Contractor financial statements

A contractor's financial statements look much like any company's at first glance: a balance sheet, an income statement, a statement of cash flows and notes. Read closely, they have features that only make sense in construction. The balance sheet carries holdback or retainage on both sides, contract assets and contract liabilities that reflect the gap between billings and work done, and often a large fleet of equipment. The income statement shows thin gross margins on large revenue. The notes describe how revenue is recognized, how much backlog the firm carries, and what contingencies hang over it. This lesson builds Kestrel Builders' statements for fiscal 2025 and explains each line from a contractor's point of view.

Kestrel reports under US generally accepted accounting principles (GAAP), set by the Financial Accounting Standards Board (FASB). Most private US contractors use GAAP because sureties and lenders expect it, though some very small firms use special-purpose frameworks such as the tax basis. Revenue recognition under ASC 606 and lease accounting under ASC 842 are the areas where contractors most often need specialist advice; Lessons 4 and 9 cover them.

The balance sheet

The balance sheet, or statement of financial position, shows what the firm owns and owes at a single date. Contractors almost always present a classified balance sheet, separating current items (expected to be collected or paid within the operating cycle or a year) from long-term items, because sureties and lenders focus on working capital.

Several features stand out. Receivables, holdback and contract assets make up about 63 % of total assets; a contractor's main assets are claims on its customers, not physical things. Payables and holdback payable are the largest liabilities, because the firm is in turn being financed by its subcontractors and suppliers. Working capital, current assets minus current liabilities, is $2,450,000. Equity is $4,400,000, about a quarter of total assets.

Contractor-specific balance sheet items

Contract assets and liabilities are the subject of Lesson 5. For now, note that they are not cash or invoices; they are adjustments that bring revenue in line with work done. Under IFRS 15 and ASC 606, contract assets and contract liabilities are the formal terms, but many contractors and sureties still use the older names: costs and estimated earnings in excess of billings, and billings in excess of costs and estimated earnings. The two are often called underbillings and overbillings.

The income statement

The income statement shows performance over a period. A contractor's statement usually separates contract revenue and contract costs to show gross profit, then deducts general and administrative overhead.

Contract costs include all direct job costs: labor, materials, subcontracts, equipment charged to jobs and other direct costs, plus any field overhead the firm allocates to jobs. General and administrative expenses are the costs of running the company: executive and office salaries, estimating, accounting, rent, office technology, professional fees and the part of insurance not charged to jobs. Where the line between them falls is a policy choice that affects reported gross margin, so comparisons between contractors should check what each includes. Lesson 6 looks at that choice.

Gross margin and overhead are the two numbers a contractor's management watches most. Here the firm earns 8.5 cents of gross profit on each revenue dollar and spends 5.7 cents on overhead. If gross margin fell to 6.5 % on the same volume, operating income would fall to about $500,000; at 5.7 % it would be zero. That leverage is why a contractor's profit can swing so much from year to year.

The statement of cash flows

The statement of cash flows explains the change in cash during the year, in three groups: operating, investing and financing activities. Most contractors use the indirect method, starting from net income and adjusting for items that did not involve cash and for changes in working capital accounts.

The working capital lines tell the story. Kestrel grew during the year, so its receivables, holdback and underbillings rose by $1.65 million, absorbing more cash than its net income. Its suppliers, subcontractors and overbillings provided $1.35 million back. Operating cash flow was positive, but much of it went into new equipment. A surety reading this statement would note that operating cash flow covered the equipment purchases and dividends only narrowly.

ni, dep, gain = 1_230_000, 620_000, -40_000
wc_changes = {"receivables": -900_000, "holdback receivable": -450_000,
              "contract assets": -300_000, "prepaid": -50_000,
              "payables": 600_000, "holdback payable": 250_000,
              "contract liabilities": 400_000, "accrued": 100_000}
cfo = ni + dep + gain + sum(wc_changes.values())
cfi = -950_000 + 120_000
cff = 350_000 - 380_000 - 350_000
print(f"Operating {cfo:,}  Investing {cfi:,}  Financing {cff:,}")
print(f"Change in cash {cfo + cfi + cff:,}; ending cash {2_600_000 + cfo + cfi + cff:,}")
absorbed = -sum(v for v in wc_changes.values() if v < 0)
provided = sum(v for v in wc_changes.values() if v > 0)
print(f"Working capital absorbed {absorbed:,}, provided {provided:,}")

Operating 1,460,000  Investing -830,000  Financing -380,000
Change in cash 250,000; ending cash 2,850,000
Working capital absorbed 1,700,000, provided 1,350,000

How the three statements connect

The statements are linked. Net income from the income statement increases retained earnings on the balance sheet, after dividends. The statement of cash flows starts with the same net income and explains how cash on the balance sheet moved from the beginning to the end of the year. Changes in each working capital account on the balance sheet appear as lines in the operating section.

The notes and supplementary schedules

Much of what a surety or lender wants to know about a contractor is in the notes and the supplementary schedules rather than the face of the statements.

The two schedules at the bottom of the table are not required by the accounting standards, but sureties ask for them as a matter of course. The schedule of completed contracts is especially telling, because it shows whether the firm's estimates of job profit while work was in progress held up when the jobs finished. A contractor whose completed jobs consistently earned less than its WIP schedules predicted has a problem with its estimates, and sureties will discount its current WIP schedule accordingly.

Levels of assurance on the statements

Statements prepared by a contractor's own staff, or compiled by an outside accountant without testing, carry no independent assurance. A review engagement by a public accountant provides limited assurance based mainly on inquiry and analysis. An audit provides reasonable assurance based on testing the records, confirming balances with third parties and evaluating job estimates. Sureties usually set the level they require by the size of the bonding program: compiled statements may be accepted for small programs, reviewed statements for mid-sized ones, and audited statements for larger programs. Lesson 11 returns to this.