Archive for year: 2014

An improving economy is often a precursor to a rise in contractor default. Why is this the case? For starters, in the excitement of building a bigger backlog contractors are often unprepared to support an increased workload with the existing resources. Uncontrolled growth often jeopardizes the efficiency of existing systems and can disrupt once successful workflow, and thereby cause overspending throughout the organization. A common statement from contractors is: “I did much more work but made way less money.” What’s the reason?

Growing Pains

Growing your company without a regard for the necessary time to effectively train personnel and obtain the necessary resources often result in no apparent gain in profitability, even though additional volume is performed. In effect, work volume outruns the company’s ability to manage and supervise the construction projects. When this occurs, project management and supervision become over-taxed and the sole focus becomes just getting the project built. Management of the project from a cost perspective gets lost, and change orders and paperwork tend to fall through the cracks. Also, subcontractor change orders are often ignored only to disrupt the relationships, triggering emergency measures to satisfy their payment requests. So, how do you grow efficiently?

The Risk of Taking on Larger Projects

Contractors often think the answer is to minimize the need for additional management resources by simply going after larger projects to increase volume. There is no doubt that controlling project size is difficult in an industry where big jobs lead to growth. Since project management resources may not be readily available to undertake many small projects, it may seem far easier to grow by simply taking on bigger jobs that can be handled by the existing management structure. However, bigger projects most often require more experienced management. When management is not experienced enough to handle a large project (often with a larger degree of difficulty) back charges occur, claims typically arise and profits are blown. Many companies have failed by taking on projects that are dangerously large in comparison to their ability to withstand a loss. But there’s an answer!

Controlled Growth

Under a controlled growth strategy both project size and degree of difficulty are considered, and the potential for failure is mitigated. And controlled growth allows time for the expansion of systems in addition to providing time for the related training programs to develop. By systematically building the management infrastructure, your company can take on an increasing number of jobs and build the experience and resources necessary to eventually manage larger projects.

In summary, carefully evaluate the mix of project sizes your company undertakes because if something goes wrong on one of these projects that are too big to handle, the consequences can be catastrophic. Both future bonding needs and capital needs can be put in jeopardy, in turn, resulting in business failure. What then is the key? Don’t let your excitement over emerging opportunities cloud the sound business practices that you have used to succeed thus far. Big is not always better!

A few days ago, I received another email from a “close and personal friend” who is a high-ranking manager at a bank in Nigeria. My “close” friend must really trust me more than anyone else because he asked that I hold, in trust, $10 million US dollars for his cousin, a now deposed village leader. Now, all I needed to do was to email him my bank account numbers and a few personal details to make sure the money got deposited. Sound familiar? If you have owned a computer with online access in the last fifteen years, you have likely received an email from a friend in Nigeria. The scam is a global classic and the reason it has continued for so long is because there is an endless supply of people who fall for it even though this fraud is so obvious.

Not All Frauds are Equal

Not all frauds are quite as obvious, especially in the construction world because of the large sums of money involved in projects. Even in the smallest firms, frauds can go undetected indefinitely and the schemes to defraud are countless.

There are ways to prevent, detect and/or deter fraud. As clarification, we are not addressing property theft or inventory shrinkage. Instead, my focus is more the “white collar” crimes, or frauds that occur mainly in the office such as forgery, phony invoicing, padded time sheets, “feather bedding,” banking schemes, check kitting, supplier bid tampering and workers’ compensation fraud, to name a few of the most common. We have seen all kinds and it boggles the mind.

Pay Attention

The first line of fraud defense is vigilance. Fraud is out there so pay attention to the way the business operates. If your instincts tell you something is wrong, it may be that it is wrong. Change banking and computer pass codes often. Bring in a “surprise” auditor to review your books, and check out your cash management and credit card procedures. Spread rumors about the fact that you are checking for irregularities. Cross train office personnel and every so often rotate positions. Fear that a person’s dishonest activities might be discovered by a fellow employee is a powerful deterrent. Hey, fear works! Sometimes the best deterrent to a would-be internal crook is the fear of getting caught. So, pay attention, put in place some simple precautions and incorporate fear into your controls. It just might prevent hard earned money from disappearing out the door!

More construction businesses fail from the lack of cash due to poor cash management than from “bad” jobs—it’s a fact. One of the main causes of poor cash management is the ineffective collection of receivables.

Your ability to survive—and even grow—in this industry demands that you get paid in a timely manner. Timely means getting paid as agreed to in contract documents.

Historically, the construction industry ranks among the worst in terms of completing the work-invoice-payment cycle. The further you are down the payment chain, the more likely you are to be the subject of payment float (i.e., the last one to be paid).

Are there laws against this? Sure. There are federal and state “Prompt Payment Act” laws, and their legal equivalents. Is slow pay or floating money a breach of contract or possibly illegal? You bet. Call Perry Mason.

While you are waiting for Perry or his legal aids to show up, consider implementing some proactive routine practices to ensure your business avoids the obvious implications of running out of cash.

1. Collect receivables: The collection of receivables is a critical business management function. A weekly review of receivables, their due dates and their aging is an absolutely necessary function of a management team. That’s you! If a customer owes you money and is past due, contact them daily until it is collected. Do not be shy about going directly to the front desk of the customer’s office and asking to be paid or making a fuss with the project owner. The squeaky wheel most often is the one that gets the grease.
2. Avoid Paid-if-Paid clauses: NEVER sign a contract containing a “paid if paid” or “paid when paid” clause. These types of clauses are usually illegal, and even if they are not, don’t sign them even if pressured to do so. Also, unless it absolutely cannot be avoided, do not stop work to leverage payment. Get legal help before you try this tactic because it can backfire for all sorts of reasons.
3. Implement a disciplined management regimen: Schedule a regular time to review the status of accounts and particularly overdue receivables.

At Direct Surety, we work with construction contractors of all sizes, specialties, geographic locations and market segments. Along with providing more surety credit at a better price, we also provide tools that reveal best practices used by all of the top construction companies. Proper collection of receivables is only one of over 75 practices that you can put in place to maximize your profit-making ability and minimize your risk of failure. Partner with us to learn more about how Direct Surety can empower you to grow and prosper!

Lack of Inventory Control —

Over the past 30 years in construction, there have been countless times when I’d meet a job foreman wandering around the shop or yard muttering, “I know we have it out here somewhere.” He’d look and look for that misplaced tool, a section of steel plate or even a backhoe. “Where did it go? I need it today for my job,” he’d say in frustration.

Being analytical, I always wondered how many costly labor hours were actually spent on such a non-productive and futile search for “Waldo” – that illusive but critical item, hidden in plain sight or actually just gone. Then the foreman would request purchasing to buy whatever item went missing.

Imagine that!  Sure you can. You’ve been there. It doesn’t take Albert Einstein to figure out the cost of a lack of inventory control.

Construction companies with large inventories of materials and equipment that may in whole or in part be “consumed” by a job can prove to be both operationally and financially challenging. Static and dynamic inventories are financial assets of the company and they have significant cost implications at the job cost level, particularly on the corporate balance sheet. In addition, there may be significant hidden liabilities.

Static inventories, such as equipment ranging from small tools to cranes and bulldozers, present (or should present) a less complex general accounting and job costing problem. Put simplistically, these mostly static items can be capitalized and depreciated at a relatively predicable unit cost and billed against a job. This may be particularly true for the most obvious items like heavy equipment that is basically being “checked” on to or off of a given jobsite. The estimator and project manager should know, in advance, the unit cost of these static inventory equipment and material items as these are used. The same is true for sheet piling and like reusable materials that are not consumed by the job.

Dynamic equipment and material inventories are treated, from a job costing perspective, in a different manner than are static inventory assets. Generally speaking, static assets in inventory (i.e., a library book) are expected to be returned and retain a certain value as a company asset. Dynamic inventory, like lumber used in concrete forming, steel components or aggregates, are almost always expensed to a job as a singular one-time job cost. These types of inventory items are also company assets until consumed by a job – and billed.

What can significantly throw the inventory ledger out of whack is when there is amassed a significantly large value of a dynamic inventory that was charged to a job, expensed, and then returned for use on a subsequent job or not used at all.

This situation gives rise to a couple of potential issues. First, returned or unused dynamic material inventories that were expensed as a job cost and placed back into inventory may later be included as an asset without an off setting capital cost. This can have the effect of inflating the overall value of the company even if the material itself has little actual value. Second, estimators who rely on the merchantability of the returned asset may overvalue its actual usability or assume a minimal budgeted job cost since these may not appear in the inventory, and, thus, are “invisible.” The affect would be to distort the financial performance of both jobs. Finally, there may be additional depreciation costs against the company bottom line. The bottom line:  this type of practice is risky.

A steel fabricator, for example, may order a large quantity of specialty rolled steel columns and beams from a supplier. These are then cut to their needed design length. What remains are scrap called “drops.” While all the beams and columns, as originally ordered, were expensed to the job, the drops were never accounted for and become part of an unseen dynamic inventory. As far as the estimating, accounting and purchasing departments are concerned these drops, which can count as a significant asset, do not exist even though these are actually assets.

Also, I want to touch on the subject of depreciation in terms of inventory control. This usually affects static inventory such as tools and equipment. These are commonly company assets that are purchased, capitalized, placed into inventory and depreciated over a period of time. In practice, when used on a specific job, the depreciation costs are included in the overall rate charged to a job when any specific piece of equipment or static inventory material is used. I call depreciation the “silent killer.”

I say this because depending upon how a company manages its finances, equipment inventories do depreciate in value when these are capitalized. If unused or under used equipment is allowed to accumulate the equity value of the company may be inflated. But then, the depreciating values of these same assets drag down the bottom line and become a significant liability. If you analyze your static inventory and see items that are a drag to the bottom line – consider liquidating them.

The other thing about most static inventory items is that they need maintenance to hold their value in your inventory otherwise they are merely costly depreciating junk. The obvious items are pieces of equipment like trucks or earthmovers that, if left to languish, become large paper weights. But, you may also own smaller items like metal frame forming panel systems. These are expensive to keep in usable condition – the panels wear out, get punctured, and parts get broken or lost. These are just a few examples, but you get the picture. Do not defer, in your job costing or inventory expense, the direct cost of routine maintenance and repair or count deferred costs as profit – it’s not. To do so creates a huge risk, that is, a liability balloon or an inventory valuation equity risk that banks and sureties will certainly discover possibly resulting in a down grade to your credit lines.

From these few examples, and there are literally hundreds, the lack of inventory controls can have a disastrous impact on your company finances. There exist inventory control procedures and costing policies that can be adopted and adapted to avoid this problem.

Here are some practical suggestions to help ensure an effective inventory control program:

1. Place someone in responsible charge – an inventory manager.
2. Train your inventory manager to serve as a librarian.
3. Treat static inventory like a library book; maintain it, check it on and off a job.
4. Treat static inventory like it was an internal rental while on a jobsite.
5. The internal ‘charge rate’ should include all costs associated with the asset.
6. Establish equipment and materials departments like they were a profit centers.
7. Track the utilization of static inventory to evaluate return on capital employed.
8. Sign out or assign smaller tools and equipment to specific person(s) responsible to avoid inventory shrink. Check their status regularly.
9. Sign in, quantify and value returned dynamic inventory.
10. Document and communicate the status of all inventories to all other operations departments.