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The home building industry came into 2020 with promising backlogs. These were driven by better than expected 4th quarter sales fueled by a strong economy and low interest rates.
Just as the spring selling season was about to start, COVID-19 hit the country. In fact, a few states were forced to close down for periods at a time as the industry was not deemed essential in some places.
Despite the uncertainty with the economy, the home building market has surged back. Record low interest rates and demand from both baby boomers and millennials has driven the industry to unexpected highs.
According to information compiled by Builder Partnerships, home building experienced increases in sales of 19.4% in May and 13.8% in June. May permits increased 12% from April and another 11.8% in June. July is expected to be equally strong. Gross margins have also remained good through this time period.
For existing homes, pending sales in May increased at a record setting pace of 44.3%, and June sales registered a 20.7% increase from May sales.
Home builders have done a particularly good job of using technology to work remotely. Despite various labor shortages, builders have been able to work efficiently dealing with various COVID-19 restrictions. There is no reason to believe the remainder of 2020 sales will not remain as strong. The main challenge will be getting the houses built. Many builders are now selling non-inventory that will close in 2021.
Strong over/underbilling management is crucial for cash flow. Improper cash flow management can lead to sour subcontractor/vendor relationships, talent retention issues, and can even lead to missed growth opportunities.
In the current environment, this concept is even more important.
While there are many ways that a contractor can manage cash flow, one way is to avoid underbillings at all costs! Sounds simple, right? Because underbillings represent earned revenue, (which has not been billed) it represents revenue to the contractor without the benefit of the cash. This is bad for cash flow and likely generates a bad tax answer, as well. As such, it is vital to ensure that this balance remains as low as possible. Here are a few tips:
- Discuss a payment schedule at the inception of the contract. Make sure this schedule tracks with the amount of cost that will be incurred over time.
- Ensure your billing team, accounting team and project team are meeting frequently (at least monthly) to discuss billings. This will help with timely and appropriate billing.
- Be INTENTIONAL about the billing process. Do not let billing become the accounting team’s process. The billing process should be owned by your executive team and include operations (project managers) and your accounting department.
- Prior to beginning any out of scope work on a contract, ensure that your team receives a signed change order (easier said than done, but do the best you can!) This will help prevent any surprises when it comes time to bill.
As it relates to overbillings, these are almost always good! However, if your overbillings are not sitting in accounts receivable or cash, you have another problem. If your overbillings are not in cash or A/R, you either have job borrow occurring or you’re using the cash on other non-job related expenses. Comparing overbillings to cash and A/R should be a financial metric your accounting team monitors on a monthly basis. By following these steps, a contractor should see significant increases in their contract cash flow.
Did you know building improvement expenditures may qualify for immediate write-off?
The Treasury Department recently issued final regulations implementing the 100% bonus depreciation rules. Updated with the passage of the CARES Act in March 2020, 100% bonus depreciation allows businesses, including construction companies and those related to construction, to write off the cost of depreciable assets in the year they are placed in service. The rules generally apply to business assets with a recovery period of 20 years or less.
Specifically as it relates to the construction industry, is the treatment of qualified improvement property (QIP), which qualifies as bonus depreciation. QIP is defined as any improvement made to a non-residential building as long as the improvement is placed in service after the building was first placed in service, are for the interior portion of the building, do not enlarge or expand the building, are not for elevators/escalators and are not part of the internal structural framework of the building.
The final regulations require that QIP expenditures must be incurred by the taxpayer in order for them to qualify for 100% bonus depreciation.
Contractors may be able to educate building owners on potential accelerated tax deductions derived from the construction project. This can help build a stronger relationship between owner and contractor.
Construction companies should take advantage of the bonus depreciation rules to help mitigate tax liability and maximize cash flow. Please consult your RubinBrown tax advisor to navigate these new rules.