Construction Companies Face Complexity in Revenue Management During Turbulent Times

With fears of recession looming and an uncertain market, construction companies must be nimble in how they contract with their clients. For many, their back-office is not prepared for the complexity this will create.

With fears of recession looming and an uncertain market, construction companies must be nimble in how they contract with their clients. For many, their back-office is not prepared for the complexity this will create.
With fears of recession looming and an uncertain market, construction companies must be nimble in how they contract with their clients. For many, their back-office is not prepared for the complexity this will create.
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Despite a looming recession, recent job market reports have had good news for the construction industry. The American Institute of Architect’s AIA Consensus Construction forecast predicts construction spending on buildings will increase just over 9 percent this year and another 6 percent in 2023. With fears of recession looming and an uncertain market, construction companies must be nimble in how they contract with their clients. For many, their back-office is not prepared for the complexity this will create.

What Are The Potential Complexities?

Many construction companies control the receipt of revenue based on a set of progress milestones established with the client. Milestone billing is a payment cycle that uses agreed-upon events or deliverables as billing deadlines. Milestone billing is almost tailor-made for the construction industry, given the prevalence of complex contracts and multifaceted deliverables. The main benefit to milestone billing is that it spaces out invoices and payments to allow businesses to maintain a steady cash-flow while also keeping a goal-oriented relationship with the client. This method can help structure budgets and ensure all parties stay within them even if the project takes longer than anticipated.

The amount types (percentage, dollar value, etc.) and milestones (project phase completion, shipped goods, etc.) are determined by the parties involved and will reflect the unique needs of the agreement. Because of this, the details of milestone billing plans are often project-specific and determined on a case-by-case basis. However, companies must pay more attention than ever, not only to their capacity to manage flexibility in constructing these schedules, but in ensuring presentation of proper bills with strong accounts receivables activity to ensure every dollar earned is received in a timely manner.

At the same time, construction companies continue to absorb relatively new revenue recognition guidance in the form of the ASC 606 standard in the U.S. (known as IFRS 15 abroad). This standard represents one of the biggest changes to revenue recognition accounting in history. It replaces more than 200 pieces of industry specific guidance in the U.S. and moves the world to a single standard across all countries and industry verticals. The standard represents a five-step process for revenue recognition recommended by the Federal Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB)Complexities from the standard include the need to separate the schedule of revenue recognition from that of billing, yet with disclosure guidance requiring companies to report on the amount of revenue billed before and after performance (the contract asset/liability disclosure requirement). It also introduces new complexity in how modifications to contracts are handled. 

Milestone Billing and Other Risks in Construction 

Unfortunately, these two events, the need to be nimble in how complex milestone bill structures are created and modified over time and the requirements of the ASC 606 revenue recognition guidance create stress on the back-office that is greater than the sum of each individually. Companies in growth mode, or seeking to maintain a competitive advantage, should evaluate back-office systems.

Most accounting systems in use today were designed before ASC 606 was established. They contain a flaw because they were designed to trigger the recognition of revenue from the bill events. The separation of these schedules under ASC 606 breaks the architecture of these legacy system. The new contract asset/liability disclosure requirement necessitates the maintenance of additional general ledger accounts that these systems do not contain. For these reasons, many companies have moved key revenue accounting processes back to spreadsheets or customizations, sacrificing agility and incurring risk along the way.

Mitigating Risk In The Construction Industry

The simplest thing is to assess whether implementation of a modern revenue management system designed for the new world is warranted. Such systems help, both in tracking milestone billing for long-term projects and to manage the recognition of revenue under the new guidance. They have added benefit in moving key processing out of data centers and to the cloud. The return to a higher level of automation preserves optionality in how contracts are constructed, freeing the front-office to react to the market. System modernization may provide a triple win by handling the certain increase in back-office complexity from a ‘freed’ front-office, while simultaneously mitigating risk of delayed or lost payments as well as risk of improper revenue recognition accounting. These systems typically provide capabilities to: 

  • Create tailor-made billing schedules for orders and contracts 
  • Schedule, generate, and deliver invoices based on specific dates, contractual commitments, and business requirements 
  • Allow billing to be separated from revenue recognition, with full unbilled accounting capabilities 
  • Enable tightly integrated analytics and reporting for additional visibility throughout the revenue management process 
  • Help manage change events, such as removed or added milestones, credits, cancelations, and a host of other post-processing events through to revenue recognition

The National Association of Home Builders estimates in the past year, prices for residential construction materials have risen nearly 20 percent. This comes as rising interest rates are pricing new homebuyers out of the market. The trends seem contradictory and signal supply and demand may vary according to project type, materials used, and geographic location.

Milestone billing is a necessary means for a company’s bottom line. A billing system can also be a critical component to keep customers satisfied. Billing systems that are consistent, error-free, tied to the terms of the contract, and easy to navigate can increase the customers’ confidence in a business. Preserving flexibility in how milestone billing is leveraged can be one way to instill this confidence during projects that are long-term and multi-faceted and involve payment over the lifecycle of an engagement. Proper revenue recognition is a must to reduce risks that include comment letters, impact to valuation, possible de-listing, and even criminal procedures. Modernizing the revenue management portion of the back-office can help with cash flow, long-term growth, and reduce risk in these turbulent times. 

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