SHOP, drop, roll or self-insure: It’s not too late to examine all health insurance options and switch

The 2015 tax season will soon be in the rearview mirror. But that doesn’t mean businesses should stop evaluating health insurance options. Since the dawn of the Affordable Care Act (ACA), businesses have been trying to figure out what’s the best route to take when it comes to health care coverage. There are a handful of options — all with unique pros and cons.

“Health care insurance options are something all businesses should be evaluating continuously,” says Joe Popp, tax manager at Rea & Associates. “Just because a business decides one route is best right now doesn’t mean that it will be the most effective or efficient choice down the road.”

Smart Business spoke with Popp about five health insurance options — Small Business Health Options Program (SHOP), drop, roll, self-insure and private exchange.

What is the SHOP and who benefits?

The SHOP is the business portal to exchange insurance. Right now in Ohio, it’s available only to companies with fewer than 50 full-time equivalent employees.

It’s best for a company that is having trouble paying for coverage or doesn’t want to contribute a lot for insurance, and whose employees generally wouldn’t get a premium tax subsidy. The employer can put as much or as little toward insurance as it wants, but the employees still can pay with a pre-tax deduction.

The drop option is self-explanatory, but doesn’t it hurt the employees?

If a business drops health insurance coverage altogether, employees would have to buy insurance on their own. If the employee qualifies for premium subsidies or cost sharing they often get better quality coverage for a lower price than with their employer.

Dropping coverage may be the best option for companies whose employees would be eligible for premium subsidies, meaning relatively low income individuals or families with many children and relatively high income (single breadwinner families).

How does roll work?

You continue with your current coverage, even though it may be inefficient in the short term. Many people decided last December to renew early and roll over coverage to get another year of reduced ACA compliance and cost.

This is typically the best option for those with more than 50 employees who want to take a wait and see approach. With uncertainties in legal challenges, new requirements coming online in future years and the exchanges still in their infancy, choosing to delay a major change for a few years is a perfectly fine strategy.

What is the self-insure option?

The employer takes on the risk that an insurance company normally takes, up to a certain dollar amount, and gets a stop-loss plan over the top for a smaller premium. The employees still pay into a system, but often at lower amounts.

For the employer, some years you’ll ‘win’ and some you’re going pay a few large deductibles. As long as, on average, you come out better in the years when no one has high medical costs, the business as a whole wins. This is a good option for those with 100-plus employees as they can more effectively spread risk.

How does the private exchange operate?

Instead of using the federal government’s exchange, you access a custom exchange with a smaller set of providers. It’s best for employers with 100-plus employees.

Your company can set up a private exchange and employees pick what they want with a monthly stipend. The employer contribution might cover the bargain basement $6,000 deductible coverage, and if employees want better coverage, they pay in. It’s like shopping on with a gift card from the employer.

When do employers need to make a decision?

Before your next insurance renewal date, evaluate these options to see if one is more efficient. Think about it, talk to employees and run numbers to see what it could do for employer and employee costs. Do the groundwork now, even if you don’t end up making a change until next year or after.

Insights Accounting is brought to you by Rea & Associates

How financial reporting can help foster board member involvement

From time to time, nonprofit organizations may experience a lack of engagement of their board members during regular board meetings. There could be many reasons why board members are not engaged in meetings, but sometimes it’s up to an organization’s staff to find ways to involve board members more in the decision-making process.

Smart Business spoke with Ben Antonelli, CPA, a principal at Rea & Associates, to learn more about what nonprofit organizations can do to increase board member engagement during board meetings.

What are some possible reasons for decreased board engagement?

While a large majority of board members have a passion for their organization’s exempt purpose, they may not be as engaged when it comes to making financial decisions. Maybe the organization’s internal financial reports are not provided in a timely fashion, are too detailed or do not provide narratives to be reviewed prior to meetings.

In order for board members to make sound decisions, they need to be equipped with the right information.

How and when should board members be provided with information?

Board packets and presentations that include financial reports should be available to board members several days before the meeting. Sending out the packet the night before the meeting can put unnecessary pressure on the members, and may make it difficult for them to make educated, well-thought financial decisions during these meetings.

How much detail should be provided in the financial reports given to board members?

Nonprofit organizations should be mindful about the level of financial detail provided to board members. There may be times when they are provided with too much financial data on large spreadsheets. It may be difficult for board members to digest and analyze the information in the time leading up to and during the meeting.

Although detailed financial data should be available to board members upon request, financial statements reviewed during board meetings should be limited to summarized data. In addition (and this varies by organization and industry), relevant metrics or ratios should be given.

This report should show the increase or decrease in various metrics over time, usually multiple years. In order to be meaningful, organizations should use the same report format during all meetings so board members can become familiar with it.

What else should be included in board meeting packets?

  • Show an analysis of the actual budget versus the approved budget or operating plan. Most organizations operate with an approved budget or operating plan. If organizations do not have such a budget, it is critical to create one. For organizations with a budget, showing a comparison of the actual budget versus the approved budget for the past month and the year to date is useful.
  • Provide a brief narrative of financial results. In addition to financial data, a narrative explaining the organization’s analysis of the most recent financial results is also very helpful. Organization staff typically knows much more about the organization than the individual board members, so providing an explanation as to why the numbers are the way they are will help provide a level of context.
  • Disclose the basis of accounting if it is different from generally accepted accounting principles (GAAP). Many organizations that produce annual board-approved GAAP financial statements also produce monthly board reports on a separate basis. If an organization reports this way, a simple footnote or disclosure to the board stating that a different basis exists will help avoid any confusion at the end of the year.

An engaged board can help propel an organization forward, and likewise, a disengaged board can hold it back.

Organizations should give board members the tools they need to be active, strategic and valuable.

Insights Accounting is brought to you by Rea & Associates

Should you start your own insurance company? Consider the benefits

Traditionally, business owners have turned to the insurance industry for protection against risks associated with their professions, including malpractice litigation and product liability. As a result, insurance companies have been able to charge high premiums for their services. But what if business owners started their own?

Smart Business spoke with Christopher Axene, CPA, a principal at Rea & Associates, to learn about captive insurance companies and how they can be used to help business owners lower their taxes while increasing wealth.

What is a captive insurance company and how can it be used as a tax planning tool?

Captive insurance occurs when a company or service professional purchases insurance coverage from an insurance company they also own and control, and this can be a desirable option for many business owners.

The captive insurance option allows business owners to pay insurance premiums to their own insurance company and claim the tax deduction associated with this expense as they normally would. But instead of paying another insurance company, they pay the premiums to themselves.

Furthermore, because of a provision in the tax law, the captive insurance company doesn’t pay taxes on the premium income it collects, as long as the premiums total no more than $1.2 million per year.

Another tax consideration for those interested in starting their own captive insurance company is that at the end of the coverage term, the unspent premiums can be reinvested and any dividends received will be taxed at a significantly reduced rate. The law says that captive insurance companies can deduct 70 percent of the dividends they receive from stock portfolio investments.

Is a captive insurance company still a valid safeguard against risk?

To be considered ‘insurance’ and a valid safeguard against risk by the IRS, the captive insurance company must meet two qualifying factors — risk shifting and risk distribution. Risk shifting means that risk can be shifted from the business to the captive insurance company.

Achieving risk distribution is a little harder because it means that the captive insurance company must be a part of a risk distribution system — a group of captives that share each other’s risks. Typically, the premiums one would pay into their insurance are used to safeguard their business against smaller risks. For larger issues, such as a malpractice claim, funds to help settle the claim would be pulled from the distribution pool.

How do I know if a captive insurance company is the right strategy for my business?

Business owners across all industries are eligible to establish a captive insurance company, but certain factors may make this strategy more desirable to larger companies. First, upfront costs should be considered. This would include any research conducted on the business, service fees and any legal considerations associated with setting up the entity. But once it’s established, there are service providers that are available to manage the captive, giving business owners the freedom to concentrate on their business.

Second, while a captive insurance company can help an owner realize significant tax savings and increase wealth, using this entity as a tax planning strategy is only possible if few (or no) claims are made against their business — at least during the first few years to give the owner time to reinvest the premiums they originally paid into the captive.

In other words, if an owner sets up a captive insurance company and is forced to make a claim in the first year or two, the owner may wind up diminishing the account and owing more than what the owner has, which isn’t an optimal outcome for anybody.

When done properly, a captive insurance arrangement can provide business owners with a cheaper insurance coverage solution. At the same time, when claims history is low, the profits of the captive can be reinvested for the owner’s benefit.

Insights Accounting is brought to you by Rea & Associates

More than a resolution for a business, controlling cash flow is a responsibility that’s essential

This is the time business owners search for a resolution that will help make 2015 one of the best years yet for their organizations. But instead, they should stop searching and look at their company’s cash flow.

Managing a business’s cash flow is critical, especially if an organization is interested in protecting its liquidity and future growth. Business owners know that various sources of cash are available to them, but do they have a plan in place to help manage it once it has been acquired?

Smart Business spoke with Dave Cain, CPA, principal at Rea & Associates, to find out how business owners can start the new year on the right foot.

Why is managing cash flow important?

Cash flow is the lifeline of a business — not to mention a powerful management and accountability tool — and a 13-week cash flow projection will provide the business and its stakeholders a detailed picture of how well the business is doing. In addition, it can empower the management team to become more accountable to the business’s success.

Internally, a regularly maintained cash flow projection will help a company develop timely and attainable goals. When the business owner and the management team have a better idea as to how much money is going out and coming in (and why), they can adopt plans to manage the cash flow in a more favorable way.

When the business is managing cash acquired from an external source, the projection becomes a way to provide stakeholders with the information they need to monitor their investment. For example, a bank may require the company to provide quarterly financial information to ensure that it complies with the terms of their investment.

What does a business owner need to include in the cash flow projection?

To generate a strong projection, business leaders must include data from a variety of sources. For example, analyze accounts receivable to determine ways to quickly turn them in to cash or to better manage sales and improve profitability. Current inventory levels can also be reviewed. Excess inventory is cash that has already been spent and is not being used effectively; therefore take the time to review and segregate inventory that is old or obsolete and consider whether it can still be used to generate cash.

Another area to review and organize is accounts payable, which will help the financial team manage when payments are made.

Finally, look at the non-core assets and determine how much money is being spent to offer them. Are they viable? Do they align with the current client base? If not, maybe they should be discontinued in favor of an offering or initiative that produces greater revenue for the organization.

What goes into properly maintaining a 13-month cash flow projection?

A proper cash flow projection is based on facts — not on what a business expects (or hopes) will happen. If this is the company’s first attempt to create a projection, the initial step should be to look at the company’s historical trends, current initiatives and any internal and external factors that may impact the financial security of the business. This includes past, present and future billing and payment patterns.

It is also important to make sure that the cash the business needs on a weekly schedule is based on fixed and recurring costs. If this is established, then variable costs and expected sales may be estimated.

After the historical data has been compiled and the cash flow projection has been put into action, the company should set aside a time each week to update the data with current figures and information. This step is important if the cash flow projection will be used as a management tool.

With regular maintenance, the cash flow projection will become an accurate representation of the organization’s financial wellness while providing a framework for generating short- and long-term success.

Insights Accounting is brought to you by Rea & Associates

Santa Claus brings an extra SBD, with some fine print included

Ohio’s small business income tax deduction (SBD) is just one of the ways legislators have sought to further stimulate the state’s economy. As the New Year approaches and taxpayers look toward the 2014 tax year filing season, even more relief is on the way.

Smart Business spoke with Joe Popp, JD, LLM, tax manager, Rea & Associates, to find out about what changes are in store for the small business income tax deduction.

Who can claim a SBD?

In October, the Department of Taxation reported that only half the number of small business owners who were expected to claim the 2013 deduction actually did. Maybe the owners — and their CPAs — weren’t up-to-speed on what kind of things qualify for the deductions. Or maybe they weren’t even aware of the deduction at all.

The SBD is available to a wide range of individual taxpayers who have Ohio-sourced business income, which can come from many different sources such as a residential rental property or select owner wages. As a good rule of thumb, if a taxpayer received a K-1 from a company that has locations, property or payroll in Ohio, the taxpayer is eligible. The same is true if the taxpayer has an activity in Ohio reported on personal schedule C or F. Investment income in a trust or pass-through entity, where investing is the business activity of that entity, can also qualify for the SBD if the income is passed through to an individual taxpayer.

What can small business owners expect when they file their 2014 personal income tax returns?

The SBD already allows individual taxpayers with Ohio-sourced business income to claim a 50 percent deduction on the first $250,000 of Ohio-sourced business income that they have. For the 2014 tax year, however, taxpayers are eligible to claim an additional deduction on this income.

How much more? Where is the matter at the state government level?

Legislation authorized up to an additional 25 percent deduction for a total of 75 percent on the first $250,000.

But there was a set pool of money to fund that, the legislation didn’t mandate an additional 25 percent (it just set a cap not to exceed), and Ohio retains the ability after Jan. 1, 2015, to draw funds from that pool to pay for budget shortfalls in several other departments.

So it’s possible you might not know just how much additional deduction you could get for some time. For now, think of this deduction as 50 percent, plus a “mystery bonus” of up to 25 percent more.

Stay tuned for more guidance on this from Ohio.

How does this deduction affect business owners who want to retire or sell their businesses?

This deduction provides an interesting opportunity for more mature companies that are currently structured as C corporations. Generally speaking, it is easier to produce great tax outcomes on the sale of a pass-through entity than a C corporation.

The SBD is also denied to owners of C corporations on their wages and on the income coming from the C corporation.

The SBD can help ease the pain of a C to S partnership conversion by providing an annual cash savings as large as $6,000 to $10,000 per owner.

While this might not be a strong enough reason to do the conversion on its own, if a business owner has a mature company that is not retaining profits to grow, and is thinking about selling the company soon, this is a great time to do the C to S partnership conversion.

Who knows how long the SBD might be on the books? The savings opportunities now make this a great time to consider accelerating a move from a C corporation structure if that was in the plans down the road.

Insights Accounting is brought to you by Rea & Associates

How oversight and a little skepticism can help curb fraud in the workplace

Business owners want to trust their employees. And many think their employees can do no wrong. But nowadays, many business owners are unfortunately being proven wrong. Workplace fraud is a serious issue that businesses across America are facing.

“Just because a business owner has complete trust in his or her employees — even longtime employees — and believes they’re immune to fraud, doesn’t mean they won’t get burned,” says Brent Ardit, CPA, audit manager at Rea & Associates.

“It’s important to have some level of professional skepticism,” he says. “Don’t cause friction within the organization, but you owe it to the company to have a level of oversight. Trust is definitely not an internal control.”

Smart Business spoke with Ardit about how the risk for workplace fraud drives the need for strong internal controls within a company.

Why would employees commit fraud?

One of the more common reasons an employee would commit fraud is because of financial trouble at home. He or she might think, ‘I’ll just take this little bit of money from my company now. No one will notice, and I promise I’ll return it. I’ll put it back once things get better.’

Several workplace fraud studies have shown that the economic recession the country experienced a few years back has led to a rise in workplace fraud.

How does workplace fraud occur?

Workplace fraud occurs most often when there’s a lack of segregation of duties. One person may be managing the majority of accounting and financial reporting tasks with little to no oversight. This increases the chances for fraud to occur.

What approach should a company take to clamp down on fraud?

First, there needs to be a tone-at-the-top approach. The company’s leadership has to set a good example for employees when it comes to managing the company’s finances.

In addition, business owners should examine the accounting department structure. After review, they may find more oversight is needed. A cost-benefit analysis can determine how to design a company’s internal control structure.

Business leaders may have great ideas for how to combat fraud, but if it’s going to cost the business more than what they would save, it might not be worth doing. The company should weigh all the options on how to reduce fraud. That may mean hiring additional staff to oversee finance functions, or it may mean a company restructures itself with existing staff to ensure that adequate financial oversight is established to deter fraud.

If a business has a single employee solely managing the accounting and finance functions, it should ensure that other employees are cross-trained in the individual’s tasks and responsibilities. Also, the business may want to ask the employee to take a vacation. If an employee refuses to take vacation, it may be a sign that something is amiss.

Is paying more attention to employee work alone a deterrent to fraud?

Regularly reviewing work, rather than waiting until year-end, is beneficial. If employees know that leadership is watching, it provides some level of deterrence. And if the temptation for fraud arises, the employee is inclined to avoid a violation since he or she knows they are being watched. It’s like the Hawthorne effect, which refers to the tendency that people will alter their behavior simply because they are being observed.

Are unannounced audits effective?

Yes, if a company has internal audit procedures, having an unannounced audit could prove effective. If employees know the company is watching and that an internal audit could take place at any time, they’ll probably be less likely to commit workplace fraud.

What’s the outlook for workplace fraud?

It’s critical that companies stay ahead of the issue. New schemes appear every day, and continued oversight and monitoring of reports will help head these off. If a company follows these guidelines, it can keep fraud to a minimum.

Insights Accounting is brought to you by Rea & Associates

Timely reconciliations aid businesses to prepare for smooth year-end audit

Businesses that reconcile their financial books at the end of each month will make it substantially easier for them to have a well-prepared, problem-free year-end audit.

“If you are reconciling every month, when you get to December you won’t find any surprises, which usually helps a great deal with the year-end audit,” says Leslie Prichard, CPA, audit manager at Rea & Associates.

Smart Business spoke with Prichard about how businesses can prepare for a calm, uneventful year-end audit.

What can businesses do throughout the year to secure a smooth year-end audit?

When conducting year-end audits, auditors will ask businesses for items such as new agreements, loan documents, contracts and board minutes. Keep those in an organized file so it is not necessary to track them down later when the business may be pressed for time.

With each year-end audit, the auditor provides management recommendations or any internal control findings. The following year, the auditor will usually require a statement outlining how the business responded to those points, so it’s a good practice to have that ready for the auditor.

Are there other steps that would be beneficial to take ahead of year’s end?

Usually, auditors aren’t working on-site with companies until a month or two after year’s end. While a business must wait until its books are closed to begin some tasks, in the meantime it can reconcile its significant accounts.

This is also an opportune time for a company to prepare supporting documentation such as bank statements, accounts receivable and payable aging reports, inventory valuation reports, fixed assets schedules and debt documents. In addition, a draft of the financial statements should be ready for the auditor to review.

Another good practice is for the business to meet with the auditor throughout the year to develop monthly and year-end closing processes. If an organization has any new or complicated transactions, it is beneficial to inform the auditor about the matter before he or she arrives.

When a company is being audited, should it fear that some blemishes might be discovered in its books?

The auditor is actually a company’s ally, not its adversary. He or she is not going to penalize the business. Should the auditor find something technically wrong, the business will be informed of the matter. If it is significant, the auditor will ask for it to be corrected. In the case of an insignificant error on the financial statement, the auditor will likely be able to pass on recording it.

The auditor may issue a management comment if there are problems with the accounting processes and procedures. This helps the business owner by keeping them informed of specific concerns related to the accounting department.

What are the particular advantages of meeting audit deadlines?

Meeting audit deadlines keeps a business in compliance with various agreements. Should a bank require an organization’s financial statement in the case of a loan, for example, an uncompleted statement may violate its loan covenants. For some construction contractors, not producing a financial statement on time limits the kind of work for which the company may apply. Investors may require financial statements by a certain date, and are often displeased if those statements are late. A business with overdue financial statements runs the risk of a lender calling in a loan or investors deciding not to loan the organization more money.

Is there any further advice that would be helpful at audit time?

A company has a voice during the audit, and if its representatives don’t understand why the auditors are asking specific questions, they should ask for clarification. If company officials understand what the auditors are trying to test, that knowledge will help them to design the most effective and efficient procedures to use during the audit.

Insights Accounting is brought to you by Rea & Associates

Updated language may be needed in retirement plan during restatement

Every six years, the IRS requires that all retirement plan sponsors restate their prototype or volume submitter retirement plan documents for any law changes since the last restatement period. The current restatement period started May 1, 2014, and runs through April 30, 2016.

If a business’s plan operates under a prototype or volume submitter document, it’s important for the business to work with its service providers to ensure its document is restated timely.

Now is a great time for businesses to make any voluntary plan design changes to their plans. By going through this procedure, it will eliminate the cost of doing a separate amendment later.

Since the last restatement period, several significant law changes have occurred.

One change in particular is causing companies to closely examine their retirement plan documents to determine what may need to be changed.

A 2013 U.S. Supreme Court decision repealed Section 3 of the Defense of Marriage Act (DOMA) and determined that it was the states’ responsibility to define the term “marriage.”

Smart Business spoke with Andrea McLane, manager, Rea & Associates, about the importance of keeping your organization’s retirement plan up to date with changes that have been made in the law.

What did the DOMA decision involve, and what was the outcome?

The Supreme Court’s DOMA case involved a same-gender couple that had been married in Canada, but lived in New York.

When one spouse died, the other inherited her estate and sought to claim the federal estate tax exemption for surviving spouses.

The IRS denied her claim and ordered her to pay $363,053 in estate taxes. It was appealed to the U.S. Supreme Court, and Section 3 was overturned under the equal protection basis.

Section 3 of the DOMA decision originally barred married same-gender couples from being treated as married under federal law. Only that section was ruled unconstitutional.

What do businesses need to know about DOMA and their retirement plans?

By holding Section 3 of DOMA unconstitutional, qualified retirement plans must now treat the relationship of same-gender married couples as a marriage in order to maintain the plans’ tax-qualified status. The term ‘spouse’ includes an individual married to a person of the same-gender if the individuals are lawfully married under state or foreign law.

If a business’s retirement plan defines a spouse by reference to Section 3 of DOMA or only as a person of the opposite gender, it must adopt an amendment by the later of Dec. 31, or the restatement period as it was defined.

In addition to ensuring the plan document reads properly, plans must recognize same-gender marriages for all plan purposes.

Therefore, businesses must be certain that participant-related documentation, such as beneficiary forms, loan or hardship requests, etc., follow the proper procedures, recognizing the marriage and obtaining spousal consent where required.

What if a business fails to amend its retirement plan documents by the deadline?

Actually, many businesses don’t realize that they need to periodically amend their plan documents by a certain date.

The IRS offers a special voluntary compliance program for businesses to restate their plan without the plan being disqualified.

There is a user fee, which gets larger as the number of participants increases.

Insights Accounting is brought to you by Rea & Associates

Updating your books all year long can make closing time a breeze

If there’s ever a time your company’s well-kept balance sheet is worth its weight in gold, it’s at year-end. That, of course, is when it’s crunch time to close the books, but the process can go much smoother if you follow some timely procedures throughout the year.

For instance, expenses charged on company credit cards can be tracked better if entered throughout the year.

“You don’t want to dump all those expenses into one bucket of miscellaneous throughout the year,” says Trista Acker, CPA, CFP, senior manager at Rea & Associates. “If you do, you’ll have no idea where you are really spending your money.”

Smart Business spoke with Acker about how to streamline processes when closing the books at year-end.

What are some keys to save time on your year-end financial reporting?

The key to accurate financial statements is your balance sheet. A good suggestion is to get your balance sheet out, work your way down and make sure that you tie all those balances to supporting documentation or calculations and that all those balances make sense.

In addition, bank reconciliations should be done monthly, make sure that your accounts receivable have been reviewed, writing off all bad debts and tie out loan balances to amortization schedules. Another process that could be done throughout the year is to update the depreciation schedule, making sure that new assets are added to the schedule and old ones are deleted. You want to make sure you properly record your gains or losses from sales or purchases.

It can be a real timesaver at year-end if you make the necessary adjustments throughout the year. It is easier to track it as it happens rather than trying to recall what you did months later. There’s also a greater chance of error the longer you wait.

What is one of the more common areas where mistakes can be made?

A company credit card is one area where errors often occur. Individuals may have a company card and may not allocate expenses to the appropriate accounts until the end of the year.

Then they will have to go back through a whole set of credit card statements and try to account for the charges.

But if you keep up with the bills monthly as you sit down to pay them, it will be a huge timesaver at year-end and will give you a clear idea of what’s been happening all year.

You should also look at your payroll. Companies should be reconciling their payroll on the books to their actual payroll registers at least quarterly if not more frequently to ensure gross wages are accurate. You may be able to download your payroll information from a third-party provider right into your software, which will save time and enhance accuracy.

Are there some other suggestions to make the process easier?

Try to distribute some of your tasks throughout the month instead of trying to do everything within 10 days at the end of the month. Spread it out so that you’re taking a look at your receivables on the 20th of the month and taking care of those at that time. Then a few days later you can sit down and do your billing. Another five to 10 days later you can be doing your bank reconciliation.

That way you’re not cramming everything and rushing through. You can be more focused on what you are looking at instead of thinking how to get it done.

What other advice can you give to get the books in the best shape?

Have a checklist for your monthly close. This will help you ensure you haven’t forgotten something as you take care of tasks throughout the month. Set a deadline for completion of monthly closes, to make sure tasks get completed.

If you keep up on your books consistently throughout the year, the year-end should go smoothly and quickly. Don’t hesitate to meet with your CPA or your tax planner before year-end because there is a lot of opportunity for planning or for suggestions to make things go smoother.

Insights Accounting is brought to you by Rea & Associates

How to run a construction company so it yields more bottom line profit

If you are manufacturing widgets, your production environment is pretty much a controlled one. Temperatures in the plant are consistent year-round, as is the speed of your production line. Other factors are well within accepted levels also.

But think of the construction company. There are unforeseen conditions, the size and scope can be staggering and the quality of workers can vary.

“A construction company does not have that luxury of consistency. Therefore, every job is unique and presents its own challenges,” says Kent Beachy, CPA, CIT, CCIFP, principal and director of construction services at Rea & Associates.

To build a more profitable construction company, taking into account these challenges takes a four-part approach.

“You first estimate, then you do the work, then you account for it and then you analyze it,” Beachy says. “You bring all those pieces together, then you tweak it, and see that you can make money in the business, and then you go for it.”

Smart Business spoke with Beachy to learn the keys of building a more profitable construction business.

What’s a good rule of thumb to follow as your first step toward profitability?

You have to be able to estimate for profit. Construction companies are generally bidding against the competition. You have to know your company’s backlog, what work flow you have in place, how busy the company is at present and how busy it will be when construction actually begins.

What other considerations are there?

Is the job within a niche of yours where your labor is skilled and has done work before and can do it efficiently and effectively? Or is it something new that you’re going to have to get up to speed on? That is a risk factor you have to be concerned about.

If you are a general contractor, you have to consider the subcontractor, what is his or her schedule and if you can use him or her.

If you are a subcontractor, you have to consider if you have the labor in place and will be able to get the job done effectively and efficiently.

You also have to know your overhead — the fixed prices, utilities, rent, the telephone — to be able to estimate for profit.

What about benchmarks and key performance indicators?

Another process within a more profitable construction company is being able to measure the financial aspect of your company. That includes breaking it down by job using a construction accounting software that allows you to job-cost.

That way, you’ll know whether or not you’ll have potential change orders, work that is added to or deleted from the original scope of the job. You have to be able to manage a change order and still be profitable.

After you tally up the figures for these jobs, then you can do your analysis. For instance, if a company wants to measure profitability on a job, you would measure gross profit margin. If you want to measure profitability within the company, you would measure return on assets or return on equity. Liquidity ratios, such as the current ratio, is an important measurement and one the surety is interested in as it measures to what extent your current assets are available to satisfy your current liabilities. An efficiency ratio one may want to consider is backlog to working capital. While backlog represents jobs waiting to start, the relationship between committed work and working capital may determine if you need more working capital to be able to finish the work.

How can ratios help you analyze your company’s performance?

You could do comparisons to industry — in fact, that is how you benchmark. You can get ratios for the industry through the Construction Financial Management Association, which conducts surveys. You can benchmark against the industry and determine which ratios are key to the company’s performance and measure those.

You can put everything in a nice package and show the company executives where they’re at. But you want to be able to determine what ratios are important to the company, to its profitability. Just a few ratios will make sense to the owner, the controller or other executive so they can measure on a regular basis to spot signs that will let them know if something is wrong.

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