Financial Reporting of Construction Companies in the Bank’s Evaluation
In principle, the construction industry consists of four segments (transport, industry, energy production and buildings). However, operation in every segment is eventually reduced to the risk of performance of long-term contracts. In relation to the above, there are several key elements which are specific for the financial reporting of construction companies.
First of all, estimates pertaining to revenues are a challenge. They encompass the initial amount of revenues specified in the agreement and changes made during the term of the agreement, claims and bonuses, yet in a scope in which it is probable that they will constitute revenues and in which it is possible to determine their value in a reliable manner. Thus, all elements of revenues, apart from the initial amount determined in the original agreement, are dependent on the adopted assumptions. The actual realisation of revenues may significantly differ from the assumptions (and thus may grow or drop from period to period).
Secondly, it is problematic to determine the current budget of the contract as of the reporting date. Costs estimated as of the date of signing the construction contract have to be updated. Users of financial statements find it difficult to evaluate the reliability of budget updates made by construction companies, in particular in case of significant changes on the market. Increase of costs may be partially secured, yet in practice this is greatly hindered.
Thirdly, in order to correctly recognise revenues and costs of a given construction contract in the financial statements, it is necessary to determine the stage of progress in agreement performance. This is necessary due to the fact that partial payments and advance payments received from the employer often do not reflect the progress of work. Depending on the nature of the contract, determination of the progress usually encompasses:
a) determination of the proportion of costs of agreement incurred on account of work performed up to a specific moment in relation to the estimated total costs of agreement, or
b) measurement of the performed work.
Each of the methods carries the inseparable risk of over-estimating or under-estimating the progress of work.
Bearing in mind the character of key factors affecting the financial statements of construction companies which is prone to assumptions and the significant credit risk (resulting from variable factors during the term of long-term agreements), procurement of financing for the construction industry is relatively difficult. An additional hindrance in the financing of operation of construction companies is also meagre property of the entity which could constitute a security for such financing. The most common type of security in the form of assignment from the contract has one significant weakness from the bank’s point of view: it does not secure repayment of debt in case the company gets into trouble.
Profitability of operation is of key importance, with simultaneous observance of positive operational flows. Banks prefer to finance entities which have a diversified portfolio of orders, do not have excessive short-term contracting, have liquidity (significant funds at their disposal) and may count on the support of their owners or have accumulated funds that allow for covering temporary losses at contracts.
The moment of economic cycle is also important. In the Polish conditions (fixed contract prices and significant contribution of EU funds in infrastructure financing), construction companies may be included among anti-cyclical companies. Profitability of contracts is often higher in the environment of slower economic growth. During a slow-down, companies have to cover their fixed costs, yet raw materials, subcontractors and employees are available at attractive prices. On the other hand, too rapid growth resulting in shortage of employees, sub-contractors, cumulation of work and increase in prices of raw materials drastically reduces profitability, causing numerous delays in investment performance and insolvency of construction companies.
Cooperation of financial institutions with construction sector companies requires trust of both sides and faith in full reliability of the presented financial data. PKO Bank Polski is always interested in the Contractor completing its contracts, thus quick and transparent reporting about losses on contracts gives both parties a possibility of reacting to negative results in a rational mode, building the necessary trust. PKO Bank Polski cooperates with leading companies, as well as smaller entities from the construction industry. Mutual understanding and trust is always the basis of cooperation. The purpose of PKO Bank Polski is to support sustainable development of companies observing a proper level of risk.
Marcin Pieńkowski, Manager in Strategic Corporate Customers Department PKO BP
Piotr Galas, Member of the Supervisory Board PKO Leasing
Last Updated on March 17, 2021 by Karolina Ampulska