9.1 Introduction

The purpose of this chapter is to discuss selected accounting and business procedures that are commonly utilized in the conduct of a construction business. While the popular conception of construction contracting is visualized as pouring concrete and erecting structural steel, there is far more to a construction business than the contractor's construction operations. The business aspects of operating a construction company are of critical importance to the success and continuance of the enterprise. While it is certainly true that the owners and managers in a construction firm are vitally concerned with the field operations conducted in the performance of the contracts the company has entered, it is also true that the financial, business, and accounting functions which are performed by the company home office are an indispensable component of the successful operation of the construction company.

9.2 Financial Records

The failure of many otherwise well-managed construction companies is frequently caused by the lack of accurate, detailed, and timely information concerning all aspects of the company's financial affairs. Financial records of several different kinds absolutely must be maintained to serve a number of business and management purposes in the company. This, in turn, means that company management must have established a structure for defining the records and documents that must be developed, maintained, and properly stored, as well as a system of policies and procedures for the business operations of the company. In addition, of course, people having the requisite talents and skills must physically build, and operate, and maintain this financial structure and its documentation system.

One of the most basic and important reasons why construction contractors, like other businessmen, must keep accurate records is that many such records are required by law. An assortment of governmental agencies require data pertaining to taxes, payrolls, and other company financial information, along with a structure and a system of accounts to serve the purpose. Additionally, the contractor's financial records must provide the basis for financial statements and reports which are required for the construction firm's interaction with owners, bankers and other lenders, as well as sureties, insurance companies, public agencies, and others.

Beyond these considerations lies the imperative of the contractor having and maintaining a financial structure and record-keeping structure to serve the purposes of effective company management. The contractor's accounting system must serve to effectively and in timely fashion provide the information necessary to assist company management in controlling company operations and in utilizing its available capital to the greatest possible advantage. Without proper records, and the structure and policies for developing and maintaining these records, it is impossible for a contractor to establish and maintain a solid financial base, or to estimate construction costs accurately, or to control costs on current projects, or to keep the company in a fluid cash position, or to be able to make sound judgments concerning the acquisition of equipment, or to perform the numerous and varied additional functions associated with the financial management of the business enterprise.

The functions of a construction company's accounting system are not limited merely to producing and maintaining financial information and keeping records. Although such information is basic and essential to the conduct of company operations, it is also necessary for company management to analyze and summarize this data in order that it can be used to best effect. It can be said that the success of the entire process, and ultimately the success of the company itself, absolutely depend on the continuous generation, maintenance, and analysis of financial information that is critical to the successful operation and management of the company. The methods that are employed, the information generated, and the use that is made of this information in this process are the subject of the remainder of this chapter.

9.3 Accounting Methods

Although the details of record keeping vary considerably among construction firms, there is a basic accounting logic and a set of fundamental accounting procedures that are common to companies in the construction industry. The primary basis of a contractor's accounting system centers on the determination of income and expense from each of its construction projects and the cost of the operations of its office staff and management. That is, the performance of each construction project is treated as a separate profit center. In an accounting sense, a profit center is any group of associated activities whose profit or loss performance is separately measured and analyzed.

In a construction company, the original estimate of costs pertaining to each contracted construction project becomes the basis for a budget for that project. As costs are incurred on the project, they are accounted for and are charged against the project activities or work items to which they pertain. Cost summaries and reports are regularly generated throughout the life of a project, and costs incurred are compared to the project budget. Management analysis follows and forms the basis for management action to assure insofar as possible that the project will be completed within the budget. Figure 9.1 illustrates the cycle of cost estimating, cost accounting, and cost control, and the record-keeping functions that accompany.

It is customary that the keeping of most of a contractor's business accounts be concentrated in the home office. However, on large projects and on some cost-plus contracts, a subsidiary set of accounts is frequently maintained in a field office where the record keeping pertaining to that project is accomplished. In this process however, the controlling accounts or master accounts for such projects are incorporated into a master set of accounting records that are maintained in the contractor's central office.

The two basic accounting methods employed by contractors in the conduct of their business are the cash method and the accrual method. In the cash method, income is taken into account only when cash is actually received, and expense is taken into account only when cash is actually expended. The cash method is a simple and straightforward form of income recognition, and no attempt is made in this method to match individual revenue payments received with the accompanying expenses.

The cash accounting method is used principally by small businesses, nonprofit organizations, and by some professional people for their personal records. Many small construction contractors use the cash method because of its simplicity, and because of the fact that tax liability for contract profits is recognized only when payment has actually been received. If a construction company performs only small projects, and maintains little or no materials inventory, and owns no capital equipment of consequence, the cash method is usually adequate.

However, for most construction companies the cash method does not work to the advantage of the contractor. For example, the cash method of accounting does not recognize depreciation of equipment and other capital assets because depreciation involves no recognition of cash income or outgo. Additionally, and importantly, income that has been earned but not received and expenses that have been incurred but not paid as of the end of a reporting period are not recorded or reflected in the company records in the cash method of accounting. An income statement, which is a summary document showing the company's revenue and expenses for a certain period of time, with profit or loss expressed as the difference between the expenses and revenue that is prepared on a cash accounting basis, will not present a realistic indication of true profit or loss for the company.

Similarly, a balance sheet, which is a summary of the company's assets, liabilities, and net worth at a certain point in time that does not reflect income earned but not yet paid and expenses incurred but not yet paid, does not accurately reflect the company's true financial condition. Income statements and balance sheets absent this information are therefore of limited value to management in assessing the financial condition of the company, and are entirely inadequate for use by lenders, sureties, and others outside the company who have an interest in a depiction of the company's financial position.

The accrual method is the second basic accounting procedure, and is the one most commonly used by all but the smallest construction companies. Under the accrual method of accounting, income is actually taken into account in the fiscal period during which it is earned, regardless of whether payment has actually been received. Similarly, items of expense are entered into the accounts as the expenses are incurred, whether or not they have actually been paid during the reporting period. The accrual method of accounting and income recognition is also more complicated, because by this method a connection is maintained on a continuous basis between the revenues earned and the associated expenses. The accrual accounting method requires a more elaborate system of accounting procedures and records. However, the accrual method is generally accepted as the accounting method that provides the most accurate and realistic portrayal of the financial condition of a business enterprise at any moment in time.

9.4 Accounting for Long-Term Contracts

A long-term contract is defined for tax purposes as one that is not completed within the taxable year in which the contract was formed. Tax codes mandate that one of three methods of accounting must be applied by contractors to their long-term construction contracts: the percentage-of-completion method; the percentage-of-completion capitalized cost method; or the completed-contract method. The three methods differ in the manner in which costs and expenses are matched to project revenue; they also differ in the identification of the period in which the income from a project is taken into account. The basic elements of each of these procedures will be discussed in the sections that follow.

9.5 Percentage-of-Completion Method

The percentage-of-completion method recognizes income and expenses from long-term projects as the work on the project advances. Thus, the profit is distributed and taxes are paid over each of the fiscal years during which the construction project is underway. This method has the advantage of recognizing project income periodically on a current yearly basis, rather than awaiting a summary of income and expenses until projects are completed.

Under this method, gross project income is recognized in accord with the percentage of the project that has been completed during a given fiscal year. The percentage which is used in this regard is the ratio of project costs incurred during the fiscal year to the total estimated contract cost, including any revised amounts (as from change orders), to complete the work. Applying this percentage of completion to the total contract price and then deducting the applicable project costs incurred to this point yields the net project income or loss for the fiscal year involved. The major weakness of this procedure is its dependency on estimates of costs that will be incurred to complete the work, a value that can be subject to considerable uncertainty at times.

9.6 Percentage-of-Completion Capitalized Cost Method

An alternative to the percentage-of-completion method of reporting income from long-term construction projects is the percentage-of-completion capitalized cost procedure. When this method is used, 90 percent of the revenues and expenses for the contract are accounted for using the percentage-of-completion method as described in the preceding section. The remaining 10 percent of the project costs are taken into account using the completed-contract method, which will be discussed in the following section. Thus, it can be seen that the percentage-of-completion capitalized cost method of accounting is a hybrid between the percentage-of-completion method and the completed-contract accounting methods. There are regulations in the tax code that prescribe the conditions pertaining to the contractor's use of this accounting method.

9.7 Completed-Contract Method

The completed-contract method of accounting recognizes project income and expenses only after the completion of the construction project. When this accounting method is employed, project costs are accumulated during construction, using what is referred to as extended-period cost capitalization, meaning that construction costs are capitalized over the duration of the project. The scope of contract costs that must be capitalized includes not only the costs directly related to the project but also indirect costs (overhead costs) that are attributable to the project. Costs such as general and administrative expenses and interest expense related to the performance of the contract are also included in the costs that must be capitalized.

By definition, the use of the completed-contract method of accounting requires clear delineation of project completion. What actually constitutes the completion of a contract for income-reporting purposes has been the subject of varying interpretations by the courts. Present practice tends largely to establish completion as having taken place when all of the work has been finalized and accepted by the owner. However, other interpretations have held that a contract is complete when the point of “substantial completion” has been reached.

No matter how the completion of the project is defined, however, the tax code stipulates that the completion of a contract may not be delayed by the contractor if the principal purpose is to defer federal income tax and/or other taxes. Additionally, federal tax regulations apply definitions and restrictions with regard to when and in what manner a contractor may use the completed-contract method.

The completed-contract method can be advantageous when, on long-term contracts, the contractor cannot accurately predict the economic results of its future contract performance. Frequently, project uncertainties preclude the making of accurate estimates of profits to be earned. Another advantage of the completed-contract method is the fact that payment of income taxes is deferral until the contract has been completed and final payment has been collected. By the same token, however, recognition of losses from the performance of a project is also deferred.

A disadvantage of the completed-contract method is that it does not reflect current performance for long-term contracts, and may result in irregular recognition of income. In some instances, this may result in greater income tax liabilities. Another potential disadvantage of this accounting method is that the year of completion of a project can be subject to considerable uncertainty if the end of the project coincides with the end of the accounting period, or especially if there are disputed claims remaining unsettled at the end of that year.

9.8 Financial Statements

At intervals of time called accounting periods, a determination can be made of the financial condition of a business enterprise. Accounting periods can be of variable length, such as one month, one quarter, or one year. The length of the accounting period is determined by company management policy, by management needs for this information, and by standard accounting practice, as well as by the need of external agencies to be informed concerning company financial strength.

Accounts are closed (summarized) at the end of each accounting period, and relevant statements are prepared that depict the financial position of the company at that time. Several forms of financial statements are typically derived from the company books of account. It is the purpose of such statements to group together and organize significant facts in a manner that will enable the person reading them to form an accurate judgment concerning some aspect of the company operation, such as the overall financial condition of the organization, or the profit-loss results of its operations. As would be expected, much of the usage of a company's financial statements is made by company management itself. These reports are invaluable for determining current status, as well as for the advance planning of company operations. Additionally, these documents reflect the company's borrowing capacity and bonding capacity. In addition, they provide a great deal of information concerning company policies with respect to elements of company operation such as purchasing, equipment ownership, and office overhead.

Additionally, these financial statements serve many important functions with respect to a number of external agencies that have an interest in the company and need this information. Bankers, sureties, insurance companies, equipment dealers, credit-reporting agencies, and clients and potential clients of the construction firm are all concerned with the contractor's financial status and profit experience. Stockholders, partners, and others having a proprietary interest in the company and its operations use these statements to obtain information concerning both the company's financial condition and the status of their investment. The two financial statements that are of primary importance are the income statement and the balance sheet. Each will be defined and discussed in the following sections.

9.9 The Income Statement

The income statement is an abstract of the nature and amounts of the company's income and expense for a given period of time, usually a quarter or full fiscal year. This document may also be known by the following terms: profit and loss statement, statement of earnings, statement of loss and gain, income sheet, summary of income and expense, profit and loss summary, statement of operations, and operating statement. This statement shows the profit or loss as the difference between the income (revenue) received and the expenses paid out during the period. Figure 9.2 is an example of an income statement for the Blank Construction Company, Inc., for the fiscal year ending December 31, 20—. The following paragraphs, keyed to the lowercase letters in parentheses as they appear in Figure 9.1, explain the various items.

1. This statement has been prepared on a completed-contract basis.

   Project income is the total contract value of all projects completed during the period covered by the statement.

   The total is obtained from a supporting schedule that shows the income figures for each completed project.

2. Project costs include all materials, labor, equipment, subcontracts, project overhead, and other expenses that have been charged to the completed projects.

   A supporting schedule of job costs lists these expenses for the individual projects.

   Included with job costs is the general overhead expense that has been allocated to the completed projects.

   General overhead is periodically distributed among the various projects in proportion to the costs incurred by those projects during the period.

3. Subtracting project costs from project income yields net project income for the statement period.
4. Other income lists the net income received from other sources.
5. Total net income before taxes is the amount realized from all operations during the statement period.
6. Net income after taxes is the amount available for company expansion or for distribution to stockholders.
7. This sum is the earnings accumulated as of the start of the statement period.

   A corporation can retain its earnings for business purposes or distribute them as dividends to the stockholders.

   However, there is an accumulated-earnings tax that is a penalty tax applicable to corporate earnings which are accumulated for the purpose of avoiding income tax to its shareholders by permitting profits to accumulate in the corporation.

   The allowable amount of retained earnings accumulation for use in meeting business needs, and the tax rate applicable to amounts exceeding this sum, are determined by the tax code.

8. Dividends paid represent distribution of earnings made to stockholders in the form of dividends on common stock during the statement period.

   This construction company has 4610 shares of common stock outstanding. A dividend of $8 per share was declared and paid during the fiscal year just ended.

9. The balance represents the total retained earnings of the corporation through the end of the report period.
10. In a corporate form of business, it is usual for the income statement to show net earnings for the year (after taxes) per share of outstanding stock.

It should be recognized that an income statement has several limitations. Concentrating as it does on past events, the income statement reports only the company's profit or loss experience during the reporting period. It does not show the present overall financial condition of the firm. Additionally, it should be understood that in the highly competitive and unpredictable construction industry, the profit or loss reported on the income statement at any point in time, is not always indicative of the management quality of the company.

9.10 The Balance Sheet

The balance sheet presents a summary of the assets, liabilities, and net worth of the company at a particular point in time. Balance sheets are commonly prepared at the close of business on the final day of a fiscal year, but can be prepared at any time to meet the needs of company management or an external entity. Balance sheets are universally used to describe the financial condition of business concerns of all kinds.

The basic balance sheet equation may be stated as follows: Assets = Liabilities + Net Worth. The balance sheet presents in analytical form all assets, including company-owned property, or interests in property, and the balancing claims of stockholders or others against this property. The foregoing equation expresses the equality of assets to the claims against these assets. Assets are defined as anything of value, tangible or intangible. Liabilities involve obligations for the payment of assets, or obligations to render services to other parties. Net worth is obtained as the excess of assets over liabilities, and represents the contractor's equity in the business. The term contractor is used here in the broad sense, meaning proprietor, partners, or stockholders.

The balance sheet may also be referred to by other names: statement of financial condition, statement of worth, or statement of assets and liabilities. A representative example of a contractor's balance sheet is depicted in Figure 9.3, the balance sheet for Blank Construction, Inc., on the last day of the year. Company assets are shown on the left side of the balance sheet and liabilities and net worth on the right side.

The major headings of Figure 9.3 are further discussed in the paragraphs that follow, in terms of reference to the parenthesized alphabetical characters such as (a) in the balance sheet.

1. Current assets include cash, materials on hand, and other resources that may reasonably be expected to be sold, consumed, or realized in cash during the normal operating cycle of the business.

   When the business has no clearly defined cycle, or when several operating cycles occur within a year, current assets (and current liabilities) are construed on a 12-month basis.

   This one-year-cycle rule applies to most contractors.

   Prepaid expenses represent goods or services for which payment has already been made and which will be consumed in the future course of operations.

2. Noncurrent notes receivable are in the nature of deferred assets, representing the value of notes that become receivable at some future date or dates.
3. Property represents the fixed assets of the business.

   These assets are more or less permanent in nature and cannot readily be converted into cash, at least not in amounts commensurate with their true values to the contractor.

   These assets generally have a useful life of several years, although assets such as buildings, equipment, vehicles, and furnishings do wear out gradually.

   These assets are capitalized at their purchase prices, or in accordance with appropriate cost appraisals in standard accounting practice.

4. Accumulated depreciation represents the total decrease in value of the property as a result of age, wear, and obsolescence.

   Depreciation is more fully discussed in sections to follow in this chapter.

5. Total assets is the sum of everything of value that is in the possession of or is controlled by the company.
6. Current liabilities are debts that become payable within a normal operating cycle of the business [see Item (a)].

   It is presumed that payment will be made from current assets.

7. In the example, the Blank Construction Company, Inc., is using the completed-contract method of reporting income.

   Deferred credits represent the excess of project billings over related costs on current contracts that have not reached completion by the end of the reporting period.

   This is treated as a current liability because the company is required to render services in the future, and payment has already been made for these services.

   If the contractor had underbilled, that is, if the billings were less than related costs, the resulting amount would be treated as a current asset.

8. Total liabilities is the sum of every debt and financial obligation of the company.
9. This is the capital stock account, showing the classes and amounts of stock that have actually been issued and paid for by the stockholders.

   In the example, 4,610 shares of $100 par-value common stock have been purchased by the owners.

10. This represents the net ownership interest the corporation “owes” to the stockholders.

    In the example, this amount is calculated as the sum of the common stock investments plus retained earnings (also called earned surplus).

    The book value of the common stock as of December 31, 20—, is obtained by dividing $645,655.32 (the total net worth of the firm) by 4,610 (the number of shares of common stock sold), which yields a value of $140.06 per common share.

    The determination of the book value of common stock excludes intangibles of all kinds that would have no value on liquidation.

    The market value of this common stock, that is, the price for which the stock can be sold, may differ substantially from the book value of the stock.

    What shares of stock are truly worth in a closely held corporation can be very difficult to determine. Yet such a value may be needed for estate, gift, or income tax purposes. The Internal Revenue Service has issued guides to assist in determining the value of closely held shares.

11. The equality of (e) to (k) illustrates that Total Assets = Total Liabilities + Net Worth.

The balance sheet is of considerable analytical value for those who wish to determine the financial condition of a firm. It discloses the nature and composition of a company's assets and shows how these assets are financed. The sources of funds tell a great deal about the quality of management and the stability of a contractor. The balance sheet also provides a good indication regarding the liquidity of a firm, that is, its ability to meet its short-term financial obligations. A comparison of balance sheet values over time discloses trends in the company's management policies and in the company's financial position.

There are also some shortcomings associated with balance sheets. The balance sheet information applies as of a specific date, and may not be representative of the normal company financial condition. Additionally, some asset values may be approximate determinations, and the person reading the balance sheet is left to determine the true value in his or her perception. It is also true that the accounting method used for the preparation of a balance sheet can appreciably influence the data presented.

9.11 Financial Ratios

Financial ratios of various kinds are frequently utilized, both by company management internally and by external constituents of a company, as quantitative guides for the assessment of a company's financial and earning position. A number of different ratios can be used to extract further information from, and to further analyze, a company's income statements and balance sheets.

It is not as much the absolute size of the figures in the income statement and balance sheet documents that is meaningful to the financial analyst, but rather the relationships or ratios among the different values. By comparing the same ratios over a series of financial reports, the interested person can extract very significant information, and can paint a very accurate picture, regarding a company's financial performance over a span of time. Additionally, when such ratios are compared with the similar figures of other contractors, a comparative financial picture of the businesses is obtained.

A number of different ratios can be used to provide company management as well as external analysts with guidance concerning the financial condition of the firm, and to point to areas that need attention. Four different types of ratios are in widespread usage:

1. Liquidity ratios. These measures reveal a company's ability to meet its short-term financial obligations.
2. Activity ratios. These ratios indicate the level of investment turnover and provide information with regard to how well the company is using its working capital and other assets.
3. Profitability ratios. These values relate overall company profits to various parameters such as contract volume or total assets.
4. Leverage ratios. These ratios compare company debt with other financial measures such as total assets or net worth.

Some financial ratios that are commonly used by construction contractors are illustrated in Figure 9.4. The value of each ratio has been computed for the Blank Construction Company, Inc., using data from the company's income statement and balance sheet. The values taken from the income statement and balance sheet for the calculation of the ratios illustrated are summarized in Figure 9.5.

This company is represented to be a building contractor whose overall financial condition is relatively good. In brackets next to each ratio obtained for the Blank Construction Company, Inc., national median ratios for commercial building contractors as reported by the Risk Management Association, are indicated. The Risk Management Association (www.rmahq.org) is an organization that works as a consultant to banks and lending institutions. Such median values change from year to year and vary with the size of the contractor and the type of construction involved, so the values given are for illustrative purposes only.

The data in Figure 9.5 are taken from the documents illustrated in Figures 9.2 and 9.3.

The ratios and values cited in brackets at the far right in Figure 9.4 above are illustrative of contractors' financial experience in general, on a national average basis. The ratios for an individual contractor can, and often do, vary substantially from these median values. Nonetheless, to the trained eye such financial ratio tells a great deal about the business, and its financial condition, and the quality of its management.

9.12 Significance of Ratios

Each of the various financial ratios conveys its own message. The significance of the ratios determined in the previous section is further discussed next.

• Quick assets to current liabilities (quick ratio). This ratio shows the number of dollars immediately available to cover current debt of the enterprise. When this ratio is 1.0 or larger, the business is said to be liquid, and the ratio is usually considered to be adequate.
• Current assets to current liabilities (current ratio). This ratio is widely considered to be the most significant short-term financial measure. It is a test of the firm's ability to meet its current obligations. The higher the ratio, the greater the assurance that short-term debts can be paid. In the construction industry, a Current Ratio of at least 1.5 is generally regarded as being favorable.
• Total liabilities to net worth (debt to equity ratio). Indicates the relative amounts that creditors and owners have invested in the business. Values of 1.0 to 2.0 for this ratio are usually considered to be acceptable in the construction industry.
• Project income to net working capital and project income to net worth. Both of these ratios convey the same general message. These ratios measure the rate of capital turnover, showing how actively the firm's capital is being put to work. If capital is turned over too rapidly, liabilities can build up at an excessive rate. If the ratios are too low, funds become stagnant and profitability suffers. In construction, these ratios are typically higher than in most other industries. These relatively high values partially explain why entry into the construction business is so easy. A construction contractor can perform more work per dollar of invested capital than is possible for workers in most other industries.
• Fixed assets to net worth. This ratio is one that can vary greatly from one construction type to another, being much higher for engineering construction than for building construction. In general, a higher value in this ratio is undesirable because heavy investment in fixed assets (principally equipment for an engineering construction firm) indicates the firm may have low net working capital, or may indicate that the company has incurred substantial funded debt to supplement working capital.
• Percent net project income (before taxes) to project income. This ratio reveals the average profit margin realized on the field work that is performed by the company. This figure is typically small in the construction industry and reveals why the rate of contractor business failures is as high as it is. It does not require much of a change to raise the cost of a project by a percent or two, and to change the project from being profitable to incurring a loss for the contractor.
• Percent net project income (before taxes) to net worth. This is perhaps the most important of the long-term ratios because it reflects the efficiency with which invested capital is employed. Considering the risk, the contractor should expect to earn more on its investment than it could realize from current market dividend or interest rates.
• Percent net project income (before taxes) to total assets. This ratio relates company profits to the level of assets available to earn a profit. Smaller construction corporations may have somewhat lower profitability ratios that can be at least partially explained by the respectable salaries of company officers.

In most companies, a significant proportion of company gross profits is often taken in the form of personal salaries.

9.13 Construction Equipment Acquisition

For contractors such as highway and heavy construction contractors, whose business operations require substantial spreads of construction equipment, the manner in which the necessary units of equipment are acquired is an important business determination. Likewise, for building construction and industrial contractors who have need for large cranes and materials handling machinery, a very careful analysis is likewise important for the business.

Construction equipment of all kinds is very expensive. Additionally, this equipment operates on a construction site in an environment that requires major support in the form of maintenance, repairs, and parts. Deliberate management analysis and decision-making are necessary in order to maximize the contractor's investment or expense in the acquisition of the equipment that is needed for the performance of the work.

The historical pattern of equipment acquisition in the construction industry has been for the contractors to purchase and own the machines and equipment necessary for the conduct of their business. However, many contractors are coming to the realization that construction equipment is a very costly business asset that must be carefully managed in all of its aspects. Frequently today, many contractors are analyzing their equipment needs more carefully, and are availing themselves of other alternatives in addition the purchase option for their equipment.

For contractors whose construction equipment consists of units that receive regular and substantial usage in the contractor's field operations on construction projects, purchase of new or used equipment is the most common method of acquiring the machines that are needed. Considerations such as the nature of the contractor's present and anticipated future need for a piece of equipment, first cost and ownership cost, operating cost, production rate, unit size and capacity, model reliability and ruggedness, risk of obsolescence, and how the unit will fit in with the inventory of the contractor's existing equipment, all are important aspects of the determination. A major consideration in the purchasing decision is how the acquisition is to be financed.

When purchasing equipment, the contractor is well advised to investigate the source from whom to buy the equipment. Most contractors have found that equipment obtained from full service, factory-authorized distributors will usually cost more on a first-cost basis, but can offer added value in terms of customer support, service and parts support, product warranties, trade-ins, and other purchase options. It is common for most major equipment manufacturers and distributors to offer financing plans, sometimes at very attractive rates.

Most construction firms that have a relatively stable volume of work within a limited geographic area continue to find it desirable and economical to own their own fleets of construction equipment. However, contractors are increasingly finding that renting or leasing their construction equipment is economically preferable to ownership. Equipment management now requires that the contractor treat his equipment as an independent profit center, and to carefully evaluate every aspect of equipment acquisition and utilization.

Although the direct cost and short-term costs of equipment rental can be substantially higher than for either ownership or leasing, renting construction equipment can have advantages. For example, rental can provide an advantageous way in which to keep the work progressing when there is an equipment breakdown on a project, or to meet specialty job requirements or times of peak demand on the project. Rental can also prove to be a very efficient option in situations where there will be low-percentage utilization of a machine, and for short-term peak or seasonal use. Rental can be a valuable option when the job site is far removed geographically from the contractor's other operations, or for providing specialized items that the contractor may have limited use for in the future.

Rentals may also be considered as a method by which the contractor can evaluate equipment for consideration for possible subsequent purchase. Because of the high purchase price and investment cost of large equipment, rental can conserve company capital and can result in a better ratio of assets to liabilities.

When equipment is rented, it is usually not rented for a guaranteed period and therefore can be returned at any time. Equipment maintenance and repair are the responsibility of the dealer or rental yard, resulting in savings in time and expense for the contractor. These savings can offset, at least to a degree, the higher cost per unit of time for a rental.

Numerous equipment centers now specialize in the rental of construction equipment. Rental rates normally vary with the length of time the unit is needed, with short-term rates typically being higher than long-term rentals. Additionally, many rental centers can arrange rental-purchase programs where the contractor has an option to purchase.

Leasing provides another commonplace and widely used means of a contractor's acquiring construction equipment. Most construction equipment leases are written for a term of one year or longer.

Leasing equipment offers a number of potential financial advantages for the contractor. Leasing can be a useful step between renting and buying. Usually, the cost of leasing is considered as an operating expense, not a liability as with a bank loan for equipment purchase. Leasing can improve a contractor's working capital position by avoiding having funds tied up in expensive fixed assets. An equipment lease can be structured so that there is no initial cash outlay, enhancing the contractor's liquidity position. Additionally, certain tax advantages can accrue with leasing. Under certain circumstances, lease payments may compare favorably with ownership costs. Additionally, many leases provide that at the expiration of the lease period, the contractor has a purchase option, if there is a continuing need for the machine, and if he believes the machine to be worth the additional payment.

9.14 Equipment Management

Many contractors own extensive spreads of equipment, or major pieces of equipment that they use to accomplish the work on their construction projects. As noted earlier, construction equipment is very expensive, in terms of first cost and also in terms of ownership and operating costs. The contractor's investment in his equipment inventory can easily run into the millions of dollars.

Equipment purchase is economically justified only when the purpose of the equipment is to make money for the contractor. However, equipment will produce the expected income only if it is properly managed. Equipment ownership must be carefully analyzed and managed in the same manner as any other capital investment.

In the case of construction equipment, effective management involves making informed judgments about equipment acquisition and financing, establishing a comprehensive preventive maintenance program, and maintaining accurate and current records of equipment income, expense, usage, and production rates. Additionally, the contractor will find it necessary to establish appropriate company policies with regard to equipment operation and usage, and maintenance and repairs. In addition, the contractor will need to establish policies with regard to equipment replacement.

A rigorous preventive maintenance program is essential to profitable equipment utilization and management. Equipment downtime has a serious detrimental effect on project costs and schedules. A contractor's preventive maintenance program must be tailored to its own equipment specifications as well as to the job site conditions where the equipment is in operation. Special attention must be given to those machines that are critical to a project, that is, those machines whose downtime would have a particularly severe impact on production, and costs, and schedules. Therefore, proper maintenance is essential so as to minimize unanticipated equipment downtime.

Once equipment has been purchased, the contractor attempts to recover the acquisition costs by using it in order to perform work and generate revenue, and by realizing the residual value of each machine upon its final disposition. The accounting procedures that are used to allocate or to “charge” equipment costs to the construction projects where the machinery is utilized, vary substantially from one contractor to another. However, a common procedure is to establish an internal rental rate for each piece of equipment, a topic discussed previously in this chapter and also in Chapter 5.

In basic terms, the contractor will account for the ownership and operating costs of each machine he owns, with operating costs including an allowance for maintenance and repairs. These calculations produce an “internal rate,” dollars per day, or week, or month for the contractor's owning and operating the machine.

During the progress of work in the field, a charge equal to the internal rental rate multiplied by the number of equipment hours, weeks, or months the equipment is used on the project is entered as an equipment cost against the project. At the same time, an equal but opposite credit is made to the contractor's central ledger account for that equipment unit. This is the same equipment accounting procedure previously discussed, where all items of expense, exclusive of operating labor, and hours of usage are continuously maintained for that equipment item.

In a business sense, what the contractor is doing is establishing in his accounting procedures a system that is similar to a separate company that owns, services, and maintains all of his major equipment and rents it to the contractor at predetermined rates. This equipment accounting procedure provides a cumulative record of expense and earnings for each major equipment unit.

Analyzing how these figures compare from one piece of equipment to another, as well as how these costs compare to other equipment acquisition options such as renting or leasing, provides company management with invaluable information concerning the management of the company's equipment assets. In short, the company knows which machines are paying their way and which are not. Many construction firms have a company policy that provides that when the annual cost of an equipment item exceeds its annual earnings, it is to be either replaced or sold.

A number of construction companies treat their equipment division as a separate profit center within the company. This simply means that the equipment investment is treated as a separate business, with the return on the investment required to be commensurate with the risk. Whether a contractor expects a breakeven performance or a profit on its equipment investment is a matter that depends on company management philosophy and is translated into company policy.

The replacement of a large equipment item is a major decision on the part of the contractor, and one that requires careful analysis and considerable study. Deciding on the replacement life and the replacement time for a piece of equipment is accomplished by construction contractors in different ways. However, it is a well-established axiom of equipment ownership that the replacement life for a piece of equipment is not the age at which the machine is no longer able to produce, but rather, replacement life is the equipment age that optimizes its advantage to the owner.

Methods of analysis are available to assist contractors in determining the point in time where the production costs of the machine are at a minimum. Another form of study can establish when profits earned by the equipment item are at a maximum. Various forms of discounted cash flow models are also available. Financial analysts and consultants are also available, who can assist contractors in making these determinations.

Associated with the replacement of certain equipment types, is the possibility of rebuilding a presently owned unit rather than replacing it. The cost of rebuilding a machine is normally one half or less of the purchase price of new equipment. This can provide an efficient way to extend the life of older machinery and restore its original productivity. This procedure may be an attractive alternative for contractors who may have difficulty supporting the financing of new equipment models.

In summary, it can be said that every construction firm that owns significant amounts of equipment needs to have some formal system of analysis in order to indicate the most advantageous time to replace or to rebuild a given major piece of equipment. In a general sense, when the average time rate of expense for a given machine exceeds the historical rate of similar machines, it needs replacement or rebuilding.

9.15 Equipment Depreciation

From the day of its acquisition, most business property, including construction equipment, steadily declines in value because of age, usage, wear, and obsolescence. This reduction in value is called depreciation and represents a cost of doing business for the contractor. Depreciation pertains to the physical depletion of capital assets the contractor owns, such as offices, warehouses, vehicles, computers, furniture; and it certainly pertains to construction equipment of all kinds as well. Because of the continuing decline in the value of such property, its cost must be amortized over its useful life so that the contractor recovers his investment cost and has capital available when replacement of the property becomes necessary. This entire process is referred to as depreciation and depreciation analysis.

Equipment depreciation is an especially important matter for contractors who own large fleets of equipment, and/or individual pieces of expensive equipment. The average contractor specializing in heavy and highway work may well have an equipment investment of $15 million or more, which may be 20 times that of a building contractor who has a comparable contract volume.

Depreciation costs for equipment-oriented contractors account for an appreciable portion of their annual operating expense. Basically, depreciation systematically reduces the value of a piece of equipment on an annual basis. The sum of these reductions at any time is called a depreciation reserve, which, when subtracted from the initial cost of the equipment, yields the current book value for the asset.

The initial cost of an asset, for depreciation purposes, includes not only the sale price, but also the costs of taxes, freight, unloading, assembly, delivery, and setup or rigging expenses. The book value represents that portion of the original cost that has not yet been amortized. As previously noted, depreciation costs represent a cost of doing business for the contractor, and in accrual accounting, these costs correspondingly reduce company earnings. At the same time, the depreciation reserve represents capital that is retained in the business, ostensibly for the ultimate replacement of the capital assets being depreciated.

9.16 Straight-Line Depreciation

The simplest and most straightforward method of determining depreciation is called straight-line depreciation. This method writes off the depreciable value of an asset at a uniform rate throughout its service life. Straight-line depreciation assumes, for record-keeping purposes, that the amount of value loss is constant from one year to the next, throughout the service life of the asset.

Some have criticized the use of the straight-line method as being unrealistic, on the grounds that the value decline of the capital item never actually follows such a course. It can certainly be said that most assets decrease in value more rapidly during the early years of their life.

In reality, few would say that the straight-line depreciation procedure accurately measures the actual decline in asset value over a span of time. In this regard, however, it is to be recognized that accurate appraisal of the value of an asset is not the objective of depreciation accounting. Rather, depreciation accounting is concerned with spreading the cost of an asset over its useful life in a systematic and rational manner, rather than attempting to gauge depreciation charges in such a way as to parallel physical decline.

Depreciation accounting should be viewed as a process of allocation, rather than one of valuation. Straight-line depreciation is a method that is widely applied by contractors to their equipment, for internal purposes such as estimating equipment costs, and for equipment cost control on ongoing projects.

Figure 9.6 illustrates the workings of the straight-line depreciation method for a ditching machine whose purchase price was $57,000, which has an expected service life of five years, and whose salvage value is zero. It should be noted that the depreciation for the first and last years of ownership is half the annual rate for five years of ownership (10 percent rather than 20 percent) because tax codes require that in the year in which a piece of capital equipment is purchased and disposed of, its depreciation rate for that year is one half its straight line rate. This figure also illustrates year-by-year depreciation for this machine by the Modified Accelerated Cost Recovery System (MACRS) and MACRS SDA (special depreciation allowance) depreciation methods, which are accelerated depreciation methods to be discussed in the following section.

9.17 Accelerated Depreciation

Accelerated depreciation provides the advantage for the contractor of a faster write-off of asset cost during the first years of its life than in the later years. There is considerable opinion that a better matching of revenue and expense is achieved by applying accelerated depreciation methods to construction equipment, because new equipment is generally more productive than old, and frequently the productivity declines very rapidly after the first few years of use.

The use of procedures that afford larger depreciation deductions during the earlier years of asset ownership may also have other important tax and financial advantages for a contractor. For example, rapid initial depreciation causes cash to be retained in the business, ensuring that cash is available, and enhancing the liquidity of the business. Additionally, larger depreciation charges against regular income in a given year causes a reduction of income taxes for that year.

In addition, accelerated depreciation methods also provide for faster recovery of equipment value, thereby offering the contractor some measure of protection against unanticipated contingencies later in the life of the equipment, such as obsolescence, excessive maintenance, rapid wear, or the need for equipment of a different size or capacity. Additionally, rapid depreciation amortizes the contractor's equipment investment more quickly, and simultaneously decreases the book value at the same rate. Speedy reduction of book value leaves the contractor with much greater latitude to dispose of unsatisfactory equipment and, to some degree, can also assist in combating the problem of obsolescence, or of replacing equipment during periods of inflation. In the usual case, many contractors favor using accelerated depreciation of their equipment and other business assets within the bounds allowed by the tax codes, for purposes of income tax reporting.

9.18 Modified Accelerated Cost Recovery System (MACRS)

The Economic Recovery Tax Act of 1981 established a detailed depreciation system for business property and has gone through several subsequent revisions. It is currently known as the Modified Accelerated Cost Recovery System (MACRS). This method is required for business income tax reporting and is, basically, an accelerated depreciation procedure with the provision that the owners of an asset can elect straight-line depreciation if they wish. This system is a relatively simple and easy procedure to use. By the provisions of this legislation, equipment life and salvage value are a matter of law rather than negotiation. This system makes it possible to depreciate construction equipment to zero salvage value over time periods that are much shorter than the typical useful life of the equipment.

MACRS identifies several classes of property and defines the allowable depreciation amounts that are calculated as a stipulated percentage of the asset's adjusted cost. The personal property classes of interest to contractors are three- and five-year assets, with the year classification depending upon the property type involved. For example, three-year property includes automobiles and light-duty trucks, while five-year property includes essentially all other contractor equipment.

Using the MACRS procedure, the value of each piece of equipment is decreased annually by the depreciation charge calculated. The sum of these charges at any point in time is a depreciation reserve that, when subtracted from the initial cost of the equipment, yields the current book value of the equipment. The initial cost of an asset, for depreciation purposes, includes not only the sale price but also the cost of taxes, freight, unloading, assembly, delivery, and setup. The book value represents that portion of the original cost that has not yet been charged off or amortized in depreciation. As previously stated, depreciation charges are a cost of doing business and correspondingly reduce company earnings. At the same time, the depreciation reserve represents capital that is retained in the business, ostensibly for the ultimate replacement of the capital assets being depreciated.

Ordinarily, a contractor favors writing off construction equipment as rapidly as possible. This is done by using the prescribed MACRS deduction rates. However, contractors also have the option of using either MACRS accelerated rates or straight-line depreciation for three- or five-year property. Additionally, there are provisions allowing the contractor as taxpayer to depreciate three- and five-year property over longer periods using straight-line depreciation. These MACRS options seemingly would rarely work to the advantage of a construction firm for income tax reporting.

It is permissible by Internal Revenue Service regulations to employ different depreciation methods for internal financial reporting and tax reporting purposes. Contractors may use straight-line depreciation (or any other conventional procedure) for the preparation of their usual financial statements, and the MACRS accelerated rates for income tax purposes.

Figure 9.6 illustrates how recovery values are obtained using MACRS depreciation. The new $57,000 ditcher is used for purposes of illustration. Under MACRS, the ditcher is classified as five-year property. The depreciation values for both MACRS and straight-line depreciation for the first and last years represent the one-half-year convention rule. This rule mandates one-half year of depreciation for the first year of service, regardless of the time of year service is started. There are numerous other rules and regulations associated with MACRS. The contractor should seek advice on matters pertaining to real property, disposition of property, partial expensing, and other depreciation tax matters from tax specialists and financial advisors.

9.19 Procurement

Procurement, which can be defined as the process by which the contractor obtains the goods and services needed for company operations, is a function of primary importance in a construction contractor's organization. This activity actually includes quite a number of different functions, each playing an indispensable role in the contractor's obtaining what he needs for the performance of projects he constructs, as well as for the functioning of the company.

The procurement function may be structured in several different ways by company management. In some companies, the project manager is responsible for the procurement function for all of the company projects in his or her portfolio. In other companies, project managers and superintendents share in this responsibility. In other firms, procurement is a centralized company operation, sometimes handled by the company operations officer, or by a vice president, or by a person known as an expediter who handles this responsibility.

In some companies, especially larger firms, the procurement function may operate as a separate department within the company structure. Centralizing all procurement functions in one department can be economical in terms of both time and money. It concentrates the expertise necessary to perform this important function, and can afford protection against improper and unnecessary purchasing expenditures of many kinds.

Whatever their title and position in the structure of a construction company, procurement personnel occupy a position of great responsibility within the organization, and typically perform a number of different duties. Performing procurement functions involves the preparation and use of a number of standard document forms such as requisitions, purchase orders, and subcontracts. The principal procurement functions in a typical construction company are discussed in the following paragraphs.

9.20 Discounts by Vendors and Suppliers

Discounts are frequently extended to contractors by material dealers and other vendors as an inducement to attract or to reward their trade or as an incentive for their early payment of statement amounts. Some of these discounts take the form of trade discounts and are often referred to as professional discounts.

Trade or professional discounts typically allow contractors to purchase products at a price less than that which a nonconstruction person would pay at retail. In providing these discounts, vendors are encouraging the trade of the contractor professionals, and are recognizing the quantity in which contractors typically purchase, and the relative ease and effectiveness with which the vendor can complete a sale with a construction professional. Additionally, trade discounts often include quantity discounts, where the larger the quantity being purchased, the lower the unit price.

Cash discounts are frequently extended in the form of a discount in the statement price, given in exchange for the payment of an invoice before it becomes due. A number of different forms of cash discounts are in commercial usage, and several variations are presented here. The expression “2–10, Net 30” is an example of one of these practices, and is, in fact, fairly commonplace. With this expression the seller is indicating that the buyer can deduct two percent from the invoice or statement amount if payment is made within 10 days of the statement date; otherwise, full payment of the net amount is due in 30 days.

Materials dealers normally date their invoices the day the goods are shipped. If the customer's location is nearby, he has time to take delivery and to check the goods prior to paying within the discount period. A customer who is far removed geographically, however, may not be able to take advantage of the discount unless he pays before the goods are actually received. To overcome this disadvantage to distant customers, some vendors will mark their invoices “ROG” or “AOG” to indicate that the discount period begins upon “receipt of goods” or upon “arrival of goods.”

Another form of cash discount provision similar to the previous, is termed prox, which means the discount period is expressed in terms of a specified date in the month which follows the shipments being made or billed. The expression “2–10 Prox Net 30” means a 2 percent cash discount is allowed if the invoice is paid not later than the 10th day of the month following the purchase. The net due date of the account is 30 days from the first of that month.

Another common way of expressing this discount structure is “2–10, EOM,” which indicates that a 2 percent discount can be taken if the invoice is paid by the tenth day of the month after the purchases are shipped. If the buyer does not make payment within this period, the net amount of the bill is considered to be due at the end of the month thereafter.

For accounting purposes, cash discounts are treated as income, and appear as “discounts earned” on the income statement. This is illustrated in Figure 9.2.

As one considers cash discounts, a two percent discount may at first glance appear to be inconsequential. However, if a contractor purchases a million dollars worth of materials in a year's time, and pays promptly so as to avail himself of the cash discounts, he has increased his earnings in the amount of $20,000. Additionally, when an auditor, a surety company, or a creditor analyzes a contractor's income statement and recognizes that the contractor has not availed himself of discounts offered by vendors, they may view this as a demonstration of inattentive management practices, or as an indicator of cash flow problems or other financial difficulties.

The status of cash discounts is a matter of sufficient importance that it is often called out in cost-plus contracts. While agreement on this point can be negotiated in different forms, it is fairly common in such agreements for the contract language to provide that all cash discounts accrue to the contractor, except when the owner has advanced money to the contractor from which to make payments to the supplier. Cost-plus contract documents written by the American Institute of Architects (AIA) reflect this policy. However, some forms of cost-plus contracts stipulate that the reimbursable cost of materials shall be decreased by the amount of any cash discounts taken, without regard to who provides the funds to make payment.

9.21 Title of Purchases

Most contractors regularly purchase appreciable quantities of construction materials. During the process of transport, delivery, unloading, handling, and storage of these materials, a variety of loss or damage can and does occur. When such difficulties arise, the mutual rights and responsibilities of the buyer and of the seller are largely controlled by the Uniform Commercial Code. Normally, the risk of loss or damage as related to personal property rests with the person holding title. When a loss occurs, the responsibility for the loss, and the rights of each party as buyer or seller, are based on whether title of the goods has passed from seller to buyer at the time the loss occurred. For this reason, the time at which the title of a purchase passes from the vendor to the contractor is a matter of considerable importance.

In a fundamental legal sense, title to personal property that is the basis of a sale passes from seller to buyer at the time when the parties intend for it to pass. If the sales contract or purchase order states or clearly implies at what time title is to pass, the terms of the agreement will prevail. It is seldom, however, that the parties to a sales agreement insert specific provisions concerning the point at which passage of title occurs.

Consequently, the Uniform Commercial Code has established a standard set of rules for application to matters of this kind. In the absence of any expressed intention to the contrary, title passes in accordance with the following general rules.

9.22 A Contractor's Right to Check on Project Financing

Many of the construction contract forms in commonplace usage provide that the contractor can request and receive reasonable evidence from the owner that suitable financial arrangements have been made by the owner to pay for the construction contract amount. The AIA General Conditions of the Contract for Construction contains this provision (see Appendix D).

It may be a good business practice on the part of a contractor to obtain advance information concerning a private owner's finances and credit rating. Just as the owner is concerned with the financial capacity and capabilities of the contractor so too, the contractor must be assured that the owner has the necessary financial means to fulfill contract requirements and to pay for the construction.

Case studies are on record where contractors have experienced serious financial difficulties when they failed to investigate the capability or integrity of the owner, and later discovered that the owner was unable or unwilling to make payment timely in accord with the provisions of the contract. This matter cannot safely be ignored, since the contractor must usually invest a substantial amount of his own money into a project before any monies are payable by the owner to the contractor. A default by the owner in meeting his payment obligations under the contract can have a very serious impact on the contractor's financial well being, and on the very survival of his business. The appreciable risks assumed by the contractor in the performance of construction contracts need not be increased by the chance of a default in owner payments.

Before obligating itself by bid or contract to a private owner, the construction firm does well to make some investigation and evaluation concerning the financial integrity of the owner, and the source of the owner's financing for the project. This step should be taken whether or not the owner is required by the terms of the contract to provide evidence, upon request, that he has the means to pay the amounts indicated in the construction contract. Especially if the owner is unknown to the contractor, additional credit information can be obtained from sources such as financial and credit rating services, industry trade groups, other contractors who may have previously dealt with the owner, or with the assistance of the contractor's banker.

There are also cases where the contractor must make certain determinations with regard to the owner entity with whom it is dealing. An illustrative example is the case where the owner is a shell, dummy, or subsidiary corporation that has been especially formed for the sole purpose of getting the project constructed and minimizing the liability of the principals or parent company. An owner corporation of this kind would have very limited assets, and would be a poor credit risk. Until any new corporation has had time to establish a record of financial stability, the contractor should be advised to assure that the principals or parent company must verify their capability for project funding or personally guarantee to make good on contractual debts. When dealing with a substantial corporation, the contractor must know whether it is dealing with that corporation or with a subsidiary that might be undercapitalized. Additionally, when the contractor is dealing with an agent of an owner, the contractor must insist on being provided written assurance that the agent has authority to bind the principal to the contract.

When the owner is a public agency, the contractor is generally assured that funds required to pay for public works will be available. However, there can be exceptions to this rule, especially in the case of quasi-governmental “corporations” being created by state or local governments to perform various construction functions. Such entities may not possess the full faith and credit backing of the governmental entity. Once the construction monies of these corporations have been exhausted, the contractor can find himself without recourse for payment. Therefore, some analysis regarding the reliability of the funding for these types of agencies should be performed by the contractor before bidding such projects.

On public contracts, it is a statutory requirement that all of the requirements for entering and fulfilling the contract must be fulfilled by the responsible public officials in order for a valid contract to exist. In most jurisdictions, the omission of any required procedural step by a public owner can leave the contractor without remedy to obtain payment for work performed. If a government body enters into a contract without complying with the statutory requirements pertaining to the bidding and awarding of public construction contracts, the contract is considered beyond the power of the public agency and may be declared void. There is a growing body of legal precedent however, that when an imperfect public contract was entered into in good faith by the contractor, and is devoid of fraud or collusion, the contractor is entitled to relief based on the equitable doctrine of unjust enrichment. A contractor who does business with a public entity must be aware of the laws governing its administration and the limitations on the powers and authorities of the public officers involved.

9.23 Payment to the General Contractor

Construction contracts typically provide that partial payments of the contract amount will be made to the prime contractor at regular intervals during the course of a project as the work on the project progresses. The exact procedure to be followed can vary considerably, depending on the wishes of the owner of the project, and may also vary with the type of work being performed.

For example, in residential and some other types of construction, it is customary for specified payments (specific in terms of amount or percentage of the total contract amount) to be made by the owner to the contractor at the completion of certain well-defined stages of construction. In residential construction, these payments are often referred to as “draws” and are made at defined points of progress, such as upon completion of site work, when the foundation is complete, upon completion of framing, when the structure is enclosed (referred to as being “dried in”), when plumbing and mechanical and electrical rough-in has been performed, at completion of the interior finish, and at full completion. Each of these payments is made to the contractor by the owner, or the mortgage company, or by the bank that is providing the interim financing for the project, following inspection of the project and receipt of necessary documentation from the contractor.

In commercial, institutional, heavy/highway, and industrial construction, the typical payment procedure that is defined in the contract is for periodic payments to be made by the owner to the prime contractor at monthly intervals. The general conditions of the contract for construction, and/or the supplementary conditions, and/or the special conditions of the contract will define and describe in detail all of the elements of the periodic payment process. The contractor should carefully analyze all of the contract language relating to payment, in order to assure that he understands each element of the payment process.

Typically on these types of projects, the general contractor will prepare a periodic payment request, also known as an application for payment, once each month on the dates specified in the contract, throughout the life of the project. Each periodic pay request is based on the work that has been accomplished since the last payment was made. This means that field progress and work performed during a payment period must be quantified by means of measurement, or by calculation, or sometimes by estimation, at each 30-day interval. A payment form is used that clearly identifies the units of work and quantities of work which have been completed, along with a notation regarding amounts that have previously been paid for each defined work item, so that the current amount due is the difference between the two.

Typically, the architect-engineer will define the format in which the application for payment is to be completed and frequently will prescribe or provide the actual form which the contractor is to complete and submit for each periodic payment request. Sometimes, however, the owner or the lending institution that is providing the construction financing may require the use of its own prescribed payment requisition form.

When the pay request has been compiled by the general contractor, it is transmitted to the architect-engineer and sometimes to the owner or the lending agency, or contracting officer. The usual contract between the architect-engineer and the owner provides that the architect-engineer will examine and approve each of the contractor's payment requests, and will certify the request on behalf of the owner and will authorize the owner to make payment to the contractor.

Approval of contractors' pay requests most certainly represents an important responsibility for the architect-engineer. In acting in the best interests of its client, the owner, it is incumbent upon the architect-engineer to see that the periodic payments that are made to contractors represent reasonable measures of the work actually accomplished. Additionally, it is the responsibility of the architect-engineer, representing the interests of the owner, to provide reasonable assurance to the owner that the work has been performed properly, that is, in compliance with the requirements of the contract documents.

The results of some recent court cases indicate that an architect-engineer may be held responsible if its negligence results in the owner's improper payment to the contractor. An example of this occurrence took place on a large project on which the contractor went bankrupt during the course of performing the construction on the project. The bonding company completed the project in accord with the terms of the performance bond (see Chapter 7). The dollar value of the work in place when the bonding company took over the work in order to see to the completion of the project proved to be substantially less than the payments the contractor had received. The bonding company sued the architect-engineer for negligence in permitting overpayment to the contractor, and the architect-engineer was found liable for the amount of the overpayments.

Additionally, all of the elements of time associated with periodic pay requests are set forth in detail in the conditions of the contract, including the dates when the contractor is authorized to submit a payment request, the amount of time within which the architect-engineer must make approval of the payment request and authorize the owner to make payment, and the amount of time the owner has, following the architect-engineer's authorization for payment, to make payment to the contractor. In like fashion, the contract documents address themselves to actions the architect-engineer can take if a payment request is not submitted timely, as well as to timelines and actions for the contractor in the event he does not receive payment within the times prescribed.

9.24 Payment Requests for Lump-Sum Contracts

The periodic once-per-month payment to the prime contractor by the owner on a lump sum contract, which is the most common type of contract utilized in building construction work, is defined and described in the conditions of the contract. The process begins when, following formation of the contract between the general contractor and the owner, the contractor prepares and submits to the architect-engineer for approval a document called the schedule of values. This document, when it has been approved by the architect-engineer, will stand unchanged throughout the duration of the project, except insofar as it might be affected by change orders and will form the basis for all payments made to the contractor by the owner throughout the project.

The schedule of values consists of line-item descriptions of the major activities or items of work to be completed in the performance of the contract requirements on the project, in the approximate sequence in which they will be performed. Both the self-performed work of the general contractor and the subcontract amounts for the specialty work items to be performed by subcontractors on the project will be included by the contractor in the schedule of values. For the elements of the work the general contractor will perform by subcontract, he will notify the each subcontractor whom he has selected for the performance of a specialty item, that they are to prepare and submit to the general contractor, a schedule of values for their part of the work, with their schedule of values to equal the amount of their subcontract. This forms the basis for the general contractor's entries on the schedule of values, which he submits to the architect-engineer and owner, for items of work he will perform by subcontracting.

The architect-engineer will typically have included in the “Payment” section of the conditions of the contract, a provision requiring that all of the activities or work items that are listed on the schedule of values be clearly identifiable, as well as being quantifiable. Along with each activity, a dollar sum is indicated on the schedule of values, which the contractor represents to be the approximate value of his performance of that part of the work and the amount of money that he expects to be paid for its completion.

The total of the schedule of values amounts for all of the activities to be performed on the project will equal the contract amount for the project. It should be noted that there will be no line item on the schedule of values for the contractor's general overhead or project overhead, for bond premiums or insurance premiums, or for the contractor's markup on the project. The dollar amounts for these elements are embedded by the contractor in the dollar amounts he submits for the activities on the project.

Additionally, because positive cash flow is of such critical importance, and due to the fact that the general contractor is typically financing the project for the first 30 days, inasmuch as he must perform work, and pay for materials, equipment, labor, and overhead costs in order to accrue earned value before he submits a payment request form at the end of 30 days, contractors will often “front load” or “front-end load” the schedule of values. This means the contractor will ascribe values somewhat higher than the true value of the work, to those activities or items that will be completed early in the life of the project.

While the architect-engineer and owner will be at least tacitly aware of this consideration on the part of the contractor, their concern is exactly the inverse of that of the contractor. Cash flow is as critically important to the owner as it is to the contractor. While the owner has a contractual obligation to pay the monies due to the contractor as set forth in the contract, the owner is usually completely unwilling to disburse any funds beyond the earned value accrued for completed work in place. Usually, this matter comes to be resolved by means of architect-engineer and owner allowing some degree of increase in the contractor's “contract amounts” or “earned value amounts” on the contractor's schedule of values, realizing that the earned value amounts are not a precisely accurate determination, inasmuch as the contractor will have his overhead expenses and his markup amount distributed throughout all of the earned value amounts for the project.

Following its submittal by the general contractor, the schedule of values will be examined for approval by the architect-engineer, and sometimes by the owner as well. In the interests of protecting their cash flow, the architect-engineer and owner will examine the schedule of values in order to ensure that the dollar amounts that accompany the earned value amounts for the work item activities bear a reasonable resemblance to the actual value of the work. Additionally, the architect-engineer and owner will examine the activity descriptions to assure that they are definitive and clear. Sometimes there will be an iterative process, wherein the architect-engineer returns the schedule of values to the contractor for revision of dollar amounts and/or activity descriptions, and this process continues until the point is reached where the architect-engineer grants approval of the schedule of values.

When the schedule of values has been approved by the architect-engineer and owner, it will stand unchanged for the duration of the project, except as it may be affected by change orders. It will form the basis for all payments made by the owner, and for all revenue received by the contractor throughout the project. Figure 9.7 depicts a representative schedule of values for a building construction project with a lump-sum contract in use.

When the schedule of values has been approved, and when the contractor submits his pay request for his first 30 days' work on the project at the time designated in the contract documents, the payment request form or application for payment that is employed for this purpose will be based on the schedule of values. Additional columns will be added to the right on the original schedule of values, having the titles “Percentage Complete,” “Gross Amount Currently Due or Earned Value Currently Due,” “Less Amounts Previously Paid,” and “Net Amount Currently Due.” Or the application for payment can contain the same information, presented in the format illustrated in Figure 9.8.

For each activity on which the contractor has performed work during the past 30 days, he will enter his percentage complete for that work item. This completion percentage will be determined and entered for each activity and may be determined for some activities or work items by counting, and for others by measurement or calculation, and for others by estimation. The “Gross Amount Currently Due” for each activity, or the “Completed to Date” column, is its contract value amount, or total cost amount, multiplied by its percentage complete.

For each activity, running totals are typically maintained throughout the project for amounts previously paid, and this amount is subtracted from the gross amount currently due to derive the net amount currently due for the current payment request. Figure 9.8 provides an illustration of the payment request form with these additional columns added, and this additional information entered.

It should be noted that at the bottom of the periodic payment request form, there is an entry called “Retainage.” Retainage, which is also sometimes referred to as retention, is a percentage, which is stipulated in the contract documents, that the owner will withhold from each payment made to the contractor throughout the life of the project, pending the contractor's satisfactory completion of all of the work on the project. The typical retainage percentage utilized is 10 percent, although amounts vary with the owner, and with the architect-engineer, and with the project.

Usually, contracts provide that, at the conclusion of the project, when the contractor submits his application for final payment, the retainage that has been withheld throughout the course of the project will be paid to the contractor. At this time, the contractor will have completed all of the work in fulfillment of the contract requirements, perhaps excepting punch list items and warranty work.

Additionally, the payment request form also typically includes an entry to the effect of “Payment for Materials Delivered and Properly Stored.” The amounts entered in this category are usually itemized in a schedule that is attached to the payment request form. Typically-used contract documents provide that the contractor and subcontractors can request payment on the periodic payment request form, for materials that are designated for use on this project and have been purchased, delivered, and properly stored. The documents usually stipulate that the architect-engineer is the final arbiter regarding the definition of “properly stored,” but usually this is interpreted to mean stored in a dry, secure, and locked location on the project premises.

After the general contractor submits the payment request form, the architect-engineer will closely examine the document in order to assure accuracy, as well as to assure for the owner that the percentages complete properly reflect the amount of work satisfactorily completed and in place on the project. The architect-engineer may ask the contractor to revise and resubmit if an error is discovered, or if the designer believes the percentages complete, and therefore the amounts due to the contractor, are not accurately reflective of the actual amount of satisfactorily completed work in place.

In addition, the architect-engineer and owner may sometimes require submittal of additional supporting information to accompany the payment request from the contractor, such as materials invoices, and/or copies of the statements the contractor has received from suppliers, and sometimes certified labor payroll records. The objective on the part of the architect-engineer and owner is to further assure themselves that the amount of money requested by the contractor in the payment request realistically reflects the actual earned value of the work that has been satisfactorily performed.

This submittal of the payment request form and the approval process will repeat every 30 days throughout the life of the project. The contract documents will stipulate the amount of time within which the architect-engineer is required to approve the contractor's payment request, and to authorize the owner to make payment. The owner then has a specified amount of time within which to make payment to the general contractor.

It should be pointed out that a cost breakdown that the contractor has compiled for payment purposes cannot be used by either party to the contract as a basis for, or to establish a precedent for, the pricing of change orders that may be issued during the course of construction of the project. Items of general expense have been prorated into the various periodic payment request items whether or not they apply directly to a given item of work. Additionally, as has been discussed, these cost breakdowns are usually unbalanced to some degree. Therefore, these periodic payment amounts are not satisfactory for pricing change order work; each component of the work in every change order will be priced separately and included in the change order documentation.

Although the pay request procedure for lump-sum contracts as described here has been in general use for many years, it has one serious defect. As shown in Figure 9.8, the project is divided for payment purposes into relatively few activity or work item classifications, most of which actually involve extensive work on the project that often extends over appreciable portions of the construction period. This situation can make it difficult to determine with any real degree of accuracy the percentages completed in the various work categories and activities. Actual measurement of the work quantities accomplished to date is the key to accurate percentage figures, but this can become very laborious, and therefore most of the percentages are established by visual appraisal or other approximation procedure.

This circumstance continues to produce vexing problems for both the contractor and the owner. If it is difficult for the contractor to estimate the completion percentages accurately, it is at least equally difficult for the architect-engineer or owner to verify these reported values. This presents the architect-engineer with a difficult problem because, in the interest of his client, he must make an honest effort to see that the monthly payments made to the contractor are reasonably representative of the actual progress of the project.

However, as has been noted, this process has been in use for many years on many projects and has usually worked to the general satisfaction of all concerned. While there is some degree of imprecision inherent in the process, no satisfactory solution to this matter, nor an alternative method for periodic payment requests has been put forward.

9.25 Payment Requests for Unit-Price Contracts

For projects on which unit-price contracts are employed, the contract documents also typically provide that the contractor is to be paid at 30-day intervals based on payment requests submitted in accord with the time schedule in the conditions of the contract. In this form of contract, the amounts set forth in the payment request and the payment to the contractor are based on the amount of each of the work items or activities described on the contractor's proposal form and then listed on the contract pay request form, which has been satisfactorily completed during the most recent 30-day period. Payment is based on the quantity of the bid item installed or completed during the period, multiplied by the contract unit price for that item. Figure 9.9 illustrates a typical payment request form as it might be used on a unit price project.

The determination of quantities accomplished in the field is accomplished in several different ways, depending on the nature of the particular bid item. When cubic yards of aggregate, or tons of asphaltic concrete have been established as bid items, the quantities of these items are usually measured and recorded as they are delivered to the work site. Delivery invoices or fabricators' certificates are used to establish tons of reinforcing steel or structural steel. For other work classifications, such as cubic yards of excavation, linear feet of pipe, or cubic yards of concrete, quantities satisfactorily installed are measured or computed from field dimensions. Survey crews of the owner and of the contractor often make their measurements independently of one another, and adjust any differences when the payment request is submitted, and before it is approved by the architect-engineer.

It is not uncommon on this type of work, for owners to use their own standard forms for monthly pay requests. On such projects, the owner or architect-engineer often prepares the pay request form and sends it to the contractor for checking and verification before payment is made.

On unit-price projects that involve a substantial number of bid items, each monthly pay request is a sizable document consisting of many pages. In essence, the total amount of work accomplished to date on each bid item is multiplied by its corresponding contract unit price. All of the bid items are totaled and the value of materials stored on the site is then added. The resulting figure represents the entire amount due the contractor for his work to date. From this total is subtracted the amounts previously paid, and the retainage amount set forth in the contract documents. This yields the net amount of money payable to the contractor for his work during that month. This process then continues for each monthly payment request throughout the life of the project.

9.26 Payment Requests for Cost-Plus Contracts

When a negotiated cost-plus contract is used on a project, there are numerous methods that may be employed for determining the amount of each periodic payment to the contractor. Typically, the payment interval is 30 days.

In many cases on these types of projects, contractors provide their own capital to pay the costs associated with the project, and receive periodic reimbursements from owners for costs incurred, plus whatever amount or fee has been negotiated. Other contracts provide that owners will advance money to the contractor for the purpose of the contractor's meeting his payroll, and paying other expenses associated with the work. Periodically, as designated in the contract, a reconciliation is performed, and the contractor is paid his fee or percentage as has been agreed.

In another method, the contractor prepares estimates of his outlay for the coming month and receives that amount of money in advance. Then, at month's end, the contractor prepares an accounting of his actual costs incurred. Any difference between the estimated expenses and actual expenses is adjusted with the issuance of the next monthly estimate.

Other contracts provide for constant-balance bank accounts, where checks are written by the contractor for project costs and reimbursing funds are provided by the owner. Again, the contractor is required to make periodic accountings to the owner of the cost of the work, either to receive direct payment from the owner or to obtain further advances of funds.

A periodic payment to the contractor under a cost-plus type of contract is not usually based on quantities of work performed, but rather on reimbursement of costs incurred by the contractor during the preceding pay period. Consequently, such pay requests consist primarily of the submittal of cost records by the contractor. Copies of invoices, payrolls, statements, and receipts are submitted in substantiation of the contractor's claims. In addition to cost records of payments made by the contractor to third parties, the periodic pay requests customarily include documentation for equipment expenses and a pro rata share of the negotiated fee. If the contractor is furnished funds in advance by the owner to pay for construction costs, the owner is customarily credited with all cash discounts.

Because of the sensitive nature of cost reimbursement, it is common practice to maintain a separate set of accounting records for each cost-plus project. When the size of the project is substantial enough to justify it, a field office is sometimes established where all matters pertaining to payroll, purchasing, disbursements, and record keeping for the project are performed. All project financial records are either routed through the owner's representative or are available for inspection at any time. This is often referred to as an open books policy and is a typical component of the matters that are agreed to in a cost-plus contract. This procedure does much to eliminate misunderstandings, and facilitates the final audit of all costs incurred during the project, which likewise is a typical component of cost-plus contracts. Cost-plus contracts with public agencies customarily impose additional special conditions on the contractor pertaining to form of payment, payment application, affidavits, and preservation of project records.

9.27 Final Payment

The procedural steps leading up to acceptance of the project and final payment by the owner vary somewhat with the nature of the work and the specific provisions of the contract. On building construction projects, the process typically commences when the contractor, nearing the point of substantial completion of the project, requests a preliminary inspection. The owner or its authorized representative, usually the architect-engineer, in company with the general contractor and key subcontractor personnel, inspect the work. A list of deficiencies to be completed or corrected is prepared by the architect-engineer. This listing is referred to as the punch list, and is defined as a listing of all errors or deficiencies requiring correction in the work that is in place, as well as a list of items of work remaining to be completed, before the project will be accepted by the owner from the contractor.

The contractor and subcontractors will then address themselves to completion of the required work, and to correction of deficiencies. When this has been done, the general contractor will request an additional inspection (usually the final inspection). If, in the judgment of the architect-engineer, the work is satisfactorily complete, he will issue a certificate of substantial completion.

The architect-engineer and owner also commonly require the contractor to provide a certificate of occupancy (CO) prior to their issuance of the certificate of substantial completion. The CO is a certification from city government that all of the building code and zoning ordinance requirements of the city have been fulfilled, and authorizing the owner to occupy the building.

Following the issuance of the certificate of substantial completion by the architect-engineer, the contractor will make an application for final payment. The contract documents typically require that the general contractor's request for final payment be accompanied by a number of different documents. For example, releases or waivers of lien executed by the general contractor, all subcontractors, and materials suppliers are common requirements on privately financed projects. An affidavit that the releases and waivers furnished include all parties who might be entitled to lien may also be required. Liens are defined and discussed in sections to follow in this chapter.

Other contracts call for an affidavit certifying that all payrolls, bills for materials, payments to subcontractors, and other indebtedness connected with the work have been paid or otherwise satisfied. Claims and disputes still unresolved at the time of final payment should be expressly identified in writing by the contractor as unsettled, and reserved in the final payment application and in the final lien waivers and releases.

Additionally, construction contracts typically require the contractor to provide the owner with as-built drawings, various forms of written warranties for equipment in the building, maintenance bonds, as well as owner's manuals, parts lists, and sometimes spare parts, and literature pertaining to the operation and maintenance of equipment and machinery in the building. Consent of surety to final payment is a common prerequisite. Sureties are defined and discussed in Chapter 7. The language of the general conditions of the contract for construction in Appendix D contains the contractual provisions concerning documentation required for final payment to the contractor.

When the work is determined by the architect-engineer to be complete and acceptable, and when all of the required documents and information have been submitted by the general contractor, the architect-engineer issues a certificate for final payment to the contractor. This payment will include the retainage that has been withheld by the owner throughout the project. The final payment and the issuance of the certificate of substantial completion mark the completion of the general contractor's contractual requirements, with the exception of warranty provisions, and are usually defined as marking the termination of the contract between the owner and the prime contractor.

On a project where a unit-price contract is in use, the closeout of the project likewise begins with inspection, punch list, corrections and completion of work per punch list listing, and final inspection. A reconciliation is made, of final total quantities of all work items on the bid form/contract form. The final contract amount is determined, and the contractor makes application for final payment. Releases of liens and as-built drawings are commonly required on these projects as well. Final payment, including all retainage withheld to date, is authorized by the architect-engineer, and final payment is made by the owner to the contractor. This usually marks the termination of the contract between the owner and the contractor, pending warranty requirements.

9.28 Payments to Subcontractors

When the owner makes payment to the general contractor during the course of a construction project, it is expected that the general contractor will then make prompt payment to his subcontractors. Subcontractors submit their payment requests or invoices for work performed during the past 30 days to the general contractor, in accord with a time schedule established by the general contractor, in advance of the date when the general contractor's payment request is to be submitted to the architect-engineer. The general contractor will carefully check each monthly pay request from each subcontractor to ensure accuracy, and to assure that it represents a fair measure of the work that has actually been performed by the subcontractor. The general contractor may require verification of portions of the subcontractor's payment request by counting, measurement, or calculation. The general contractor will then include the amounts of the subcontractor's request for payment in the appropriate line items within his application for payment to the architect-engineer and owner, and the general contractor will subsequently make payment to the subcontractors in accord with the subcontract agreements he has executed with the subcontractors.

Depending on his experience history with the subcontractor and his confidence in the subcontractor, as well as the management philosophy of the company, the general contractor may or may not elect to withhold retainage from the payments he makes to the subcontractors. This matter will be defined in the subcontract agreement with each subcontractor.

While the matter of payment to the subcontractors by the general contractor can be and frequently is a routine matter, sometimes there are problems associated with this matter. Sometimes general contractors are slow in paying subcontractors' payment requests. This can occur for a variety of reasons, but when it occurs it is always a source of great consternation to the subcontractors.

Subcontractors sometimes receive payment from a general contractor and then apply the funds to pay the bills for other projects on which they are working, or to finance other portions of their operation, leaving their suppliers on the first project unpaid. When the general contractor makes payment to a subcontractor, it is understandable that he wishes to have assurance that the subcontractor is meeting his financial obligations on that project. In this regard, the contractor should use certain precautions to protect itself from the hazard of a subcontractor's failure to pay his bills and meet his payrolls. Joint checks issued by owners and general contractors to pay subcontractors and their suppliers is a practice sometimes employed. Joint checks generally protect the owner and the general contractors from liens and payment bond claims.

When the prime contractor furnishes the owner with a payment bond, he has a liability to those unpaid parties within the coverage of the bond who comply with the notice provisions of that bond. Even though the contractor has paid a subcontractor in full, an unpaid creditor of that subcontractor can still file a claim on the payment bond. Contractors have been required to pay twice for the same item of work because of their payment bond liability. As a consequence of this possibility, general contractors frequently are obliged to take steps to obtain appropriate releases of lien, receipts, or affidavits of payment when payments are made to subcontractors. The general contractor can also indicate on the check the application of proceeds desired and include a letter of transmittal that specifically states the purpose for which the payment is being made. If a general contractor makes payment to a subcontractor's supplier by a check payable to both the supplier and subcontractor, specific instructions on how the payment should be credited by the payees should be provided. Another possibility for the general contractor in this regard is to require that subcontractors furnish payment bonds to the prime contractor.

Some states have construction trust-fund statutes that declare that the funds paid to a prime contractor by the owner are trust funds held by the contractor as trustee for the benefit of his subcontractors and material suppliers. Such statutes afford subcontractors an additional avenue of recovery from the general contractor. A few states now have statutes that provide for fines when contractors on public or private projects fail to pay their subcontractors on time. Additionally, some conditions of contract for projects, and many subcontract agreement forms, now provide the subcontractor the right to request directly from the architect-engineer or owner, information about percentages of completion or the payment amount to the prime contractor certified by the architect-engineer or owner for work performed by the subcontractor. In this way, the subcontractor will know the amount of money he should have been paid by the general contractor.

The American Subcontractors Association (ASA) is a national trade association with a membership consisting of subcontractors of all kinds. The ASA has authored standard subcontractor agreement forms that are more subcontractor-friendly than the subcontract agreements utilized by many general contractors. Additionally, the ASA has established a national reporting network to provide member subcontractors with information about the business practices of specific general contractors, including data concerning the matter of periodic and final payments.

As a matter of good management, and also as a matter of sound and beneficial business practice, general contractors who make it a priority in their business to assure prompt and proper payment to their subcontractors, can achieve significant business advantages. Such practices consistently attract the business of the best subcontractors, and also elicit the best prices from subcontractors. Especially in the construction world of today, particularly in building construction work, where most or in some cases all, of the work on a project is performed by subcontractors, this becomes a matter of significant importance to general contractors.

9.29 Direct Payment

There has been considerable effort over the span of a number of years by the ASA to change the method by which payments are made by general contractors to subcontractors. The ASA maintains that the traditional procedure of the owner paying the general contractor and the general contractor then paying his subcontractors exposes subcontractors to slow payment, cash flow problems, and an assortment of other problems. One method that has been suggested by the ASA to speed up and facilitate payments is to have a third party act as paymaster under the terms of a common agreement between the owner, lender, general contractor, and subcontractor. In this proposed method, owners would make periodic payments intended for the subcontractors into an escrow account from which subcontractors would be paid directly in amounts approved by the general contractor.

The concept of direct payment to subcontractors has been stoutly resisted by general contractors and their professional associations on the basis that it would be detrimental to the general contractor's overall control of the project. They maintain that the present system is not defective so long as the general contractor and the subcontractors conduct their affairs on a project in a responsible, prudent, and businesslike manner. The basic position of general contractors is that the advantages and benefits to the owner of the single-contract method of construction would be adversely affected by a direct payment system. The direct pay procedure has been used in this country on a very limited basis to date, on some public and private projects.

Additionally, there have been times when the owner and general contractor have agreed to have the owner make progress payments and/or final payment directly to the project subcontractors and material suppliers. In such a case, the owner deducts the amounts paid to these parties from the payments he makes to the general contractor. While there are various reasons for which such an unusual arrangement could be made, a commonplace basis is the owner's wish to assure that the subcontractors and suppliers are paid promptly and in full, for their contributions to the work on the project. This can protect the owner from claims and liens. There sometimes have also been situations where general contractor-subcontractor relationships have become strained, and direct payment by the owner to the subcontractor may improve subcontractor performance. Although a direct payment arrangement of this kind is not generally desirable, it can at times be employed in order to ameliorate risk of claims, liens, or subcontractor default.

9.30 Backcharges

Occasionally in the course of the performance of the work on a construction project, situations occur where the general contractor will incur or assume an expense that is chargeable to a subcontractor. For example, the general contractor may pay some of the subcontractor's bills, or may temporarily provide the subcontractor with labor, or equipment, or materials, or facilities for use in performing the subcontractor's work. Or the general contractor may perform cleanup or hauling services on behalf of the subcontractor or because of the subcontractor's failure to do so.

The usual way for the general contractor to recover these expenses is to subtract them from payments made by the general contractor to the subcontractor. Such a deduction is called a backcharge. Backcharges can be a source of disagreement and dispute, unless provisions in this regard have been written into the subcontract arrangements and timely notice as provided in the subcontract agreement has been given.

9.31 Payments to Material Suppliers

A contractor's payments to his vendors or material suppliers are made in accordance with the terms of the applicable purchase order or materials purchase contract. Whether payment is made by the contractor to the vendor upon purchase or the goods are purchased on account, the vendor expects timely payment in accord with the terms of the purchase order, without regard to whether the contractor has received payment from the owner. Most contractors have accounts with vendors whereby payment is due and payable in full 30 days after the invoice date, upon receipt of materials, at the end of the month in which delivery was made, or in accord with other stipulations that may be included in the purchase order. As noted in a previous section, such payment terms frequently include provisions for professional discounts, or quantity discounts, or cash discounts, in order to encourage early payment by the contractor. Payments to material dealers are made in full by the contractor, since retainage provisions do not apply to purchase order payments.

Almost all well-managed construction firms have company policies in place whose purpose is to provide for management verification and control with regard to materials purchases. To illustrate a typical procedure established by policy in many construction companies, a purchase order is required to be issued for all project materials purchases of any consequence. Such a purchase order not only assigns the materials purchase to a specific project and specifies the cost of the materials, but also serves as an internal control document for the contractor. As deliveries are made, the responsibility is assigned for inspection of the materials, verification of quantities, and for the performance of any quality control or tests as pertinent. After inspection and testing, a receiving report is sent to the disbursement section of the contractor's office listing the materials received, identifying the vendor, and describing any shortages, damage, or variations from specified quality. No payment is issued on the vendor's invoice until a receiving report has been received from the project or the contractor's warehouse, attesting to proper materials provided and proper delivery made, and the quantity and dollar amount on the invoice has been verified against the purchase order.

9.32 Cash Flow

Maintaining positive cash flow is a critically important matter for all contractors, general contractors and subcontractors alike. It is a fact that most construction contracting concerns that fail do so not because total liabilities exceed total assets, but rather because current liabilities exceed cash or quick revenue. When payroll for labor cannot be met, and/or when creditors' claims for payment cannot be fulfilled, contractors sometimes have no choice but to close the business.

Cash flow refers to a contractor's income and outgo of cash. The net cash flow is the difference between disbursements and income over a period of time. A positive cash flow indicates that cash income is exceeding disbursements, and a negative cash flow signifies just the opposite. Cash is the fuel that operates the construction business enterprise, and a contractor must maintain a cash balance sufficient to meet payrolls, pay for materials, make equipment payments, and meet emergencies, as well as to satisfy other financial obligations as they become due.

In itself, however, cash is not a productive asset; it must be invested in some way in order to make it productive. Therefore, good business management means having sufficient cash and liquid assets readily available to meet needs as they occur but keeping excess cash suitably invested. Likewise, if a contractor must borrow funds to use as operating capital, it wishes to recognize this need as early as possible and seeks to manage liquid assets in such a way as not to borrow any more than is necessary.

The management of cash flow and cash on hand are especially important for determining a company's working capital requirements. Likewise, knowing the present and future cash position of a construction firm is of great importance to its management. This matter will be discussed in the following section.

9.33 Cash Forecasts

Because of the critical importance of maintaining a positive cash flow and effectively managing cash in hand and other liquid assets, some contractors have a policy whereby their accounting and finance departments prepare periodic forecasts of cash needs. A cash forecast is defined as a schedule that summarizes the estimated cash receipts, estimated disbursements, and available cash balances for some defined period into the future.

The forecast begins at a point in time with a known beginning cash balance, and then produces estimates of cash income and disbursements, either on a weekly or monthly basis, thus yielding an estimated cash balance at the end of each period. These figures will indicate when the available cash balance will be below the minimum needs and when it will be above. This, in turn, provides advance warning that additional finds must be obtained by borrowing, or that excess funds will be available for investment or company growth. For the most part, only short-term future cash predictions are optimally useful for contractors because of the unpredictability of new contract acquisition, as well as the variability of other financial matters generally.

The preparation of a cash forecast begins with the collection of detailed information regarding expectation for future cash income and expenditures. For a construction contractor, this must usually first be done for each individual project, based upon its proposed progress schedule and schedule of values. The resulting cash flow figures (the net result of cumulative cash income and outgo on a time basis) are then combined with the company's general and administrative disbursements to develop a total cash flow forecast for the given planning period. The computational process is complicated somewhat by the fact that both project earnings and expenses occur on a discrete basis, and these are normally not on the same time frequency. To illustrate, project income is received in some regular and periodic way, typically in monthly payments that are keyed to the earned value (percentages complete) on activities in the schedule of values. Project expenses, however, are more variable in their timelines for payment. For example, payrolls are costs that are paid on a weekly basis, whereas disbursements to material suppliers and subcontractors are made on a monthly basis. Payment of taxes, insurance premiums, and certain equipment expenses are payable on timelines that are largely independent of the physical progress of the work.

When done properly, however, the preparation of a cash forecast is a valuable management tool, providing information that makes the expense and time of the effort well worthwhile. After the forecast estimates are made, they are periodically reviewed by management in order to assure their continued validity. When significant variations occur, new estimates are prepared and the forecast is revised.

9.34 The Mechanic's Lien

A mechanic's lien is a right created by law to secure payment for work performed and materials furnished in the improvement of real property, that is, land and improvements on land. This lien attaches to the deed or title of the land itself. The purpose of a lien statute is to permit a claim on the premises where the value or condition of real property has been increased or improved, and where suitable payment has not been received by the person providing the material or service. Maryland was the first state to adopt such a law in 1791, and since then every state has enacted some form of mechanic's lien law. While all of the various state statutes are similar in their basic intent, specific language and provisions of the statutes vary considerably from one state to another.

These statutes are referred to as mechanic's liens, based in the use of the term mechanic in days past, to describe a construction craft worker. These lien statutes are also sometimes referred to as mechanic's and materialmen's laws.

Lien laws are based on the theory of unjust enrichment and are designed to protect workers, material suppliers, and, under certain conditions, general contractors and subcontractors, who have furnished labor, expertise, or materials for the improvement of real property but have not been paid. Rights accruing to general contractors and subcontractors within the provisions of these statutes are generally the same, but there are differences in the details, such as requirements regarding notices required of the two parties. Legal counsel is recommended for the construction contractor, for understanding the specific elements of the lien laws in the state where the contractor is performing work, or planning to perform work in the future.

For a general contractor to file a lien, a usual requirement is that the owner has agreed to have the work done and to pay for it. In some states, a written contract must exist. In case of default by a private owner on a construction contract, the general contractor actually has two remedies available. He can file suit against the owner for breach of contract, or he can exercise his right of filing a lien. In some cases, the contractor can take both courses of action.

Architect-engineers are also provided protection by lien laws in some states. However, for a lien right to be available, work usually has to commence on the property. Design service, in and of itself, may not be sufficient basis for a lien filing, unless construction has actually proceeded. Because there is significant variation in the provisions of state laws, regarding the lien statutes and the rights they may provide designers, architect-engineers also must familiarize themselves with the specific provisions of the statute in the states where they are working or plan to be working.

Additionally, it should be realized that public property is not subject to a statutory lien. However, many states allow unpaid workers, subcontractors, and material dealers to establish lien claims against contract funds that are still held by a contracting public agency. This type of claim is referred to as a municipal mechanic's lien, and applies to contract funds, and not to the real property. Under such liens, when a payment claim is filed, disbursements to the prime contractor are stopped and the unpaid funds are preserved for payment to the claimant. The right to recover from a public owner is limited to contract funds that are still in control of the agency.

The lien statutes of certain states restrict the lien rights of unpaid parties where a private owner has required the general contractor to furnish a payment bond. In those states, upon receipt of the bond, the owner is exempted from liabilities for mechanic's liens filed by unpaid claimants other than the general contractor. The payment bond takes the place of the owner's real property as security for the lien. The bond exempts the owner's property from the possibility of lien foreclosure.

For any party who contracts directly with the owner to be able to file a lien, the statutes typically require that party to record a notarized claim for public record with a county authority within the prescribed time set forth in the statute. In most jurisdictions, this lien claim is considered sufficient if it names the owner, describes the project, contains appropriate allegations as to the work performed or materials furnished, and states the unpaid amount and from whom it is due. The time for filing differs from state to state. Many states require, in addition to the filing of a lien claim, that written notice also be given to the owner or its agent within a specified time. In some cases, notice to the owner must precede the filing of the claim. The advice of a local attorney is imperative when filing, or when considering the filing of, a claim of lien.

Laborers, subcontractors, or material dealers who contract with the general contractor rather than directly with the owner are also entitled to the protection of liens, but the statutory requirements for these parties are often different from those for the general contractor. Typically, they must not only file a notice of lien for the public record but also are usually required to give notice in writing to the owner or its agent. The time limit for such filing is prescribed by statute and is frequently different from that required of parties contracting directly with the owner. In addition, the statutory time for filing a claim may begin with the date when the last labor or materials were furnished, rather than at the time of project completion.

Once a lien claim is filed and no payment has been made, proceedings must be brought to enforce the lien, usually within 90 days after filing. The court procedure by which the claim is judicially determined is known as a foreclosure action; it varies from one state to another but is highly technical and requires the services of an attorney. If the evidence substantiates the claim under the mechanic's lien and the court finds that there is a sum of money due and owing, the court can order the property to be sold and the proceeds used to satisfy the indebtedness. The sale of the property is made at auction by the sheriff, and a certificate of sale is executed to the successful bidder. The holder of the lien is paid from the proceeds of the sale. Most lien statutes provide the original owner a prescribed period of time to redeem its property by payment of the judgment, interest, and costs, before foreclosure action is taken.

Although the logic and benefits of lien laws are easy to appreciate, because they vary greatly in their details from one state to another, it is important for contractors, subcontractors, materials suppliers, and construction craft workers to familiarize themselves with the provisions of the lien statute in the state in which they are performing work. Legal counsel is recommended, both for gaining understanding of the lien provisions of the state, and for filing a lien if this becomes necessary.

9.35 Release of Lien

Because liens place an encumbrance upon the owner's title to his property, or may force a foreclosure action, owners will understandably typically take a variety of different actions, seeking to ensure that no lien is filed in conjunction with the performance of a construction project on their property. Some owners require contractors to furnish payment bonds, so that if there is a claim regarding any debt incurred in conjunction with the improvement of the owner's property that remains unpaid, the bonding company can see to payment of the outstanding debt, thus precluding the possibility of a lien.

Owners also can, and frequently do, require the submittal of waivers of lien by contractors and subcontractors. The right to file a lien may be released or waived in a number of different ways, depending on the particular state statute. Construction contracts with private owners sometimes include a clause whereby the general contractor agrees not to file or place any liens against the owner's premises and waives its right in this regard. After the contract has been signed, this clause becomes binding on the contractor. The courts have long held that a contractor, by the terms of a contract, may release its right of lien. However, some states have enacted legislation that makes the waiver of a mechanic's lien void on the basis of being against public policy and hence unenforceable.

A broader form of release of lien that is sometimes used in construction contracts provides that no liens shall be filed by the general contractor or any subcontractor or material dealer. This provision can be made binding on the subcontractors and material dealers provided it is permitted by the state statute, and provided that certain actions are taken by the general contractor. For example, the contractor may be required to give timely notice of the waiver of lien before the purchase orders and subcontracts are signed, either by direct notification in writing to the subcontractors and material dealers, or by making the release agreement a matter of public record. Additionally, the subcontracts and purchase orders may have to include a clause that expressly provides for the release of lien by the subcontractors and material dealers. This is a consequence of the fact that lien statutes often provide that the right of lien may be waived only by an express agreement in writing specifically to that effect.

Rather than the contractor releasing its right of lien through the medium of a contract clause to that effect, the owner very often will require thecontractor to submit a signed waiver of lien form to the owner as a condition of his receiving final payment, or in some cases, each time the contractor requests a progress payment. Similar releases are often also required from the subcontractors and material vendors.

9.36 Assignment of Contracts

As a general principle of contract law, practically all rights arising out of contracts are assignable. A common contractual right is receiving payment in exchange for the performance of a stipulated contractual duty. Assignment means the transfer of such a right from the party to whom the right belongs by contract to a third party. For example, to provide security for a loan, or to pay off an impatient creditor, a contractor may assign funds due or to become due under a construction contract to a lending institution, or to the creditor.

After notice of the assignment has been given to the owner, the owner must then make payments to the assignee. Basically, the assignee acquires the same but no greater rights than its assignor had, and the owner is required only to make payments as required by contract. The owner cannot be placed in a worse position than it would have been if the assignment had not been made. For example, payment by the owner to the assignee can be excused by the contractor's failure to perform properly.

However, freedom of assignment can be, and often is, regulated by the terms of the contract itself. Construction contracts usually contain provisions that expressly forbid the owner or the general contractor from assigning the contract as a whole to third parties without the written consent of the other. The AIA General Conditions of the Contract for Construction, included in Appendix D, contains just such a provision.

Subcontract agreement forms used by general contractors typically include a restriction of assignment as well (see Appendices L and M, subcontract agreements). The general contractor is often requested by subcontractors to approve an assignment of moneys due or to become due to the subcontractor under a subcontract agreement. By assignment of such funds to a bank, for example, the subcontractor may be able to obtain a loan from the bank to provide capital to finance its operations. Upon receipt of notice of such an assignment, the general contractor generally has the duty to pay the assigned, whether or not the general contractor has accepted the assignment. It is important to note that the failure of the general contractor to honor a subcontractor's assignment of funds has resulted in liability of the general contractor to the assignee. This follows from the Uniform Commercial Code, which provides that if an assignment is made as security for a loan, consent of the other party is not required, despite any contract clause to the contrary.

9.37 Marketing

For many construction contractors, one of the most neglected aspects of good management of the construction contracting enterprise is the development of a vigorous and comprehensive company marketing plan. Marketing efforts can serve the contractor well when there is a need to acquire additional work, or when management has expressed a desire to expand the firm's operations geographically, or to include new work types, or to perform larger projects. In an era where owners and architect-engineers are increasingly employing project delivery methods other than lump-sum competitive bid for their projects, it is becoming ever more important for contractors to reach out and inform potential customers with regard to their capabilities, and their qualifications, and their proven track record of performance.

In its most basic form, marketing involves identifying a target audience that needs or might potentially need construction services, and then developing a strategy and the necessary materials and media for reaching and influencing this target group. This can be done by means of the contractor analyzing his own operations, and by identifying market needs and trends, and by determining what types of work the company can perform most effectively and most profitably, based on its strengths and capabilities. From this analysis, the company's target markets can be identified, remembering that the construction customer is very sensitive to price, time, and quality of product.

The company then communicates its capabilities to its potential clients as a means of attracting additional contracts. A formal marketing program is an investment by the contractor that is aimed at achieving long-term success, and it strives to establish a positive image of the firm's capabilities in the minds of those in a position to influence the procurement of construction services. For many firms, the existence of an effective marketing plan has meant the difference between success and failure for the firm.

When the management of a construction company makes a decision to undertake an active marketing program, a detailed plan of action should be developed by management in order to define what is to be done, how it is to be done, and who is to do it. Initially, an analysis is typically made of company strengths and weaknesses, along with a determination regarding what markets should be pursued, accompanied by a finding made as to how the firm is perceived by outsiders. The marketing plan should define company goals and objectives, should instill a sense of trust in the company, and should broadcast the message that the company is interested in pursuing certain types of business. The message should underscore the point throughout, that the contractor is the most qualified firm available, and can do top quality work at competitive prices, along with meeting all of the project objectives of a potential owner and designer. It is also noted that consulting firms are available to assist the contractor with any aspect of developing a marketing strategy, or forming a marketing plan, and for assisting with the particulars of the marketing effort itself, including the development of suitable marketing materials.

Many companies have found that two of the best sources of new business can be repeat business from previous customers, and referrals from previous customers. If the contractor serves owners well and provides excellent service in everything the contractor does, and if he unfailingly accomplishes all of the owner's project objectives, those owners will continue to bring their return business, and importantly, will also recommend the contractor to others.

It is certainly an established fact that the users of construction services rank trust as one of the most important criteria when selecting a construction contractor. When previous owners again utilize the services of a contracting firm because of the trust developed on a previous project, or when previous owners convey their trust in a contractor to their circle of business associates and acquaintances, then the construction firm has acquired an extremely powerful asset.

The marketing plan and marketing initiatives of a construction firm might include all or some of the marketing components listed below.

9.38 Employee Motivation

An important aspect of the operation of a successful and cost effective construction contracting firm is the motivation of company employees. The ability of a contractor to motivate its workforce, craft workers and management workers alike, and to maintain the workers' motivation on a continuing basis, largely determines its success in constructing projects on time and within budget. Studies have repeatedly shown that motivated workers are more productive, and work more safely, than those who are not motivated. Unfortunately, motivation is a somewhat nebulous concept, and it is often difficult to understand just what stirs an individual to put forth his best effort. Nevertheless, there are some guides in this regard that can be very effective.

Fundamental to motivation is giving the worker the sense that the company is a good place to work and instilling the belief that the worker is part of a team effort, the company effort. This can be done by involving the employees in two-way communication with their managers and supervisors. The employee will have a greater interest in contributing to company success, the more he knows about the company, and how it functions, and the role that he plays in the overall picture of the operation of the company.

An effort by management in getting to know the workers and maintaining open lines of communication with them prevents feelings of isolation and detachment on the part of the workers. Soliciting their ideas and suggestions, and taking action on them when the ideas are good ones, can create feelings of belonging, let the workers know that their thoughts and opinions matter, and generate interest on their part in contributing toward achieving a common goal.

There needs to be an established procedure for workers to voice their grievances, as well as a mechanism to cultivate the feeling that management genuinely wishes to ensure that the workers are treated fairly. Maintaining open lines of communication between supervisors and workers, and preserving an established communication system can be very effective in improving worker attitudes and morale.

The opportunity for growth and advancement within a company, as provided for by company personnel policies and by formal training programs at all levels, can be a powerful stimulant. Facilitating workers' participation in training and continuing education programs can pay huge benefits, some of which are direct, and many of which are indirect.

A variety of incentives can be used to foster team spirit, and to reward employees for creative thinking and for work well done. Profit sharing, bonuses, and public recognition can be effective motivators. Company newsletters and individual awards can be used to recognize outstanding performance. Money is important, but it is not by any means the only motivator to productive performance. A company's ability to communicate with its workers, to understand their viewpoints and their problems, and to work as a team toward a common goal can be one of the firm's greatest assets.

9.39 Substance Abuse Programs

Construction companies should address themselves to developing and maintaining company policies and procedures relating to substance abuse. Alcohol and drug abuse have grown to epidemic proportions, a national problem that is shared by the construction industry. Substance abuse poses a definite and severe threat to the safety, productivity, and image of construction. It presents the contractor with major problems in the form of decreased productivity, absenteeism, job accidents, damage and destruction of property, increased insurance claims, lower quality of workmanship, employee turnover, increased cost of insurance, low employee morale, low motivation of employees, and reduced efficiency of company operations. To combat this threat, contractors must establish company substance abuse programs.

The basis for the company position in all of its aspects with regard to substance abuse must be a written company policy which is definitive and clearly written, and which is communicated to all employees. The policy should include clear and concise guidelines for supervisory personnel. The contractor should obtain assistance and input from legal counsel, and substance abuse experts, as well as human relations experts when formulating the company policy.

Most companies conduct a preliminary employee orientation program where the language and workings of the company's substance abuse program is discussed, along with the reasons for the company's position. Those who are conducting these orientations should provide copies of the company policies for the new employees to keep. Employees are usually required to sign consent forms indicating that they are aware of and intend to comply with the company substance abuse policy, as a condition of their initial employment as well as their continued employment with the company.

The everyday functioning of the company procedure may involve aspects such as undercover investigations on job sites, urine screening tests for prospective and present employees, supervisor training, searches, counseling programs, and internal employee assistance programs geared to rehabilitation. A common company policy requirement is that any employee suffering an injury on the worksite must immediately be given a urine test. Employees are informed and reminded that failure of any employee to conform to the company policies regarding substance abuse can result in termination.

The preparation and implementation of such a company policy is a difficult task and, as previously noted above, requires competent legal advice, as well as input from substance abuse experts and human relations experts. Contractor trade organizations can also provide valuable assistance in this regard. There are now reasonably safe legal guidelines that allow a contractor to establish substance abuse control programs based on legitimate business interests.

With regard to union contractors establishing programs that include drug or alcohol testing for current employees and for job applicants, the National Labor Relations Board has ruled that this is a mandatory subject of collective bargaining and is not a unilateral management prerogative. The contractor must notify the union of its intent to initiate such testing, and upon request, to bargain to an agreement or good faith impasse before implementing such a program for union employees.

Private owners have added considerable impetus to the establishment and use of substance control efforts by contractors. It is now a common contractual requirement set forth by the owner that the contractor must demonstrate to the owner that a program for controlling drug and alcohol abuse has been established and is in effect on the projects which the contractor constructs. Some private owners require that all contractor employees be tested for drugs before they are allowed to enter the construction job site. The prime contractor conveys this requirement to all of the subcontractors on the project by including a similar provision in all of the subcontract agreements. Construction labor unions have also adopted substance abuse programs and also provide drug and counseling services to their members.

9.40 Job Site Crime

Job site theft and vandalism have been and continue to be a major source of financial loss to construction contractors across the country. Job site crime can take many forms, ranging from malicious damage done by trespassers, to the theft of tools and materials by employees or others on the job site, to the theft of heavy equipment by organized criminals. In addition, losses from job site theft and vandalism can cost the contractor many times more than the value of what is actually stolen or vandalized. This is true because when theft or damage occurs at a job site, the work is disrupted, being slowed or brought to a halt when the necessary tool or material is not available when it is needed. Additionally, as has been pointed out previously, such disruptions in the flow and progress of the work also become employee motivation and morale issues. Such delays are very expensive in terms of their dollar effect, and also can cause serious delays in the construction time schedule. In addition company insurance rates are often increased.

While there are no foolproof procedures that can be followed, there certainly are some effective steps that a contractor can take to combat this problem. Certainly, crime prevention must become a part of company policy and a component of how the contractor conducts his business.

In order to minimize losses from jobsite crime, company management must establish a crime prevention program, and must commit itself to administering, and adhering to, and enforcing the program. The details of such a company policy and program will obviously vary with the wishes of company management, the type of equipment owned by the company, the type of work normally performed, and the general location of company projects. It has been demonstrated repeatedly that the cost, effort, and time devoted to designing and implementing such a crime prevention program can be recovered many times over by reducing the direct and indirect costs caused by theft and vandalism. Company employees should be given to understand that such a program is for the purpose of reduction of company losses and is essential for the protection of the best interests of the company and its employees.

9.41 Employee Training Programs

Many construction contractors today have realized the benefits of providing opportunities for training and professional development for their employees. Such training is invaluable for both the craft workers and also for the management workers in the company. These companies have come to realize that the expense and time associated with development and presentation of such programs, and facilitating employees' participation in programs of this kind, is clearly beneficial, as demonstrated by the increased skill, efficiency, and productive capacity, as well as the motivation and morale of the construction team.

Open shop contractors, who do not have construction unions and the union apprenticeship and training programs as a ready source of skilled craftsmen, often find that they must train their own craft workers. Additionally, all contractors are concerned with the need to train their supervisory and middle management personnel with regard to enhancing their professional development, as well as providing them the tools and skills with which to perform their job responsibilities in a more capable and productive fashion.

Today, there is a wide variety of programs available for instructing construction craftsmen who do not have access to formal apprenticeship programs like those which the unions have developed. Some contractor and subcontractor professional associations are conducting programs of this kind at the national, state, and local level. Additionally, there are special programs available at both the federal and local levels, which are designed specifically to provide training to minorities, women, and unemployed workers. In addition, many vocational and technical schools today are providing construction craft training.

Privately supported and conducted trade skills development programs are largely concentrated in the open shop sector of the construction industry. In addition, some contractors conduct their own in-house training programs. Many local chapters of contractor and subcontractor professional associations sponsor and conduct programs to instruct craft workers. These efforts include all types of training in programs of varying style and scope. Many involve specialized instruction to create craftsmen highly skilled in a particular class of work. Classroom instruction, on-the-job training, and home study are all used in varying degree by different training programs.

Many of the programs of this kind train workers to be craft worker helpers. These programs usually consist of providing training in on-the-job procedures that prepare workers to fill jobs in support of skilled craftsmen, and thereby provide them the opportunity to learn the skills of the craft, with the potential to advance into the role of a skilled craft worker or journeyman.

Some programs offer both task-specific and cross-craft instruction. These training plans stress the efficiency of competency-based, task-oriented, on-the-job training, and craft worker mobility for workers who can then advance to more highly skilled jobs.

Certainly, training for supervisory and middle management personnel is no less important than providing training for the trade skills. Contractor and subcontractor professional associations, and an assortment of other professional groups, and a variety of consulting firms, as well as continuing education programs conducted by colleges and universities, are sources of customized training and education programs for current and aspiring management workers in construction companies. Such training programs typically may take the form of providing books and manuals, as well as audio tapes, videotapes, and CDs; providing resource materials; conducting or participating in teleconferences and webinars; and providing for the conduct of in-person presentations and programs of instruction of all kinds. Additionally, a number of contractors have developed their own in-house programs for providing training for their supervisory and management employees.

9.42 Summary and Conclusions

From accounting, documentation, and record-keeping functions, through managing accounts receivable and accounts payable, to understanding and managing the transformation of contract amounts into revenue for the business, and understanding the consequences that can follow when creditors do not receive payments for monies owed to them as the result of their furnishing materials or labor on a project, to marketing and motivation—numerous and varied are the business functions the construction contractor must understand and effectively manage if the business enterprise is to be successful. As many would-be contractors have discovered, successful construction contracting entails far more than having the technical knowledge and skills necessary for the building of a construction project. In the highly complex and highly competitive world of construction contracting, business and management knowledge and acumen are vital ingredients for the operation, and for the continuance, and the success of a construction contracting enterprise.

Chapter 9 Review Questions

1. Define schedule of values. Include discussion of who prepares it, and what its significance is for a construction project.
2. What are the key provisions of mechanic's liens?
3. Name and discuss five key components of an effective marketing program for a contractor.
4. Name and define the two most basic financial documents for assessing the financial strength of a contractor.
5. Define the key elements of difference between cash accounting and accrual accounting. State which accounting method is preferred by most construction contractors, and discuss two reasons why this is the case.
6. Name and define three different methods of depreciation. Discuss the common use and application of each.
7. Name and define three financial ratios which are very widely used to assess the financial position of a construction business.
8. Explain why a contractor might elect to utilize straight-line depreciation for internal purposes and accelerated depreciation methods for external reporting.
9. Describe the payment request processes for lump sum, and unit price, and cost-plus projects, and how they are alike and how they are different.
10. Define cash flow, and describe its significance for a construction contracting firm.
11. Define releases of lien, and discuss when they are executed and their significance.
12. Discuss why training programs for craft workers and for management workers are important to the success of a construction firm.