The #1 Question to ask on Contractor businesses
Jason Pagan, ASA
The short answer: When accounting for contractual work, how revenue and expenses are booked on time-based projects (that span longer than 60 days) will have a direct reflection on cash flow and business value.
Why is this question critical to the value of the business and the loan you are underwriting?
There are 2 accepted methods for this:
Completed Contract Method (conservative approach):
- Expenses are being recorded as the contractor work is being performed.
- Revenue is recorded upon completion of the job.
Percentage of Completion Method (most common approach):
- As the contractor moves the project the revenue, expenses are tracked according to completion milestones.
The RED FLAG to be on the lookout for:
- Mismatched trends in accounts receivables and revenue OR above average cash flow margins
- Make sure you understand the sellers revenue recognition and that the accounting method aligns accordingly.