2011 Construction Industry Update

I recently attended the Pacific NW Construction Industry Conference in Seattle, WA hosted by the Washington Society of CPA’s and CFMA. The analysis below represents key thoughts, ideas, and individual predictions made by presenters at the conference.  If you would like additional information contact Kyle Walter at (503) 399-7306.

ECONOMIC UPDATE
• A prediction was made that 50% of all contractors will be out of business in the next 5 years (mergers, sales, bankruptcy, dissolution, etc.)
• Sureties are scrutinizing financials much more closely than ever before. Profit fade will not be tolerated.
• Construction economy generally lags regular economy by 12-18 months. When recession ends, expect construction economy to lag behind.

TAX UPDATE
• State update- all states are aggressively seeking to collect revenue and establish business nexus (sufficient connection to their state) to tax your construction activities. Be aware that if you have people, property or sales into another state you may be subject to their tax jurisdiction. Note- state of Washington is generally not tax friendly to businesses. Businesses in Washington pay approximately 50% more in business taxes than other states. This makes up for their lack of personal income taxes.
• Federal update- not much changes in 2011 for construction industry. IRS audit activity has been seen in 2011 related to domestic production activity deduction (DPAD) now that it has reached the 9% level. IRS lost an important court case challenging a contractor on qualified receipts as relates to repair work. This is good news for construction industry but a reminder that the burden of proof in establishing that gross receipts meet “qualified” status is on taxpayer, not IRS.
• Construction tax accounting continues to be very complicated given many different methods of accounting allowed for long-term contracts. Many taxpayers and CPA’s struggle with applying these methods correctly, and even when applied correctly, many times the most favorable method isn’t being used. These methods should be continuously analyzed in light of a contractor’s changing business during these economic times.
• A reminder that capitalized work in progress (big issue for homebuilders and developers) is not inventory, and therefore not available to be written down to market value for tax purposes. Unfortunately, this is allowed for generally accepted accounting purposes (financial reporting) but not tax reporting.

FINANCIAL ACCOUNTING UPDATE
• There are changes coming to the percentage of completion revenue recognition standard but not as pervasive as some previously thought. The basic percentage of completion calculation is expected to remain intact.
• New lease accounting rules will come into play shortly. Contractors should identify all of their leases, both capital and operating, and have a good understanding of lease terms. The change in external financial accounting reporting may impact important ratios used for bonding.

CLOUD COMPUTING AND SOCIAL MEDIA (For Business)
• Linked In and Facebook (the Big 2) are becoming commonplace in business. These social media tools are expected to become as commonly used in business as email in a few years. These tools offer the ability to significantly extend your professional network. However, they do not replace face to face communications.
• Twitter has yet to prove itself as valuable for business as the Big 2.
• Voice and data communications are converging to define the next wage of technology.
• The Internet is fast becoming the platform for computing and communications.
• Enterprise level software applications are moving web based. Benefits of a web based environment include having your data readily available in the field, main office, job shacks and at home.

REPOSITIONING YOUR COMPANY FOR THE FUTURE
• Document your Company’s systems and processes
• Establish feedback loops/systems within your system to flush out inefficiencies and provide a backdrop to reinforce positive behavior.
• Document your Company’s organizational chart and strategy (who is responsible for doing what).
• Your strategic plan must not only be documented but dynamic and fluid and based on our current and changing environment (a plan based on the economy 5 years ago is dangerously outdated).
• Comprehensive (and individualized) project management systems and reporting are a must.
• Lack of talent will be an issue in the future as a labor shortage is looming. Baby boomers will be retiring and employees are currently leaving the construction industry. Do you have good people in place to capitalize on opportunities when the economy turns?
• 1 in 4 contractors are actually positioned today to succeed. Reasons for anticipated failures are:
o Contractors failing to bring overhead down with declining revenues
o Contractors straying too far from core competencies
o Contractors taking on unacceptable risk in the bidding process
• Management focus should be on 1) improving productivity and 2) reducing overhead; however, greater emphasis should be placed on improving productivity.
• Private financing is expected to replace certain bank financing
• Understand that profits are generally made on the front-end of projects and lost on the back-end. Shore up your project management processes and productivity measures as relate to the back-end of jobs.
• Manage your field “Profit & Loss” activity by developing field level key metrics applicable to your industry. Use of Project Management software and understanding of key productivity measures is vital. The Company monthly Profit and Loss report, while still valuable to management and outside service providers, is a consolidation of all of your department level P&L’s that simply reflects what happened in historical, summary form.
• Utilize company dashboard information. Contrary to popular belief, this is not a summary Balance Sheet or Profit & Loss report.

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