for these costs, especially if the contractor is deeply into or fully extended on a line of credit,” Horne says.

There will always be items sureties want to get a better understanding of beyond prepaids and underbillings. These revolve around aged and unbilled receivables.

“Regardless of the condition of the market, the surety needs to understand the composition of working capital,” says Barry Shabashkevich, vice president of Sompo International–Surety. “Specifically, how old are the receivables and when will the unbilled receivable turn? What’s the true liquidity?”

That very question leads to the analysis of another ratio, receivable turnover.

Supplementary Information

When analyzing a construction company’s financial statement, Shabashkevich delves into the included supplementary information relevant to the construction industry, such as the schedules of contract receivables, contracts completed and contracts in process. These schedules supplement (no pun intended) the surety’s working capital analysis by providing a starting point to forecast cash receipts on a project-by-project basis and establishing how backlog and the associated gross profit will be recognized over the next operating cycle. In other words, using the supplementary information in conjunction with the current working capital ratio, the surety can forecast “tomorrow’s” level as part of the underwriting purposes.

But the analysis does not end with the numbers. Off-balance sheet, it is also important for the surety to understand the customer that the contractor is working for; specifically, what the customer’s payment habits are in terms of the requisition approval process, turnaround time and whether upfront/mobilization costs can be requisitioned.

“Whom a contractor works for and how that customer pays are important to the process,” Horne says, especially if the customer is new.

External Complications

In April 2020, as part of a larger stimulus package, the federal government implemented the Paycheck Protection Program (PPP) as a measure to counter the financial impact businesses were experiencing as a result of the COVID-19 pandemic. The spirit of the program was to allow companies, meeting certain requirements, to apply for a loan with favorable repayment terms; those companies would have the option to be forgiven the loan, if the monies were used on payroll and related employee benefit expenses. In other words, if used for wages and employee benefit costs, the loan would transform into a grant.

Even though the construction industry, especially in the middle market, was a direct beneficiary of this program, the PPP adds a wrinkle to the working capital equation. As loans were granted, contractors saw an infusion of cash offset by a current and long-term loan payable. At present, the construction industry has had no issue in meeting the utilization requirements for these funds to warrant forgiveness, which means that by the end of 2020, or in early parts of 2021, the PPP loan payable amounts being carried on the contractor’s balance sheet will flow through operations and become a permanent increase to equity, net of income taxes as of the date of this article.

While on the surface this seems like an immediate increase to contractors’ working capital capacity, most credit providers, including sureties, are taking a “wait-and-see approach.” As this is an unprecedented program, which has changed a number of times since its implementation, the conservative approach is to analyze working capital without the PPP, in the instance that the program’s forgiveness guidelines change again or if the loan (or a portion of the loan) is not forgiven and has to be repaid.

The working capital analysis will soon face another complication as ASC 842 Leases is adopted, effective for nonpublic entities on Dec. 15, 2021. The guidance will require all long-term leases to be capitalized on the construction company’s balance sheet. In other words, the contractor will recognize a “right of use asset” similar in nature to property and equipment, offset by a current and long-term obligation under the remaining life of the lease. The key here is the contractor will be reporting a new current liability with no offsetting asset.

As noted by Kevin McCann, this will have an impact as to “how working capital is analyzed.” But there could be some relief, as most sureties will make the connection that there is a current portion of the capitalized lease to consider.

Cash Is King

Users, such as the surety community, including professional surety agents, will rely on the work and opinions of CPAs regarding the financial health of a construction company. It is important that the CPA industry understands how the surety looks at working capital so the CPA industry can design the appropriate procedures around the riskier components of this metric.

No two working capital cases are alike, and the process applied to a general contractor should not be the same for a trade contractor.
One recommendation is to analyze working capital both with and without the under- and overbillings, because underbillings are a current asset that does not add to the contractor’s ability to fund the project, and overbillings are a current liability that do not detract from the contractor’s ability to fund the project.

But in the end, all sureties, other creditors, and advisors to the construction industry share the same sentiment: cash has been, is, and always will be king.

The post Working Capital: It’s Not Just Math first appeared on Construction Executive.

Reflecting the responses of over 100 industry insiders, more than 82% of the respondents were either general contractors (43%) or sub- contractors (39%). A summarized version of the results is as follows:

The top issues identified relate to the skilled labor shortages, general business conditions and the challenges of complying with regulatory oversight, compliance was cited by more than 25% of the survey respondents as a top industry concern.

Union Versus Open Shop

When respondents were asked about union trends in the construction industry by sector, 46% of industry professionals said that non-union and open shop work had greatly increased in the residential sector, and further indicated that the share of non-union and open shop in the non-residential sector was increasing as well, but at a slower pace.

This trend was cited less frequently in the civil/infrastructure sector, with almost half seeing no change on projects in that sector. More than 87% of the survey respondents believe these current union versus non-union and open shop trends will continue. This shift in share, between union and non-union contractors, has broad implications for the competitive landscape.

Regulatory Compliance

Another challenging issue for contractors has been compliance with the minority/women-owned business (MWBE) requirements. More than half of the survey respondents (54%) said MWBE compliance was difficult or very difficult while only 13% said it was easy or very easy. Roughly one-third (34%) indicated that MWBE compliance was not a significant issue for their business.

Staying with the compliance topic, survey respondents were also asked how NY Labor Law Sections 240 & 241 is impacting their profitability. While the consensus was generally negative, assessments on the scale of the impact varied considerably among industry professionals. For 42%, the negative impact on the bottom line was large, while 46% said the impact was negative or slightly negative. Only 12% said that there was no impact.

“New York State and City regulations are becoming unbearable…I think a sensible tradeoff for having to provide so much OSHA training is that the contractors should be able to hold employees who have height-related injuries partially responsible for their negligence,” was just one of the many comments received.

Respondents were also asked how Local Law 196 (construction safety training) was impacting their businesses. Sixty-three percent said they were factoring compliance costs into their project bids. Safety training seemed to be a significant investment focus of compliance for respondents, with 60% saying that they were investing or planning to invest in safety training. Forty percent of firms were complying with Local Law 196 by hiring in-house safety personnel and 36% said they were engaging outside firms. Twenty-nine percent said they were investing or planning to invest in safety technology.

Cybersecurity

Cybersecurity and related awareness was another key issue raised in the survey. With an ever-increasing reliance on data at the core of every construction business, around 45% of respondents strongly agreed or agree that construction projects are increasingly susceptible to cybercrimes.

Construction sites are especially risky. Many people have access to confidential information and the industry uses network-enabled equipment in a relatively unsecure environment. Work-site cybersecurity caused concern among 76% of survey respondents, and it’s clearly a problem with the potential to have a material impact on any business. The construction industry should think beyond their four walls to ensure they have not only a physically safe job site, but also a cyber-safe jobsite.

In addition, according to the survey, only about half of contractors have cyber insurance. At one time, this coverage was reasonably priced, but with the rise of cybersecurity incidents, costs have risen as well.

Tax Reform

Another change impacting the industry these past few years lies with income tax reform. Anytime there is reform, it creates a tenuous situation because there’s always uncertainty surrounding the regulations. However, reduced tax rates are generally a good thing for any industry—especially for the construction industry, which relies heavily on cash. The change in the small-business threshold from three-year average annual revenue of $10 million to $25 million could be seismic as it enables qualifying companies to go back to a cash basis for income-tax reporting purposes. It can take construction companies extended periods of time to get paid, so not having to pay tax on uncollected revenues creates an opportunity to retain corporate capital and cash for reinvestment and growth.

The post Union Trends, Compliance and Cybersecurity Top-of-Mind for New York Contractors first appeared on Construction Executive.