Many construction contractors are only now feeling the COVID-19 impact that most other industries experienced in 2020. In the new year, they will face dwindling backlogs, material price increases, continued labor concerns, interest rate hikes on capital expenditures and other significant challenges.
To help contractors navigate the road ahead, Grassi’s Construction team has issued their annual outlook of the Top Contractor Strategies for a profitable 2023. From tried-and-true financial tools to new trends for combating inflation and risk, these are the planning opportunities your construction company won’t want to miss.
- Purchasing & Procurement. Take inventory of how you have been dealing with the price fluctuation of construction materials. To mitigate the impact, 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.
- Revisit Your 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 When the contractor’s prequalification program relies on year-end information, the issue becomes the reliability of outdated financial statements on which you are making award decisions.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 could give the qualifying contractor greater insight into the current financial health of a subcontractor before it is too late.
- 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.
- 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.
- Internal Controls & Auditing. Reflect on whether your business has sufficient internal controls in place to deter 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.
- Cybersecurity. Hackers love the construction industry as they perceive it to be one with a high proliferation of middle-market companies that are either unsophisticated when it comes to technology investments 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. Promote awareness of cybersecurity throughout your 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 penetration testing.
- Cash Flow Forecasting & Operating Budgets. We all know that contractors fail in good times due to cash flow constraints, let alone in tough times. Each project has is its own cash flow eco-system. By implementing and employing a project-centric cash flow forecast and operating budget process, you 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. When a constrained period is identified, management will be able to take the necessary steps to identify other sources of cash flow to carry operations.
- 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. But financial reporting should not stop at the job or corporate level. Benchmarking your company to construction industry key performance indicators can help you identify if a certain metric is above/below industry average and where your business is excelling or needs help, as compared to the rest of the industry.
- Income Tax Planning. 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 you are 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.
- 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 $12,920,000 per individual for 2023, 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 set to expire at the end of 2025. If you have 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.
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.
For more information, please contact Carl Oliveri, Construction Practice Leader at Grassi Advisors & Accountants, at [email protected] or 212.223.5047.