Contractors: Are Your Estimates Effective

Have you noticed any significant changes in your estimates during your long-term contracts? To optimize profit and loss tracking for construction contractors, it's essential to implement a contract schedule. A contract schedule is a system used to track revenue, costs, job completion, and billing positions on in-process and completed long-term contracts. If you haven't already, I recommend that you learn more about contract schedules.

But tracking doesn't end with a contract schedule. Another useful tool for contractors is a profit gain-fade analysis, commonly used by auditors. While a contract schedule reflects the revenue, costs, and billing position of a job at a particular point in time, a profit gain-fade analysis seeks to clarify the progress of a job over time. Although assurance services are often viewed as a sunk cost to meet compliance requirements, I encourage you to leverage audit procedures to enhance your internal analysis.

Why a Profit Gain-Fade Analysis?

The gain-fade analysis is a useful tool that benefits both contractors and audit teams. This tool is commonly used by auditors to assess the accuracy of a contractor's estimation and to identify significant changes in contracts over time. The analysis focuses on the revenue, costs, progress towards completion, and gross profit that were estimated at an earlier point in time (such as the prior year-end) and compares it to the current position of the contract (which is typically the current year-end).

The next step is to explain the observed trends. Several frameworks can be used for analysis at this point. To clarify the trends, you must first identify the main drivers of fluctuations or inhibitors of progress. You can then classify and analyze them. Identification is crucial - before addressing a problem, it must first be identified.

Some common factors that affect profitability on contracts include both increasing and decreasing factors.

An internal-external analysis can help identify trends that originate within the organization versus the greater industry or economy. The primary goal is to maximize internal factors that increase profit, minimize internal factors that cause profit decline, take advantage of external factors that increase profit, and hedge against external factors that decrease profit. Once you've identified the key drivers and labeled them as internal or external factors, the next step is to determine how your team can improve on future jobs or salvage the job in question if contracts remain open.

Once you've identified the relevant factors and their origin, you can start planning for improvement. The contract schedule is the gold standard for revenue recognition over the life of a long-term contract. However, the contract schedule presentation forces a point-in-time analysis. Dynamic tools like the profit gain-fade analysis provide a deeper analysis of factors that impact profitability and progression over the life of a contract. This tool can be used internally to strengthen your analysis and response to contractual trends. Contact us today to learn more about how MarksNelson can help analyze trends in your contract progression and profitability.