Do you see significant fluctuations from your estimates over the life of your long-term contracts? A first step in optimizing profit and loss tracking for construction contractors is the contract schedule, a system used to track revenue, costs, job completion, and billing positions on in-process and completed long-term contracts. If you haven't yet taken advantage of a contract schedule, learn more.
Tracking doesn't stop at a contract schedule, however. A tool commonly utilized by auditors of contractors is known as a profit gain-fade analysis. A contract schedule reflects the revenue, costs, and billing position of a job at a single point in time. A profit gain-fade analysis seeks to clarify the progression of a job over time. While your assurance services are commonly viewed as a sunk cost to satisfy compliance requirements, we would encourage you to leverage audit procedures to strengthen your internal analysis.
Why a Profit Gain-Fade Analysis?
The profit gain-fade analysis is a tool that provides value to the contractor in addition to the audit team. Auditors commonly use this tool to evaluate the effectiveness of a contractor's estimating and to understand the key shifts in contracts over time. The gain-fade analysis highlights the revenue, costs, progress towards completion, and gross profit estimated at a beginning point in time (for example, the prior year end), and compares this to the contract's position at a later point in time (the current year end).
Looking at Trends
The next step is explaining the trends noted. A variety of frameworks can be used for analysis at this point. To explain the trends, you must first identify the key drivers of fluctuations or inhibitors of progress. Then these can be categorized and analyzed. Identification is key—before an issue can be addressed, it must first be identified.
Common factors that increase and decrease profitability on contracts include:
| Factors That Increase Profitability | Factors the Decrease Profitability |
|---|---|
| Job efficiencies | Missed costs required in bids |
| Cost savings | Cost overruns |
| Overly conservative bidding at job initiation | Overtime labor |
| Strong project management | Supply chain issues |
| Favorable change orders | Inefficiencies and inefficient travel to job site |
| Favorable scope increases | Workforce shortages |
| Self performing work built into the bid to be completed by a subcontractor | Poor project management |
| Swift close out process | Issues with job owner |
| Strong labor supply | Poor close out process |
| Low supply of competitors within market | Inexperience of team |
Internal vs. External Analysis
An internal-external analysis can be used to identify trends that originate within the organization versus the greater industry or economy as a whole. The goal is to maximize the internal factors that increase profit, minimize the internal factors that cause profit-fade, take advantage of external factors that increase profit, and hedge against external factors that decrease profit. Once the key drivers have been identified and labelled as internal vs. external factors, the next step is isolating how best your team can improve on future jobs or salvage the job in question if contracts remain open.
Once you have identified the relevant factors and their origin, planning for improvement can begin.
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, such as the profit gain-fade analysis, allow for a deeper analysis of factors that impact profitability and progression over the life of a contract. This auditor’s 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 you identify and analyze your key financial data.
