Curing Inaccurate Accounting – A Contractor’s Guide
Bank and surety underwriters rely heavily on a company’s internal financial reports when assessing its overall strength and capacity to support bank loans and meet surety indemnity obligations. Thus, a contractor’s ability to obtain favorable financing terms and secure surety credit is directly tied to its ability to produce accurate internal financial information. And to produce accurate financial information, strong accounting practices are essential.
That said, the term ‘accounting practices’ is somewhat vague. What actually needs to be in place to guarantee accuracy? Well, there are many specific, detailed procedures that must be followed to produce accurate financial reports, but there is one that is key. Since people, in general, are mistake-prone, there is only one way to make sure that an accounting department produces accurate accounting information. That is, perform a monthly audit. It is well known that CPAs produce three types of financial statements: compilation, review, and audit. Amongst those, the audit is most rigorous and most reliable. So too, by applying the same procedural methods that CPAs use to affirm the accuracy of audited financial statements, accounting departments can apply a similar level of control. Such a control consists of a well-defined written procedure to audit internal general ledger accounts for accuracy regularly.
For those unfamiliar with accounting, the core of any financial system is called the internal general ledger accounts, aka ‘chart of accounts’. That is simply a list of all the accounts (buckets, so to speak) in which day-to-day money-related transactions are entered. Whether it be deposits, payroll, job costs, purchases, or any other money-related transaction, current or planned, they all get placed in these various buckets, often fifty or more. Those accounts, organized and displayed in a specific manner, are what make up a financial statement. Therefore, it can easily be concluded that auditing what goes into those accounts is paramount to achieving accuracy.
It is quite common for a transaction to be placed in the wrong account, causing financial statements to be inaccurate. For instance, if a purchase for a project is charged to inventory, then the job will look more profitable, potentially misleading estimators when bidding a future project of a similar kind. This is simply an example of many other potential mistakes, too many to discuss. Suffice it to say that if a monthly audit of the entries made into each account is conducted, then the mistakes will likely be caught, and a subsequent entry can be made to place it in the correct bucket.
Since construction is a fast-paced business, transactions from a month ago are often forgotten, and mistakes get buried. Thus, having a monthly procedure in place to scan all the entries that went into each ‘bucket’ will likely catch most errors that can then be corrected. So, what are the many benefits? Well, when mistakes are found, the person making the mistake is likely not to do so in the future. The financial statements will show consistency and track appropriately from month to month, exuding confidence from bank and surety underwriters. Corporate decision-making that relies on accurate financial information can be done with greater confidence, and estimating that relies on past project cost data can be performed with greater accuracy. The list goes on.
The simplest way to install an audit procedure is by placing each general ledger account in a column on a spreadsheet with columns for each month-end date of the fiscal year next to it (an example is at the end of this article). When a quick review of each entry in an account is complete, i.e., audited, a check mark is placed in the column. Since people, in general, do not like to have their mistakes exposed, to make sure the mistakes are found, it is often best to have personnel within an accounting department review each other’s entries. For instance, having the person responsible for A/R review the entries made by A/P, and vice versa, can produce the best results.
In summary, the accuracy of financial information is directly linked to the strength of a very specific audit procedure and the disciplined implementation thereof. Poor internal accounting controls can cause mistakes to go undetected, often culminating in misstated financial reports. When financial statements contain errors or inconsistencies, they not only mislead internal management but also raise red flags with bank and surety underwriters who depend on these reports to make credit decisions. On the other hand, strong internal controls guarantee the accuracy of the financial information regularly produced by the accounting department. Maintaining disciplined, documented accounting audit procedures ensures accuracy and consistent reporting, thereby earning the confidence from owners, banks, and sureties alike that the company has the stability to meet its financial obligations and qualify for future work.
