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I just finished a great training session with my friends at Granite Construction. It was nice to renew a long-term relationship with an old client. It’s been a few years since I’ve worked with Granite. While a lot has changed some things have remained the same. One consistent thing I’ve seen over the past decade of training and working with Granite is a smart and engaged workforce. This session was no different in that way.
The session was held in Tempe, Arizona near the Arizona State University campus. We did a day and a half of finance. It was the perfect time to go to the Phoenix area, it’s nice to visit the desert before it gets too hot.
The session centered around the financial statements. In this version of the class we spent more time on stock pricing and the big 5 metrics that drive stock value. We spent some significant time on project based revenue recognition. That is always an issue with project based construction companies. It’s also a topic near and dear to my heart since I am a board member and owner of a project based automation business called Setpoint.
One of the issues in a project based business is how you measure earned revenue on partially completed projects. It turns out that with accrual accounting the generally accepted accounting principles (GAAP) require that you recognize revenue by taking a percentage of project cost completed. The obvious problem here is how do you know your total cost on these projects to get that percentage. Consequently, it’s hard to really know earned revenue on a project for sure until it is completed. How much you invoice on a project had literally nothing to do with how much revenue you recognize.
For example, let’s say you have a $5 million dollar revenue project with a $4 million projected cost. If you bill the client $1 million on execution of contract, there is no earned revenue because you have not started incurring cost on the project even though you have a million dollar billing. To offset that million dollar invoice your accounting friends will create a liability called something like unbilled revenue to offset the million dollar invoice and they will reverse that liability as the project is completed. On the other hand, after you complete a project, clearly you have earned the full $5 million in revenue. That may be the case, but if in your contract the final 10% is to be held as a retention for 30 days by the customer you have not billed the final $50,000. You can still count that final $50,000 as revenue even though it is unbilled. This billing would show up as an unbilled revenue asset on the balance sheet.
When evaluating a project based business it is important to look at the unbilled revenue and unearned revenue. If the unbilled revenue is greater than the unearned revenue it typically means the client is in the later stages of their projects and the project is not completely billed relative to new projects that are in the early stages where the billing exceeds the earned revenue. On the other hand, if the unbilled revenue is less than the unearned revenue then the company typically has more new projects in their pipeline than older nearly complete projects. The relationship between unbilled and unearned revenue is a quick way to check a project based business’ prospects. You always like to see the unearned revenue higher than the unbilled. That is consistently the case with Granite. In fact at the end of 2016 Granite’s unearned revenue was $97.5 million while its unbilled revenue was $73.1 million. That’s a great indicator that Granite had more newer projects in their pipeline than old ones.
The group had a lot of discussion around this topic and how it provides a great indicator for investors and bankers that work with Granite. I have more sessions with Granite coming up in the next month and a half so I will continue to talk about these project based financial issues. To leave you with a cliff hanger for the next Granite training blog I am going to talk about the elimination of the Granite ‘25%’ rule related to project accounting.
To wrap things up I had a great couple of days in Tempe with Granite. While the food was OK there was nothing to get too excited about. I did have a chance to run from my hotel to the top of the ASU mountain/hill above the stadium to watch the sun rise over the valley (thanks for not going to day light savings time Arizona). It was spectacular, I recommend it if you are visiting the area.
Do you need business finance training? Contact us at 818-591-5955 to talk about scheduling a training session.