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FMI Quarterly/June 2012/June 1, 2012

Twelve Essential Roles for CFOs in 2012

Twelve Essential Roles for CFOs in 2012The CFO is often the last line of defense in avoiding crippling errors and omissions and is the driving force for positive changes to enhance productivity.

The economy is driving all contractors toward highly sophisticated financial management to survive the slowdown and succeed in the construction industry. The competitiveness in the industry is forcing decisions that border on financial insanity. Does your organization excel at financial management? Is your CFO providing economic guidance for your organization? What are crucial roles for CFOs in the construction industry?

Now more than ever, CFOs possess extensive financial skills and capabilities beneficial to the construction industry. Effectively implementing the right roles, combined with exceptional performance, helps contractors create a competitive advantage. CFOs are smart, hard-working and dedicated managers who have many attributes that may be leveraged through training and development. These leaders and managers set standards, provide credibility to outside parties, and interface with owners and managers with respect to the operational aspects of the business. The key roles a CFO can play increase asset values and mitigate liabilities, adding significant value to any contractor (See Exhibit 1). How can your firm capitalize on your CFO? This article presents 12 essential roles and best practices to leverage your CFO’s value in your organization.

Twelve Essential Roles for CFOs in 2012 - 2

BUSINESS PLANNER AND STRATEGIST

Financial road maps and economic modeling include setting priorities to provide guidance to operational execution. The CFO must be forward-thinking, particularly regarding cash flow management. Without effective cash flow management, the contracting firm will not survive. The CFO must master the incremental economics of the business. In a cost-based pricing industry, the CFO holds the key to success or failure since the margin for error is only plus or minus 2% on average in construction. Pricing models and participating in the selection of customers, services and delivery methods represent key strategy choices for contractors. Selection of the wrong project or customer results in the “bad jobs” all contractors experience, costing horrendous losses for this industry. Your CFO is the gatekeeper to prevent bad jobs from happening in your firm.

Input from the conservative voice and risk manager in the financial area adds greater depth to the decision-making that all successful contractors value and utilize. Because there are so many unknowns in project execution and numerous variables in delivery of construction projects, combined with the thin margin of profit, the selection of owners and the “right jobs” are imperative for success. The market bias toward selection of the low bidder and the significant number of competitors willing to compete on price significantly increase the risk. As a steward of the financial model, your CFO has to know when to draw the line and maintain margins of safety for profitability preservation. The margin of safety and the accurate timely financial control from the accounting processes provided during the life of a contract are assets to any project team. Your CFO is the vital agent responsible for development of financial modeling and for subsequent monitoring and control of the project execution processes.

SCOREKEEPER

The CFO has ultimate responsibility for timely, accurate financial reporting for both internal and external users, and the best CFOs master this responsibility. The construction industry has specific reporting methodologies and practices, which are unlike most other industries. Construction contracts serve as profit centers where revenues are recognizable on estimates of contract profitability. In most cases, profitability from these estimates flows through the income statement each month. Construction accounting (percentage of completion on uncompleted projects) matches the economics of the earnings with the costs associated with those earnings on a monthly basis and changes in job profitability affect the income statement on a monthly basis. Earnings and costs are distorted when scope of work changes occur and change orders are not approved. Costs continue for the differences in scope of work without associated contract earnings.

While the accounting for construction contractors makes sense under the circumstances of long-term contracts, it creates a challenging environment for the CFO and others involved in the accounting process, including construction project managers. Estimates that are constantly changing drive the information used to produce financial statements. These changing conditions mandate that the construction CFO be an astute evaluator of data. Project cost estimates are prepared prior to beginning a contract and fluctuate from that point through completion of all of the contract work as scopes change, as anticipated production rises or falls, and as contemplated prices from suppliers and subcontractors rise or fall. The construction contract scope of work is subject to change due to changing owner requirements, changed working conditions and unanticipated events during the build-out. Optimistically, the large majority of scope changes will result in positive changes to the contract amount. Other changes have a less beneficial effect. The CFO’s responsibility is to analyze the estimates and other assumptions from project teams being used to predict the outcomes of projects and to separate logic from pure speculation.

Reporting results for the month, quarter or year gives the CFO significant opportunities for analysis. Comparing the numbers in hand to the prior corresponding time periods and to expectations, such as budgets and projections, with variances identified, allows for the CFO’s analysis and discussion of operations, financial position and likely cash flows. This analysis is generally a written explanation of unusual items in the income statement and balance sheet that provides insight to what is occurring and affecting the financial statements. The CFO is the financial expert and is the person most qualified to provide and interpret the key impacts on the financial statements.

ACCOUNTING TECHNICIAN

The CFO must be an expert in applying generally accepted accounting principles (GAAP) that pertain to the construction industry. Financial statements are valuable only if accurately presented. Additionally, one of the most important uses of financial data is benchmarking — providing useful comparisons against the industry. Furnishing accurate financial statements that are reliable to bankers, sureties and internal users is paramount. GAAP is an evolving proposition and has had an accelerating rate of change in the last several years. Accounting standard setters are in the process of GAAP for the United States to be consistent with accounting practices used internationally. Three key changes are currently being considered that will significantly affect the construction industry. They are the methodology for recognizing revenues, accounting for leases and accounting for liabilities in multi-employer plans. The CFO must not only be aware of current requirements, but also anticipate changes likely to come. The effects of those standards on the company’s reporting will be substantial, and the impact on banking and bonding relationships will hinge on successful foresight.

Several provisions in the Internal Revenue Code are sections (laws) applying specifically to contractors. While extremely complicated, there are a variety of potential benefits and pitfalls in applying income tax law. Some of the laws apply at the company level, such as choosing the most advantageous accounting or revenue recognition method, and some apply at the contract level, such as determining that a particular contract is a home construction contract. Understanding the impacts of the tax-accounting treatments available for equipment purchases can greatly influence the cash-flow analysis of investment decisions. Although outside advisors are available in the form of your outside accounting firm or other consultants, success in identifying issues and making the correct ultimate decisions depends upon a diligent and proactive CFO.

SYSTEMS ADMINISTRATOR

Growth can strain systems, procedures and staffing capabilities. The accounting and administration for construction contracts is an onerous task with enormous amounts of detail and complexity. Change orders, for example, are constantly taxing organizations for pricing, approval and payment. Some contracts may have hundreds of change orders. A compounded annual growth rate (CAGR) of 10% doubles the size of a contracting business in 7.2 years. A fully functioning system that works effectively at $100 million may be inefficient and ineffective at $200 million. People who were competent at lower volume levels may exceed their competencies at the higher volume levels. In the construction industry, this pace of growth is not unusual. The exception is the current recessionary period, but the question becomes more relevant as the industry begins to recover. Planning and developing the software, hardware, document flow and support staffing in an organization requires constant diligence. Technology developments only compound these challenges.

CFOs are at the center of all these practices. The CFO ensures that practices remain efficient and effective in light of current activity levels. The choices of software and hardware packages support capturing transactions and operational practices. Compliance with procedures is also important. The very essence of higher productivity is consistency of procedural execution. Variability is the enemy of productivity. CFOs not only select and implement systems, but also ensure that people in the organization comply with best practices put in place.

The administrative support staffing must also be adequate and competent to maintain organizational administration. The best CFOs recognize that they do not have to master all of the disciplines to achieve effectiveness, but they have to identify and select the right talent. They constantly evaluate staffing and make the necessary additions and changes. The CFO should never let the administration fall behind the operational needs of the organization.

RISK MANAGER

CFOs are proactive risk managers, constantly vigilant to avoid unnecessary liabilities. Financial management is managing risk. Risk is a cost driver and comes from several sources, such as safety, contract provisions, relationships with employees, customers (owners or general contractors), subcontractors, vendors, bankers and sureties. The first steps in risk management are identifying and analyzing sources of risk so that they are manageable. Insurance is a tool in the risk management arsenal, but the transfer of risk by insurance coverage is generally the most costly alternative. Other risk management techniques include risk avoidance and loss control. The primary defense against the consequences of risk is avoidance through advanced planning, coupled with procedural compliance.

Proactive safety management programs can generate significant cost savings through reductions in insurance premiums, diminished lost time from accidents and injuries, and avoidance of legal costs and disruptions caused by claims. Most insurers serving the construction industry offer ongoing safety training as a supplement to training from other sources.

Contract analysis identifies the most significant risks in any given contract. Pricing contract risks fairly into the cost of the work is one method to manage risk. Understanding contract terms and conditions and having open and consistent communications of those items among project personnel, are imperative to effective risk reduction.

Effective communication is the underpinning of relationship management. Recognizing issues and open, honest and prompt communication to all parties involved help to avoid escalation of resultant negative consequences. The CFO is often the company’s voice and, with the project team, is a key to successful project completion that meets targeted profit objectives.

LEADER AND MANAGER

CFOs are effective leaders and managers. Leadership and management are two different skills. Leaders set direction and align and motivate people while managers plan, organize and control the environment. Most of the CFOs in the construction industry tend to have stronger skill sets in the managerial area. Their background and training build depth in the managerial practice disciplines of planning, organizing and controlling. Those skills are a significant asset and resource to an organization because all organizations require planning, organizing and financial control. CFOs tend to have less operational experience, and their focus is narrow in scope, more managerial in nature. The operational focus of the CFO role can limit leadership skill development.

Where a CFO has evolved as the leader and CEO, he or she tends to excel because of the balance of risk and reward that CFO brings to the organization. The type of leader who balances risk and reward is more likely to build a successful contracting business. The industry itself is mature and loaded with competition. Some competitors in the industry exist without a business purpose. Return on investment, stock appreciation and other monetary incentives are foreign concepts to these firms. The more progressive firms today are investing in training to build both skill sets of managers and leaders. Coaching and development programs are focusing on growing the next generation of these managers and leaders, including those who aspire to become CFO.

COMMUNICATOR

CFOs who excel are great communicators. Communication skills contribute to the success of any leader or manager. Many construction industry executives have little, if any, formal training in communications. What to communicate, how to communicate, methods of communication, confrontational skills, negotiating skills, salesmanship, mediation skills and other important communication abilities are, for the most part, skills learned through on-the-job training by managers and leaders. CFOs must deal with the economic reality of the organization. The CFO needs to be able to confront difficult situations and follow through to gain understanding of the economic reality. This determination of reality sometimes is unpopular and can cause significant internal friction. “Kill the messenger” reaction has caused the demise of more than one CFO. There is a delicate balance between being approachable and being susceptible to manipulation. Being approachable is both acceptable and highly desirable in resolving complex transactions that arise during the construction process. Allowing oneself to be manipulated by operational managers is never acceptable. Stakeholders rely on the accuracy of the financial reporting process.

The CFO requires a high emotional quotient (EQ) for effectiveness. People skills are some of the best and most value-adding abilities managers and leaders have in their arsenal. Building work groups that deal with and manage the voluminous level of detail in the accounting process is vital for CFOs. High turnover causes excessive cost and disruption to the accounting process. Staffing is constantly increasing for growing construction organizations. Methods and systems for all types of communication require constant attention to enhance sharing of information. Little, if any, time and fewer resources are devoted to this important aspect of operations. The challenge becomes just keeping up with one’s day job, let alone any time for leadership messages and sharing of direction so important in organizational growth and development.

CUSTOMER SERVICE MANAGER

Customer service for CFOs is easier than it appears. The right questions are “Who are my customers?” and “What are their needs?” CFOs who are effective have answers to both questions and are responsive to internal and external users of financial information. Constantly seeking input from the users allows the CFO to adjust reporting practices, systems and procedures to accommodate the users. CFOs who monitor and measure their success on delivery and customer satisfaction find increased satisfaction in the roles they play in organizational success.

As with any service, technology changes, rule and regulation changes, growth and a number of other external factors can alter the customer service component of the business to its end users. CFOs who keep flexible and stay on top of market developments always have an easier time adjusting to changing market conditions. The inflexible manager who has done things the same way for the past 30 years will find his or her service and relevance in the modern contracting firm of little value.

The CFO who views the CEO as his only customer worth servicing is providing both a disservice to that CEO and a liability to the organization at large. Such a view generally comes coupled with a corollary of “Catch ’em doing bad,” when it comes to the operational managers of the company. That CFO is emphasizing ambush rather than arming the company’s managers to work more effectively. Such a CFO would do well to take an extended course in the “Leader as Servant” philosophy … or find other work.

EDUCATOR AND TRAINER

CFOs who can paint clear pictures of the financial picture and communicate financial performance to nonfinancial managers are valuable assets. Accountants have their own unique language that all accounting types understand. The issue is that the accountant’s language is not user friendly to the nonfinancial manager. Course after course has been presented on financial management for the nonfinancial manager with limited success. What is needed is the customer-service approach mentioned earlier to present financial information in ways those nonfinancial managers understand. The financial people in the organization should take responsibility for educating the operations personnel on financial reporting for contracts as it relates to their role in project management.

Over time, the balance of training and educating users creates a consistent understanding of financial practices in the contracting organization. As important as the concept is, few, if any, project personnel receive sufficient training from colleges and universities on financial reporting practices for contractors. With technology, graphics allow financial departments the ability to “paint the picture” for the operations personnel. The better the understanding, the more effective the systems and decisions that support excellent financial management practices will be in the end.

TECHNOLOGY INNOVATOR

Technology comes at a high cost, but not having the proper technology and supporting structure drives up the cost of doing business substantially more. Because of the dollars involved, the CFO typically has substantial input, if not final authorization authority, over the selection of an IT system or determination if an IT system needs replacement. As with most aspects of the construction industry, IT decisions are important elements of sound risk management. CFOs must understand the risks, whether they result from within the company or from outside sources. Internal risks consist of company culture, technological sophistication of personnel, system selection, implementation, training and support as well as the suitability of hardware infrastructure expected to accomplish tasks. External risks consist of natural disasters, external service providers, malicious attacks and other threats beyond the company’s control.

Common risk management and mitigation approaches, such as risk-cascade modeling, heat mapping and scenario planning, among others, can be used to identify risks, evaluate the likelihood of occurrence and consider the significance of the consequences. These techniques place the focus of efforts on the highest value targets. Decisions such as the level of internal administration versus outsourcing; cloud computing versus internal data management; document management solution alternatives; and tasks, such as developing a disaster recovery plan, are all products of appropriate analysis.

LEGAL COMPLIANCE OFFICER

CFOs are part-time lawyers. Laws of some jurisdictions, if not multiple jurisdictions affect almost any action taken by a contractor. Contractors deal with income taxes, sales taxes, contract provisions, employment law, Davis-Bacon and other government contract requirements, among other laws and regulations on a daily basis. While the wise contractor consults with legal professionals, as needed, much of the day-to-day common sense applications of legal requirements are left to the CFO.

While income tax law is primarily determined by larger decisions, such as choice of entity, domiciles and other far-reaching determinations, actions taken on the contract level can have significant consequences. These include decisions to work in other states, performing work on contracts that have special income tax treatment and contracting with governmental agencies. Sales tax laws are determined at not only the state level, but also the municipality and other local or district levels. To understand cash flow from a contract, the CFO has to understand the tax effects of contracts along with impacts of other decisions.

Contract terms generally include requirements and timing for payments, change orders and submission of claims. Government contracts have even greater compliance requirements. All of these items have the ability to affect the cash flow, and possibly profitability, on a contract when provisions are disregarded. Often, project personnel are focused on building the job, rather than administrative requirements of the contract. The CFO has primary responsibility for some aspects of the contract, such as Davis-Bacon compliance, and has compliance oversight responsibilities for other contract requirements.

MORAL COMPASS KEEPER

The cultural foundation for organizational ethics and internal controls is often called “tone at the top”. As a company leader, the CFO is looked upon to guide the organization with suitable values and ethics. In this position, value comes primarily from two sources, your knowledge and skills, and your integrity. As a successful CFO, the old adage “figures lie and liars figure” can never be associated with you. As important as it is to be honest with everyone, it is most important to be honest with yourself. Next, it is vital that you are honest with those who are relying upon you to provide valid information that will inform their decisions.

Financial reporting for contractors involves significant estimates, more so than most industries. Manipulating numbers and estimates is easy for a short time. Many financial statement manipulations are well intentioned and rationalized with logic such as “We will make up the cost overruns with future cost savings.” Although entered into with good intentions (smooth earnings so as not to upset the bonding company or banker, etc.), the foundation for the manipulation is inherently dishonest. Dishonesty at the top has a trickle-down effect to subordinates. The company culture becomes one of manipulation and “tell them what they want to hear”, which has never been the road map to success. The CFO is willing to face the consequences and rewards for the economic reality of the firm and does his or her best to present the financial picture accurately.

CONCLUSION

The CFO’s responsibilities cross virtually every aspect of a construction organization. The CFO is often the last line of defense in avoiding crippling errors and omissions, and is the driving force for positive changes to enhance productivity. The position requires breadth and depth of skills as well as management and leadership abilities, and is extremely challenging in all economic environments. As most CFOs rise through the accounting function, training and development are integral to successfully fulfilling the variety of requirements of the position. Successful CFOs have the intelligence, drive and dedication to discharge their responsibilities.

Leadership is challenged to provide an environment that values the roles CFOs play. Opportunity for advancement is necessary for talented CFOs, and this includes exposing CFOs to operational responsibilities, management succession and work acquisition aspects of the business. Greater opportunities allow intellectual advancement and increasing contributions to organizational success.

How does your CFO perform in these 12 crucial roles? Are there indications of personal growth? Is he or she appropriately rewarded?

If you are the CFO, what goals and action plans should you set for personal growth? ■

Lee Ackerman, CPA, is director of Audit and Accounting with Brock and Company. He may be reached via email at lackerman@brockcpas.com. Ken Roper is a principal with FMI Corporation. He may be reached at 303.398.7218 or via email at kroper@fminet.com.

 

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