Sound, trustworthy financial statements are key to any construction company’s success.
That’s why, in today’s tough lending and bonding environment, every contractor should at least consider investing in audited financial statements.
Weighing the differences
Most contractors maintain an in-house accounting system to manage their financials. The documents your staff prepares through your in-house accounting system are called “internally prepared financial statements.”
In many cases, internal financials are perfectly functional for the day-to-day operational needs of a construction company. But they often don’t follow every reporting standard prescribed under Generally Accepted Accounting Principles (GAAP).
When an external CPA audits your financial statements, he or she will examine various accounting documents to check whether you’re following GAAP and, afterward, offer an opinion on your statements. If the auditor issues an “unqualified” opinion, he or she agrees with the methods your in-house team used to prepare your financial statements and that your financial statements are free of material misstatement.
If a “qualified” opinion is issued, it usually means the auditor has identified one or more GAAP reporting methods that your construction company hasn’t followed. This doesn’t mean your financial statements are inaccurate; it just signifies that you didn’t prepare them according to GAAP. (There may be other reasons for a qualified opinion as well.)
Looking at both sides
Who cares whether you’re in compliance with GAAP? Lenders and sureties do. Many of them require contractors to provide audited financial statements before they’ll approve loans or bonding. Some local and state governments also provide increased work and project award capacity to construction companies with audited statements.
You may even save money. Small businesses with audited statements obtained interest rates on loans that were more than half a percentage point lower than those obtained by businesses without audited statements, according to a 2011 study by the University of Chicago’s Booth School of Business.
In addition, because of the extra steps an external auditor takes, audited financial statements are more likely to be free of reporting mistakes, such as data entry errors, than are internally prepared statements. For example, if your balance sheet shows that you bought a crane for $100,000, your auditor will double-check that figure by looking at your receipts.
Although audited financial statements can provide the benefits mentioned, they’re not something your construction business should leap into without foresight. In addition to requiring a financial investment, an outside audit will call for you and your employees to invest a substantial amount of time and energy toward its completion. You’ll need to gather and provide extensive documentation and even submit to interviews.
If your lender or surety doesn’t require audited financial statements, talk about the issue with your CPA. There may be better options. (See the sidebar “Don’t want an audit? Try a compilation or review.”)
Providing the documentation
If you decide to give a try to an external audit of your financial statements, you and pertinent staff members will meet with your auditor to establish a good working relationship and discuss timelines and responsibilities before the audit begins. From there, expect to provide documentation such as:
• The general ledger, up to date through the end of the period the audit covers,
• Original source documentation (such as canceled checks, bank statements, vendors’ invoices),
• The schedule of accounts receivable,
• Work- in-process schedule (including contracts, change orders, billings, job-cost reports)
• The schedule of priced inventories,
• The trial balance,
• The schedule of fixed assets and depreciation taken on them,
• The schedule of prepaid expenses,
• Schedules of loans, trade payables, and other liabilities reconciled with the lenders’ and creditors’ records,
• Schedules of all other accrued liabilities (for example, employees’ accrued vacation and sick time), and
• Lease agreements, loan covenants and notes of all lenders.
Documents specific to your construction activity will also come into play. The auditor will look at financials regarding ongoing and upcoming projects and either confirm a certain percentage of the costs or test your entire job cost system. It’s important to both lenders and sureties that contractors engage auditors with expertise in the construction industry.
Making the right call
Even if you’re not looking for financing or having bonding troubles, think about at least an occasional external audit of your financial statements. Getting one can shed a strong, objective light on your construction company’s financial health. Your CPA can explain more and help you make the right call.
Don’t want an audit? Try a compilation or review
Generally, contractors have three options when it comes to externally prepared financial statements: compilations, reviews and audits. Although audited statements (see main article) are the most thorough, compiled or reviewed statements may suffice for some construction companies.
A compilation is typically the fastest, least expensive option. Compiled financial statements are helpful for internal use and may support a loan or bonding application, depending on your lender or surety. During a compilation, your CPA learns how you collect financial data, formats this information and evaluates whether your financial reporting includes any obvious errors. Compiled statements don’t include the accountant’s opinion or any other quality assurances.
A review is a step up from a compilation. The process is usually limited to inquiries of company personnel and analytical procedures involving financial data to ensure the subject business is in compliance with Generally Accepted Accounting Principles (GAAP). Although reviewed financial statements provide some CPA assurance, the reviewer isn’t required to understand the company’s internal controls or test its accounting records.
For more information contact Bill Poland at bpoland[email protected]