The Voice for the St. Louis Construction Industry

 
 
Category archive

Finance

Preventing Fraud In Your Organization

in Finance/Homepage Primary

It seems that every day we hear a new story of significant monetary loss due to embezzlement or other crimes perpetrated from within a company by a trusted insider. We hope this column from an earlier edition of St. Louis Construction News & Review Magazine will help protect your business.

By Ken Van Bree

Here’s a statistic that will keep you up at night: according to the Association of Certified Fraud Examiners (ACFE), fraud within the construction industry is now costing an average median loss of $245,000 for organizations. Further, ACFE report that the construction industry’s median loss is approximately $90,000 higher than the average fraud losses across all industries.

Type of Fraud Schemes

The threat of fraud can never be wholly removed, but leadership should take steps to identify schemes their organization might face. Below are a number of schemes frequently used to defraud construction companies.

Billing Schemes

The ACFE indicates that billing schemes account for 35 percent of the fraudulent activity within construction companies. Such schemes can be payments to fictitious vendors, overpayment to vendors (often through collusion with an internal employee), and purchase of personal items with company funds.

Bid Rigging & Corruption

The ACFE reports that nearly 47 percent of the fraud cases examined in the construction industry had an element of corruption, whether it is bribery, kickbacks or quid pro quo situations The bid process can be riddled with opportunity for this type of fraud.

Theft

The construction industry is particularly susceptible to theft of materials due to the location of jobs and the difficulty of tracking construction materials. Job sites can be in remote areas or some distance from the corporate headquarters and subject to less supervision.

Additionally, materials on job sites are hard to track and measure during the construction process. Items lying around a job site such as lumber, concrete, copper pipe, wire and cable can create an opportunity for thieves if proper controls are not in place.

Misuse of Company Equipment

Similar to theft of materials, misuse of company equipment can also become an issue if there is a lack of controls present. For instance, an employee could operate a side business using a company’s idle equipment.

Other Fraud

The construction industry is subject to the same fraudulent activities faced by every other industry. These include payroll fraud through fictitious employees, check tampering, and fraudulent expense reports.

The Importance of Internal Controls

After identifying common fraud activities, an organization should design a control structure that will reduce the opportunity for fraud and increase the chances fraud will be detected. Although there are no guarantees, the foundation to a strong internal control environment is proper segregation of duties.

For example, the person in charge of setting up vendors should not be the same person who approves vendor payments or reconciles bank statements. Proper segregation of duties applies to all areas of business and can be employed effectively at little or no cost.

Here are some other simple yet effective internal controls organizational leadership should consider implementing:

  • Check all estimates for accuracy of calculations, labor rates and correspondence with drawings.
  • Compare job cost estimates with actual costs. Require approvals for cost adjustments or transfers of costs between jobs.
  • Require that estimates for materials above a specified amount include quotes from two or more vendors.
  • Make purchases only with pre-numbered purchase orders, and match them to both receiving reports and invoices before payment is made.
  • Check vendor invoices against estimates to ensure proper discounts and pricing.
  • Always refer to specific job numbers, phase codes or work order numbers in onsite communications.
  • Obtain ink or electronic signatures on change orders before work begins and revise contract values accordingly.
  • Allocate equipment usage to contracts weekly and record equipment maintenance expense in the ledger as they occur.
  • Review all billings for timeliness, accuracy, conformity with contract terms, and correct customer information.
  • Reconcile contract billings with general ledgers monthly, and calculate under-billings and over-billings.
  • Prepare and review monthly financial statements and reconcile them to supporting ledgers, bank statements, and loan schedules

Not all controls are created equal when trying to detect and prevent fraud.  For instance, according to the ACFE, an external audit was performed in 80 percent of the fraud cases reported, but detected the fraud in only three percent of those cases. The majority of fraud was uncovered through tips to a fraud hotline or management, and employees or customers were the leading sources of those tips. A fraud hotline was in place for 54 percent of the fraud cases examined.

Based on this information, it is important not to put too much reliance on a single control, but rather have a series of processes that will prevent and detect fraud.

Know The Signs

The profile of a fraudster can be as important to know as understanding the typical fraud schemes employed themselves. Per the ACFE, fraud typically is not perpetrated by a repeat offender. In fact, only 5 percent of fraudsters had been previously convicted of a fraud-related offense prior to committing fraud crimes.

Additionally, 82 percent of fraudsters had never been punished or terminated by an employer for fraud-related conduct, which shows that while background checks are useful in screening out some bad applicants, they might not be effective in predicting fraudulent behavior.

Most fraudsters were employed for more than one year before committing fraud, but most displayed some, such as living beyond their means, financial difficulties, or having unusually close associations with vendors or customers, that could have served as warning signs. Training management to recognize these warning signs for employees, vendors and auditors is important to help detect fraudulent behavior.

Protect Your Company’s Reputation

Ultimately, knowing the types of fraud, what controls to implement and the profile of a fraudster can help mitigate the chances of a significant fraud loss, but maintaining your reputation is another critical factor.

Reputation is a construction company’s most important asset since the construction industry is small enough for word of mouth to carry great weight in the decision process of sureties, bankers, suppliers or customers. Across all parts of the organization, companies should operate under a code of ethics that builds their reputation in the community.

Ken Van Bree, CPA, is a partner of St. Louis-based accounting firm RubinBrown and serves as the partner-in-charge of the firm’s Construction Services Group. For information, visit

Manage Your Company Finances like a Project Contract

in Columns/Finance
Mark O'Donnell Photo
Mark O’Donnell

By Mark J O’Donnell, CPA, Schmersahl, Treloar & Co

If any one thing is required to succeed in contracting, it is managing the contract. The best contractors have a reasonably well-defined processes for bidding, preconstruction planning, execution and project close out. Very few details are left to chance. Each job is different, and the details are critical to profitability. There are both external factors (unions, other contractors, environment, etc.) and contract changes to be considered. And of course, there is getting paid. In summary the major steps are;

  • Planning (take off, estimate, bid, etc.)
  • Execution
  • Check on benchmarks
  • Modify the contract with CO’s as needed
  • Complete the job.
  • Get paid.

We have noticed that some, but not all contractors take a similar approach to managing the financial health of the business. Consider for a moment how similar the financial process is to the contract management process;

  • Develop an expectation (planning)
  • Execution
  • Check on benchmarks with month to month feedback (timely financials and job reports)
  • Modify the plan based on significant changes
  • Near the end of the year review the results and make key decisions (Complete the job)
  • Get paid

Many privately owned businesses do not plan the year due to a general distaste for ‘budgeting’. No doubt, it is a negative concept. But would you even consider starting a contact without a detailed set of plans? Of course not, it is a recipe for disaster. If you just wing it, you will be lucky to get what you expected. Oddly enough, that is exactly how many of us manage our financial future, we just wing it. The most often used response is related to a general lack of the ability to control the financial results, that they cannot be reasonably predicted. It is very difficult to predict next year’s revenue with pinpoint accuracy. However, our experience is that when asked, many contractors can estimate how they will do (e.g. revenue) the next year with amazing reliability. If you can estimate revenue, most of the balance of the plan can be complied and spread out over a year. Even the most basic effort will establish a basic expectation and an effective tool for decision making.

During the year, monthly financials and job reports are critical to determine if you are meeting your benchmarks / financial objectives for the year. Just like a project, things will go well, or not so well. With timely and accurate financial reports and comparisons to your expectation, information will be there to support decisions to make changes (CO’s if you will) or remain status quo. Without those reports, the year-end results will be a surprise. More importantly, some of the decisions made during the year may not have been optimal, at best. Think about the analogy that was popular years ago. To sail a ship across an ocean, you have a clear starting place and a destination. Along the way there will be regular checks on the ships actual position and thousands of course corrections to deal with the many variables encountered at sea to get back on course. It is true of contract management and financial management as well.

As the year comes to a close, you will need an accurate projection of the financial results for the year, and appropriate advice as well. At least two topics are very important. First, a plan to minimize tax to the company (and its shareholders) over the year just ended, and the next year. Both years must be considered to take advantage of our current income tax structure. Second, a decision regarding how much of the current year’s profits must be retained in the company to build equity and support growth. Accomplishing those two tasks, its time for the owner to get paid!

The similarities between managing a construction contract and your corporate finances are striking. Affixing that same level of attentiveness brings a similar result, a job well done.

Mark J O’Donnell, CPA is a partner with Schmersahl Treloar and Co, a locally owned CPA firm serving successful privately owned businesses, not for profit entities and the professions. A significant portion of the clients Mark represents are either contractors or the companies that serve them. Mark is also Treasurer of the American Subcontractors Association Midwest Council.

Planning ESOPS for Construction and Real Estate Firms

in Columns/Finance

By Thomas H. Mug

Maybe it’s the preservation of a legacy, perhaps it’s the conclusion of thoughtful succession planning, or it might be a desire to motivate employees and enhance corporate performance … for whatever reason, the construction and real estate industry is increasingly embracing employee stock ownership plans (ESOP).

Indeed, this publication documented the trend three years ago, noting transfers to some form of employee ownership at Brinkmann Constructors, McCarthy Building Companies, CH2M Hill, Parsons, Black & Veatch, HDR, HNTB, Burns & McDonnell and Terracon. Last year, Lawrence Fabric & Metal Structures Inc. and Balke Brown Transwestern, Inc. joined the ranks of employee-owned companies with the help of our law firm, Greensfelder, Hemker & Gale. However, ESOPs are not for every situation and require considerable forethought and planning.

Many businesses begin considering ESOPs as they approach a transition in leadership and want to preserve the distinctive qualities that define the company and its culture and ensure the company’s long-term success. That has been accelerating with a wave of baby boomers entering retirement.

An ESOP is an intense planning process. Business owners should consider the following:

  • Is the firm suited for an ESOP? Business owners should conduct a feasibility study as a first step to determine whether the company is a suitable candidate for an ESOP. This will consider the motivating factors for establishing an ESOP, the financial capability of the company to finance ESOP debt and suitability of the company as an ESOP candidate. The feasibility study will also identify any issues or obstacles in the establishment of an ESOP.
  • Before entering into an ESOP, a business owner needs to know the value of the company. It is likely that the owner will have an expectation of the amount that will be paid for his or her stock. One of the first steps in examining the ESOP as an exit strategy is for the owner to obtain an independent valuation of the company stock. If the result is not to the owner’s satisfaction, the owner may elect to forgo the ESOP and consider other alternatives. Valuation typically involves projecting the future earnings of the company and will rely on those projections of company income. Industry outlook is also a major consideration, as well as the general economic forecast. If appropriate, the valuation may also consider book value and sales of comparable businesses.
  • Federal regulations. ESOPs are heavily regulated by both the U.S. Department of Labor and the Internal Revenue Service. As an ESOP is a retirement plan designed to invest in company stock, the interest of the Department of Labor is to see that plan participants and their retirement savings are adequately protected. Consequently, the Department of Labor will scrutinize an ESOP transaction to assure that the terms of the transaction, including the price paid for company stock, are fair. One way to assure compliance in this regard is to engage a well-qualified independent trustee to represent the interests of ESOP in the transaction.
  • Repurchase obligations. One major consideration for any ESOP, new or mature, is an understanding of the company’s repurchase obligation with respect to its ESOP shares. As employees approach retirement, they will seek to cash out the company stock in their ESOP accounts. In addition to retirement, a repurchase obligation can also occur due to termination of employment, death of an employee or a participant’s exercise of diversification rights. In order to prepare for this eventuality, a company will want to have a repurchase liability study performed and develop a plan to have adequate resources available when the need arises. Failure to plan for this eventuality can result in a crisis in future years.
  • Creating a culture of employee ownership. Critical to the success of any ESOP is the presence of an ownership culture. Some companies have a workplace culture that will give them a head start on this. Others will need to work harder at the developing the ownership mentality. What is important is to have a culture in which employees are engaged as owners and are aware of the responsibilities that come with ownership. This is enhanced through the sharing of information on the financial health and outlook of the company and by developing a team approach to achieve success. An old saying is that there is no “I” in ESOP.

In a sense, a transition to an ESOP takes on the same attributes of a personal family decision. Business owners need to work with financial, legal, and accounting advisors who are familiar with the culture of the firm and its mission. It is a significant advantage when the team has an understanding of the challenges unique to the construction and real estate industry.

It can be more remunerative and sometimes easier to sell to an outside buyer than to embark on an ESOP. The decision depends on the motivation and goals of the owner, the desire for the future of the business, and the feasibility of an ESOP as a succession alternative. Many St. Louis construction and real estate firms have found that properly planned ESOPs are an effective way to develop the next generation of leadership who will continue to advance the legacy of excellence that has defined the company since its inception.

Thomas H. Mug is an attorney in the employee benefits and trust and estates practice groups at the St. Louis law firm Greensfelder, Hemker & Gale, P.C.

Go to Top