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The Numbers That Matter to the People Who Matter

By Marj Weber

As CFMs, we’re all used to providing financial information to third-party users. However, are these numbers looked at differently for a subcontractor? Are they essentially different in and of themselves?

To answer these and other questions, the Specialty Trade Subcommittee gathered some experts in the field of third-party users: Scott Baxter, Senior VP of The Frost Bank; Jim Bracy, Senior Surety Associate of Willis Towers Watson; Kristine Newman, VP of Finance at McCarthy Building Companies; and Warren Hennagin, CPA, of Marcum LLP for a panel discussion at CFMA’s Annual Conference on Tuesday, June 6. Marj Weber, CFO & Treasurer, Irontree Construction, Inc., moderated the group.

Panelists all agreed that cash is still king, especially for subcontractors. Beyond that major topic, all four participants pointed out different issues that would affect a subcontractor's ability to get a loan, get a bond, be prequalified, or be seen as best in class in a CPA's mind. Below are some direct quotes and information from the participants that may be of help to you.

What is the #1 number/factor/ratio each of you consider to show the financial health of a subcontractor, and how does that differ from a GC?

Scott Baxter: When I think about a banker’s “top numbers” for specialty trades, these come to mind (in no particular order): leverage (total liabilities/tangible net worth), liquidity (either directly in the company or via a guarantor), dollar amount and diversity of backlog, and tangible net worth (aka equity). If you don’t have “skin in the game,” I don’t want to put mine in either.

Jim Bracy: Although each account is evaluated on its own merit and underwritten individually, some key things that are evaluated include strong working capital position (current assets compared to current liabilities), solid cash to current assets position, established bank line of credit, strong track record of profitable job performance, history of positive cash flows, positive net worth to yearly G&A coverage, reasonable debt to net worth coverage, strong personal indemnity package, healthy credit rating, and timely A/R collection.

We also look at some of those differently depending on the type of work involved (e.g., vertical construction, bridge work, paving, utility). We look at the same information for GCs and subcontractors, but because a subcontractor is more removed from the money, we would look to them to have stronger results in these areas.

Kris Newman: We look closely at key financial ratios and trends, including current ratio, EMR/incident rate, debt to equity, equity to underbillings, backlog to revenue, consistent gross and net profits, references,  project history, and prior relationships.

Warren Hennagin: Cash is king!

Cash flow is a real issue for subcontractors. Is this the first sign to you that a subcontractor is in trouble?

Scott Baxter: Unreliable financial reports or financial reports not generated on a timely basis. Another sign is surprises; I have yet to have a “good” surprise.

Jim Bracy: An interesting and unique KPI I look at is the Open Gross Profit to Average Monthly Overhead (OGP/AMO): the greater the number, the better. When analyzing the WIP, the amount of open gross profit remaining in the backlog is a measure of not just profitability of the jobs but of time. That is, the time before additional profitable work needs to be obtained before the company begins cutting into equity, especially if overhead is not adjusted. For example, if a contractor has $200k in unearned gross profit still in backlog, and the company runs roughly $40k/month in overhead, then the company theoretically has approximately five months’ worth of overhead covered. Of course, not all jobs bill and pay the same, and if the contractor is heartily overbilled and there are no matching A/R or cash balances on the asset side, then this indicator is not useful and other pressing issues are afoot. When I come across a backlog with hefty OGP against conservative and consistent average monthly overhead, I see a financially sophisticated contractor and a company not pressed for time; they can obtain the projects they want vs. taking projects they need.

Personal Debt
Personal statements have been unexpected linchpins in the approval or declination of an account. Recently a multi-state federal contractor had a corporate statement that financially supported the bond line being requested. But on the personal side, he was liquidity-wise very scant, but depreciable asset equity heavy with the exception of the lavish home. That signals that his company is fine when things are fine, but if volume drops or a few jobs burn corporate equity and cash flow, then there is no other reserve to backfill the corporate statement. A personal financial statement is a window into the mind, character, strengths, weaknesses, and desires of a person, and a bellwether of how the business will be treated.

Kris Newman: The liquidity ratios are the key indicators for us. In addition, we look to the size of the project they are bidding vs. their project history.

For bankers and sureties, what numbers are considered dealbreakers?

Scott Baxter: Insufficient tangible equity; consistently EBDITA positive, but not profitable; management inexperience or bad character; too much “value” concentrated in intangible assets; stagnant intercompany receivables; working early in long duration projects, but lacking sufficient equity to carry the long-term retainage receivables; lack of succession planning (whether to transition to a new owner, or in case of a catastrophic event); lack of ability to provide reasonable financial forecasts; moving into new geographic areas during a local downturn (that is, if it’s so great over there, why did you wait until it got so bad here?); and lack of “off balance sheet” or “hidden” equity in equipment or real estate.

I expect a GC to have a higher level of liquidity: Generally GCs are holding the subcontractor’s money. If the GCs self-perform, they might have a reason to borrow for a portion of those costs.

Jim Bracy
Bad Character
Construction has and always will be built on relationships and relationships are the foundation for success in life. Being honorable and honest in the work you do and in your relations with others are essential to success.

Poor Financial Manager
A good financial manager improves profitability and cash flow 1-3% and provides leadership and direction throughout the company. The consequences of a bad financial manager can devastate a company beyond repair.

For prequalification, what is the most important number by which you judge a subcontractor? What can a subcontractor do to improve its profile?

Kris Newman: Current ratio, EMR/incident rate, debt to equity, equity to underbillings, backlog to revenue, and consistent gross and net profits. We will call references, so ensure the ones you list are the ones you want giving a reference. Also, safety record and history is even more important to us than financial strength. We won’t qualify on financial information alone.

CPAs, what advice do you have for subcontractors with questionable numbers?

Warren Hennagin: Keep in mind the following:

  • Cash is king!
  • Proper business lines of credit (collateral based and A/R based)
  • Job borrow
  • Cash surrender value of life insurance
  • Issues that CPAs have with prequalification policies
  • Subchapter S corporation distribution for shareholder’s income taxes
  • Shareholder loans at the end of the year to increase working capital and bonding capacity

Marj Weber, CCIFP, is CFO and Treasurer of Irontree Construction, a plumbing subcontractor in Mesa, AZ. During her more than 35 years at Irontree, she has been responsible for all of the accounting, banking and credit, risk management, and human resources areas, including supervision of staff.

Marj has been an active member of CFMA’s Valley of the Sun Chapter since 1994 and has served as past chapter president. Her association involvement includes Education, Conference Planning, Sub-Specialty Task Force, Finance & Budget, Strategic Planning, Succession Planning, and Executive Committees. She frequently presents on issues relevant to the industry. As Chairman of ICCIFP in 2009-10, she spearheaded the Strategic Planning process; served as Vice Chair of the Examination Development Committee; and formed a task force to investigate the Accreditation process for the CCIFP designation.