By Carl Oliveri, Partner, Grassi & Co.
2022: The Year of the Tiger or Construction Contractors
It feels like we barely got to know 2021, as the year closed as quickly as it roared in. And just as suddenly as 2022 came upon us, so did the realization that we are approaching the two-year anniversary of the COVID-19 pandemic and all the changes that it has forced businesses, including those in the construction industry, to undertake. In hindsight, some of these changes were good: accelerated investments in technology, stronger cybersecurity protocols, increased job site collaboration. And some were not so good: quarantining of personnel, increased costs related to testing, supply chain issues.
While the industry has navigated these changes well, uncertainty still lurks behind the excitement of a new year. The savvy contractor knows that, even in a year of unknowns, a proactive strategic plan can be capitalized on. But what should this plan look like in 2022?
Get Ready for Your Paycheck Protection Program (PPP) Audit
PPP needs no introduction. It was (and continues to be) one of the most talked about topics arising out of the pandemic. Like others, the construction industry greatly benefited from the PPP and, now that most contractors have received their round 1 and round 2 forgiveness, now is the time to prepare for the PPP audit. Construction contractors expecting an audit should start to compile and centralize the information to support their case for necessity, usage and forgiveness of the PPP funds.
Clearly, your payroll records, union reports and backup of other qualified spend items need to be made available. But also understand how your loan base was calculated and what you considered within that math. At the early stages of the audit process, the SBA is questioning loan bases.
And while there is a strong financial condition component to these audits, the uncertainty at the time needs to be emphasized. Look to documentation of real-time conditions from the onset of the pandemic, including project shutdown notifications, board minutes/internal memos discussing management’s decisions to lay off employees, and any other impactful documents to help paint this picture.
Live Your Cash Flow Forecast and Budgets
Enough cannot be said about these tried-and-true construction financial management tools – they are the life blood of any successful contractor. When done properly and pushed throughout the organization, a culture of “cash is king” can be cultivated and maintained. Each project is its own profit center with its own cash flow cycle.
By forecasting cash flow on a project-by-project basis and globally, management will be able to identify cash peaks and valleys. This insight will enable the construction financial professional to proactively redeploy cash resources if a project is forecasting in the red or employ an investment strategy with excess cash. After all, contractors don’t go out of business due to lack of work, but rather due to lack of cash flow.
The companion piece is a strong operating budget. Of course, this is going to outline and help track overhead, but it will also help the contractor identify the levels of administrative support the company will need to yield an industry accepted profit and, not to mention, meet the expectations of creditor providers, who are asking for these practices now more than ever.
Evaluate Your Income Tax Strategies
Nobody likes tax surprises, and the construction industry is certainly not an exception to this rule. And while tax reform was discussed but not enacted in 2021, advisors would be remiss if they did not explore income tax strategies and options with their construction clients as we move through 2022. Based on the types of contracts a construction company performs under, there are opportunities to employ an accepted income tax deferral strategy. For example, while a construction company’s overall method may be accrual, to the extent any projects are completed within a single tax year, that project could qualify for cash basis. Further, a residential contractor (not houses) could employee a 70-30 accrual-cash basis split on reporting a qualifying project for tax.
Also consider that, even if nothing changes, we know the current income tax rates will sunset by the close of 2025. If a contractor is already employing an accepted deferral methodology, the strategy could shift to accelerating the recognition of income for tax advantage at the lower rates, which is a real dollar savings.
These are powerful techniques that should be fleshed out, especially since cash flow is vital to a project’s success. Siphoning off cash unexpectedly due to an April 14 phone call can be extremely detrimental to the construction contractor.
Don’t Neglect Your Succession & Estate Planning
This is one of the more overlooked topics for most construction contractor executives – not because it is not important, but because most times, it is not immediate. On the succession side, having a plan in place to identify, engage and create success for the next executive is imperative. In an industry where there is a skilled labor shortage, not to mention the Great Resignation, a formalized and practiced succession plan acts as a differentiator for future-facing contractors.
In terms of wealth preservation, owners of construction companies still have the opportunity to transfer highly valuable assets out of their estates – gift tax free. By utilizing the lifetime gift tax exemption, which is $12,060,000 per individual for 2022, an owner can move the ownership of the company to the next generation while controlling the tax implications. Like current income tax rates, this was subject to potential change in 2021 and is scheduled to sunset in 2025. To the extent the owner of a construction company has not done this type of planning yet, 2022 is the time to get strategic on this point.
Get ASC 842 Compliance Right
The construction contractor’s financial statement is about to undergo another change. Much like the changes to their GAAP revenue recognition model, contractors will now have to adopt changes to reporting leasing arrangements (as the lessee). In short, all long-term leases will be pulled up on the contractor’s balance sheet as a right of use asset with an offsetting current and long-term liability. The challenge will not be in identifying and accounting for the leases, but rather in how bringing on debt impacts the contractor’s working capital, maintenance of financial covenants, project prequalification and so on.
While the CPA industry is educating the credit community on these changes, the construction company’s financial professional should be analyzing the potential impact of ASC 842 and engaging in an active dialogue with the bank and/or surety with the ultimate goal of maintaining the bond program and modifying financial covenants.
Collectively, we look forward to the endemic and hope to put COVID-19 behind us sooner rather than later. But for 2022, successful construction companies will dissect and act upon the above issues as a starting point – because they understand that hope is not a strategy.