By Ken Roper and Lee Ackerman
CFOs are often the last line of defense against crippling errors and omissions, and the driving force for positive changes to enhance productivity.
The economy is driving all contractors toward highly sophisticated financial management in order to succeed in the construction industry. Now more than ever, CFOs are being called upon to serve in an increasing number of roles – which includes functioning as a legal stopgap by identifying and responding to potential risk or exposure. CFOs who effectively implement their optimal roles can help improve operations and reduce costly litigation.
CFO as Keeper of the Moral Compass
The cultural foundation for an organization’s ethics and internal controls is often called “tone at the top”. As a company leader, the CFO guides the organization using suitable values and ethics. In this instance, values come primarily from three sources: knowledge, skills, and integrity.
Financial reporting for contractors involves a significant amount of estimating, more so than most industries. Manipulating and juggling numbers and estimates are easy for a short time. Many financial statement manipulations are done with the purest of motives and rationalized with logic (however faulty), such as: “We will make up the cost overruns with future cost savings.” Although entered into with good intentions -- smooth earnings so as not to upset the bonding company or banker, etc. -- the foundation for the manipulation is inherently dishonest. And dishonesty at the top has a trickle-down effect. The company culture becomes one of connivance and collusion (“tell them what they want to hear”), which has never been the road to success.
The old adage “figures lie and liars figure” should never be associated with a CFO. As important as it is to be honest with everyone, it is even more important for CFOs to first be honest with themselves. Next, it is vital that they are honest with those who are relying upon them to provide valid information that will inform their decisions. The CFO must be willing to face the consequences of economic reality for the sake of the firm. He will do his best to present the financial picture accurately and assist other leaders in making the right decisions, both for the firm and the clients.
CFO as Risk Manager
CFOs are also proactive risk managers, constantly vigilant to avoid unnecessary liabilities. Financial management is, at its essence, managing risk. Risk is a cost driver and comes from several sources, including safety, contract provisions, and relationships with employees, customers (owners or general contractors), subcontractors, vendors, bankers and sureties.
The first steps in risk management are identifying and analyzing sources of risk. Insurance is a tool in the risk management arsenal, but the transfer of risk by insurance coverage is generally the most costly alternative. Other risk management techniques include risk avoidance and loss control. The primary defense against the consequences of risk is avoidance through advanced planning coupled with procedural compliance. To that end, the CFO plays a major role in the three greatest areas of risk:
The CFO should be part of an aggressive safety management program. Effective safety management programs can generate significant cost savings through reductions in insurance premiums, diminished lost time from accidents and injuries, and avoidance of legal costs and disruptions caused by claims. Most insurers serving the construction industry offer ongoing safety training as a supplement to training from other sources. Involving CFOs in these training sessions provides them with the knowledge and backing they need to properly promote safety throughout the company.
Clearly, the CFO needs to be involved in contract analysis and in identifying the most significant risks in a contract. One method CFOs have of managing risk is including a price or value of contract risk in the evaluation of the cost of the work. Such things as anticipating the implications of missing deadlines, or contract allowances for price changes due to commodity pricing or change orders, would make a contract much more viable. Understanding contract terms and conditions, and having open and consistent communications regarding those items among project personnel, are vital functions of a CFO practicing optimum risk reduction.
Keeping the lines of communication open is the keystone of relationship management. Recognizing issues and following-up with open, honest and prompt communication among all parties involved helps to avoid escalation of resultant negative consequences. CFOs who excel are usually great communicators. Many construction industry executives have little, if any, formal training in communications. What to communicate, how to communicate, methods of communication, confrontational skills, negotiating skills, salesmanship, mediation skills and other important communication abilities are, for the most part, skills learned through on-the-job training by managers and leaders.
The CFO is often the company’s internal voice. In conjunction with the project team, he is a key player in the successful completion of projects that meet targeted profit objectives. CFOs must deal with the economic reality of the organization, and be able to confront difficult situations.
People skills are some of the best and most valuable abilities managers and leaders have in their arsenal. Building work groups that deal with and manage the voluminous level of detail in the accounting process is vital for CFOs. High turnover causes excessive cost and disruption to the accounting process, and staffing is constantly increasing for growing construction organizations.
Methods and systems for all types of communication require constant attention to enhance sharing of information. Little time and fewer resources are devoted to this important aspect of operations. The challenge is just keeping up with one’s “day job”, let alone finding any time for leadership messages and sharing of direction -- both so important in organizational growth and development.
CFO as Legal Compliance Officer
Many jurisdictions have laws affecting almost any action taken by a contractor. Contractors deal with income taxes, sales taxes, contract provisions, employment law, Davis-Bacon rates and other government contract requirements -- just a few among many laws and regulations -- on a daily basis. And these are often in a variety of jurisdictions. While the wise contractor consults with legal professionals as needed, much of the day-to-day common sense applications of legal requirements are left to the CFO.
While income tax law is primarily determined by larger decisions, such as choice of entity, domiciles and other far-reaching determinations, actions taken on the contract level can have significant consequences. These include decisions to work in other states, performing work on contracts that have special income tax treatment, and contracting with governmental agencies. Sales tax laws are determined at not only the state level, but also the municipality and other local or district levels. To understand cash flow from a contract, the CFO has to understand the tax effects of contracts along with the impacts of other decisions.
Contract terms generally include requirements and timing for payments, change orders and submission of claims. Government contracts have even greater compliance requirements. All of these items can affect cash flow, and possibly profitability, on a contract when provisions are disregarded. Often, project personnel are focused on building the job, rather than the administrative requirements of the contract. The CFO has primary responsibility for some aspects of the contract, such as Davis-Bacon compliance, and has compliance oversight responsibilities for other contract requirements.
CFO as GAAP Technician and Lawyer
The construction industry also has specific reporting methodologies and practices, which are unlike most other industries. While the accounting for construction contractors makes sense under the circumstances of long-term contracts, it creates a challenging environment for the CFO and others involved in the accounting process, including construction project managers.
The CFO must be an expert in applying generally accepted accounting principles (GAAP) that pertain to the construction industry. Financial statements are valuable only if accurately presented. Additionally, one of the most important uses of financial data is benchmarking — providing useful comparisons against the industry. Furnishing accurate financial statements to bankers, sureties and internal users is extremely important.
GAAP is an evolving proposition and has had an accelerating rate of change in the last several years. Three key changes either recently released or currently in the works will significantly affect the construction industry. They are the methodology for recognizing revenues, accounting for leases, and accounting for liabilities in multi-employer plans. The CFO must not only be aware of current requirements, but also anticipate possible future changes. The effects of those standards on the company’s reporting will be substantial, and the impact on banking and bonding relationships will hinge on successful foresight.
Estimates that are constantly changing drive the information used to produce financial statements. These changing conditions mandate that the construction CFO be an astute evaluator of data. Project cost estimates are prepared prior to beginning a contract. From that point, they fluctuate through completion as scopes change, anticipated production increases or decreases, and contemplated prices from suppliers and subcontractors rise or fall. The CFO’s responsibility is to analyze the estimates and other assumptions from project teams and to separate logic and reality from pure speculation.
Several provisions in the Internal Revenue Code are sections (laws) applying specifically to contractors. In addition to being extremely complicated, income tax laws also encompass a variety of potential benefits and pitfalls. Some of the laws apply at the company level, such as choosing the most advantageous accounting or revenue recognition method, and some apply at the contract level, such as determining that a particular contract is a home construction contract.
Understanding the impacts of the tax-accounting treatments available for equipment purchases can greatly influence the cash-flow analysis of investment decisions. Although outside advisors are available in the form of your outside accounting firm or other consultants, success in identifying issues and ultimately making the correct decisions depends upon a diligent and proactive CFO.
Supporting the CFO as Ad Hoc Lawyer
The CFO’s responsibilities cross virtually every aspect of a construction organization. He prevents the company from making catastrophic errors and omissions, and is the driving force for positive changes to enhance productivity. A successful CFO demonstrates a breadth and depth of skills, as well as management and leadership abilities, and is extremely capable in all economic environments. CFOs are being called upon to serve as a stopgap to identify and address legal risk and exposure. As most CFOs rise through the accounting function, training and development are integral for CFOs to fulfill the variety of this position’s requirements.
As greater responsibility is placed on the shoulders of CFOs, firm leadership is challenged to provide an environment that values their talents. Opportunity for advancement is necessary for talented CFOs, and this includes exposing them to operational responsibilities, management succession and work acquisition aspects of the business. Greater opportunities allow intellectual advancement and increasing contributions to organizational success.
Ken Roper is a principal with FMI Corporation. He has been implementing profitable growth strategies with construction companies across the country for the past 30 years. Ken leads FMI’s strategy practice, and teaches courses on competitive strategy for contractors, pricing and bidding strategy, and financial management for non-financial managers. He may be reached at 303.398.7218 or via email at email@example.com.
Lee Ackerman, CPA, is director of Audit and Accounting with Brock and Company. Ackerman is a contributing author for FMI on accounting related topics. He may be reached via email at firstname.lastname@example.org.