Year-end Financial Planning
The 4th quarter usually brings financial planning for the upcoming year, including next year’s potential credit needs. Both surety companies and banks heavily rely on CPA-prepared fiscal year-end financial statements when reviewing their client credit. Even late into the following year, large amounts of emphasis are placed on “The most recent CPA-prepared financial statements.”
Surety Companies weigh bond programs on the combination of a contractor’s character, operational capacity, and financial capital. If maximizing your surety program is a goal, one should make sure they present their financial capital in as strong of a position as they can.
Current Year Results
If the year’s financial results are strong, determine whether the next year will bring more revenue growth. If revenue growth is the plan, allowing the balance sheet to grow accordingly is wise. If your revenues are stable and the balance sheet supports the company’s operations (meaning you did not use any bank support all year), growing retained earnings a modest amount is a good idea. Tax planning may be more of a focus at this time. Fixed assets may need to be purchased before the end of the year or accelerated depreciation used on equipment to reduce tax liability. Most tax mitigation tools can only be useful if they are done before 12/31.
Many construction companies are filed as an S-Corp which means taxes are paid at the shareholder level. Many companies will generate distributions out of current year profits to provide capital to the shareholder for tax payments. Typically, these have been going on throughout the year in quarterly payments. If there are large discretionary distributions, it is a wise idea to give the surety company a “heads up” with some of those plans.
If you are trying to grow your company, distributing as little as possible to pay taxes and retaining the rest of the profits in the company for balance sheet growth is highly advisable. Privately owned companies don’t need to grow forever like their publicly traded counterparts. But if they need surety support, they should grow at least to the size their capitalization will allow them to take advantage of opportunities. A great principal is not distributing more than your net income.
If the year isn’t going to meet projections or is generating a net loss, it may be wise to discuss sooner rather than later with your surety agent. Discussing this with an active and engaged agent can help formulate a “State of the Union” address to the surety company. Having a surety agent help deliver this information to the surety company may greatly mitigate negative impacts.
Audit, Review, Compilation, In House? All of these are different versions of how financial information can be presented. Each of them offers the reader differing levels of assurance based on how much investigation and testing a CPA has done on the company’s financial condition. All should be presented with additional schedules explaining project Percentage of Completion and any other pertinent details to assist the reader.
– An Audit is the most intensive and intrusive. It is the most in-depth review and accordingly offers the most assurance and information to the users. Companies requiring large surety support or bank relationships can benefit from reporting their annual results in this format. Similarly, companies with complex organizational structures and many layers of accounting transactions may choose to have their financials audited as ordinary operations
– A Review is a very common level of CPA assurance. Note that there is a difference between getting a “CPA Review” and having your CPA review your transactions. During the Review process, a CPA will test a sample of transactions within the company for accuracy. A quality CPA Review will typically suffice for the great majority of clients. While it can be more costly than a simple Compilation, it is the best way to “buy” bond credit. You cannot literally “buy” surety credit, but the same financial information presented on a quality Review versus a Compilation will generate more capacity and likely better rates. This is valuable when trying to stretch a surety program.
– A Compilation is the lightest level of CPA services we would advise. The CPA will compile the construction company’s financial information into one organized format and produce on their letterhead. There is no assurance that any of the information has been tested by the CPA, but simply that it is what was provided by management of the construction company. A quality CPA will likely do some basic tests to ensure accounting balance and may do some investigation into anything that is significantly out of the ordinary. This is a suitable financial statement for light users of surety credit or non-complex financial statements.
While we typically suggest getting Reviewed financial statements with job schedules, we understand that is not feasible for many clients. Our agency will work hard to get the best surety responses out of any presentation. Whether your statements are In-house, Compilation, or Review, we focus on maximizing your surety relationship.
Next Year’s Plan
A contractor’s management team is always be thinking about direction and future operations. Developing plans and goals for the organization to achieve in the next “1-3-5 years” is a common theme of many 4th quarter meetings.
You likely have projections for the upcoming year already mapped out. Communicating these projections to your surety agent before the new year has started can pay dividends. An engaged and helpful agent should provide constructive advice on any significant organizational changes such as geographic expansion, scope expansion, or ownership transactions. A surety agent may have insight from knowing what has not worked for others and can help their clients prepare for risks.
The common theme is being proactive. Consistent communication with your surety partners throughout the year can prevent surprises down the road. Being proactive with your business partners positions your organization for the most positive response to tough developments.
A good bond agent can help get the ball rolling through thoughtful engagement. If you are starting to think about year-end planning and want to have a more in-depth conversation, contact us.