The #1 Question to ask on Contractor businesses

Jason Pagan, ASA

How is revenue being booked on contracts?

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.