If there is one thing I learned in grade school, it is that some days are more important than others. Most notably, in the life of a grade schooler, picture day was of great importance. This was the day you should look your best. It's that one snapshot in time when you would be captured for your student body card and the yearbook. This snapshot is how you will be judged. The ramifications were powerful for the whole year, if not for a lifetime.
It is not that different for Construction Companies. One day of the year is more important than all the rest. For most companies that day is December 31. It is important that a construction company look their best at their fiscal year end. This one day of the year, this one snapshot of your success and worth, is how you will be judged for surety and bank credit. As a surety underwriter, my advice is that a construction company should always look their best for their "picture day" in order to maximize their bond credit.
That said there are competing forces that would have the construction companies not look their best for picture day. The reality is that fiscal year end of the contractor is not just picture day, it is also the day on which you base your annual tax obligation. The construction-oriented CPA that was hired may feel their first job is to, within the bounds of the law, appease the construction company owner's desire to pay less tax and make the construction company look as poor and tattered as possible and mute the year’s success to minimize the company’s tax obligation.
Therefore, it is sometimes the job of the surety underwriter to look past the tattered clothes, the cowlick, the braces and the crooked glasses to find the beauty in each snapshot we examine. We learn how bottom lines are “managed”. We familiarize ourselves with tax incentives that beg companies to invest cash at year end into heavy equipment they can fully depreciate in the first year, which to the untrained eye makes it appear that a lot of cash just disappears. Likewise, it is important that the contractor work with a construction oriented CPA that understands the value of surety credit and the balance they must strike in the image they present on picture day.
We have seen where contractors have attempted to present a picture that is perhaps better than they actually are. Over estimating job profits on work in progress can lead to a lovely year end picture, but can result in the disappointing negative result of profit fade when the jobs close out. Sureties do not like profit fade. It is better that the contractor take a more conservative approach to their estimates. I spoke with a senior tax manager from one of the leading construction oriented CPA firms in my area.
These are the questions a construction oriented CPA asks for picture day:
- Did they have a big year? If so, are we being conservative enough on open jobs?
- If they had a big year, should we accrue distributions to pay taxes? It looks odd to have a down year follow with distributions way in excess of net income.
- Is the balance sheet getting too big so the next generation has trouble buying in?
- Are we doing all we can to minimize and smooth out taxable income to maximize after tax cash flow over the long haul?
A good surety underwriter desires and will get to the real picture. We are not looking for a glamour shot that shows a fake representation (all hat and no cattle – as they say in Texas). Nor do we want to see an overly aggressive tax-motivated picture that wipes out your equity and working capital. Choosing your CPA and surety partners carefully will help you find the right balance you need to minimize your tax bill and maximize your surety credit - and have a fantastic picture day!
For more information on contract bonds, construction-oriented CPAs, work in progress reports, and how Old Republic Surety can help you prepare for picture day, please contact your insurance agent and ask to work with Old Republic Surety. For a list of insurance agencies that represent Old Republic Surety, refer to our branch locator and they can assist.
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