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Financial Management and Accounting Fundamentals for Construction

Financial Management and Accounting Fundamentals for Construction

Daniel W. Halpin, Bolivar A. Senior

ISBN: 978-1-118-15649-0 August 2011 320 Pages

 E-Book

$115.00

Description

TECHNOLOGY/ENGINEERING/CIVIL

SUCCESSFUL FINANCIAL MANAGEMENT IN THE CONSTRUCTION INDUSTRY BEGINS WITH THIS HANDS-ON GUIDE

While construction professionals are skilled in the technical side of their work, they often find the financial management aspect of the business daunting. Financial Management and Accounting Fundamentals for Construction will help you better understand and navigate the financial decisions that are part of every construction project.

This book is a compact summary of the basic financial skills that a construction professional must have to be successful in the management of a construction company and its projects. Its topics address many of the questions that any construction administrator will face, such as:

  • How to organize and use a company's financial reports
  • What amount of cash must be made available to the contractor to complete a project
  • Why the early payment of supplier invoices can enhance profitability
  • How to quantify the time value of money in financial decisions
  • What tax amount is owed by a company and how it impacts the bottom line
  • How to control project costs
  • What financial sources are available to a construction contractor for capital expansion

In this text, you will learn about accounting fundamentals, project-related financial matters, and company level financial issues—three factors that are key to your career success. An ideal reference for students of construction management and engineering, as well as professionals who need a quick refresher when dealing with cost control analysis and other financial issues, this text also offers:

  • Easy-to-understand coverage of financial concepts specific to the construction industry, including business taxation, project control, engineering economy, and financial forecasting
  • Numerous worked examples, plus end-of-chapter review questions and exercises
  • Helpful appendices that present the structure of a typical chart of accounts, the flow of transactions through a construction accounting system, and tables required for computing interest and the time value of money

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Preface ix

1 INTRODUCTION 1

The Big Paradox 1

What Is Financial Management? 2

First Stop: Financial Accounting 2

Why Construction Accounting Is Different from Accounting in Other Business Sectors 4

Who Is at Risk? 5

Projects: The Output of the Construction Process 6

Project-Level Controls 7

Time Value of Money 8

Entrepreneurial Issues 8

Review Questions and Exercises 9

2 UNDERSTANDING FINANCIAL STATEMENTS 11

Introduction 11

Why Should You Care about Accounting? 12

Generally Accepted Accounting Principles 12

Cash and Accrual Bases: Two Ways to Look at Accounting 13

Cash Basis of Accounting 14

Accrual Basis of Accounting 15

Accounts 16

Account Hierarchy 16

Financial Reports 17

Bookkeeping 19

The Balance Sheet 20

Balance Sheet Layout 21

Balance Sheet Account Categories in Detail 21

The Fundamental Accounting Equation 22

Asset Values 23

The Fundamental Equation and Owners’ Risk 24

Balance Sheet for Fudd Associates, Inc. 24

Key Accounts 26

The Income Statement 29

Components of an Income Statement – More Details 32

The Statement of Cash Flows 35

Contract Backlog 37

Public Corporations 38

Review Questions and Exercises 39

3 ANALYZING COMPANY FINANCIAL DATA 43

Introduction 43

Vertical and Horizontal Analyses 44

Vertical Analysis: Financial Ratios 44

Liquidity Indicators: Can This Company Get Cash in a Hurry? 45

Current Ratio 45

Quick Ratio 46

Working Capital 47

Profitability Indicators: Is This Company Making Enough Profit? 48

Return on Equity 48

Return on Revenue 50

Return on Assets 51

Earnings Per Share 51

Efficiency Indicators: How Long Does It Take a Company to Turn over Its Money? 52

Average Age of Inventory 53

Average Age of Accounts Receivable (Collection Period) 55

Average Age of Accounts Payable 56

Other Average Ages 57

Operating Cycle 57

Turnover Ratios 58

Revenue to Assets Turnover 58

Capital Structure Indicators: How Committed Are the Owners? 59

Debt to Equity 60

Assets to Equity (Leverage) 60

Other Indicators 60

Horizontal Analysis: Tracking Financial Trends 62

Time Series Graphs 62

Index-Number Trend Series 63

Conclusion 63

Review Questions and Exercises 64

4 ACCOUNTING BASICS 71

Introduction 71

Transaction Processing 71

Journalizing the Transaction 73

A Transaction to Enter Initializing Capital 74

A Vendor Billing Transaction 74

A Billing to the Client 76

Posting Entries to the Ledger 78

Relationship of Work-in-Progress and Revenue/Expense Accounts 80

Closing the Accounting Cycle 82

Recognition of Income 83

Percentage-of-Completion Method of Income Recognition 83

Completed-Contract Method of Income Recognition 85

Transactions during a Period 86

Posting to the General Ledger during the Accounting Period 88

Closing Actions at the End of the Period 91

Review Questions and Exercises 93

5 PROJECT-LEVEL COST CONTROL 97

Objectives of Project-Level Cost Control in Construction 97

Unique Aspects of Construction Cost Control 98

Types of Costs 99

The Construction Estimate 99

Cost Control System 101

Building a Cost Control System 101

Cost Accounts 103

Cost Account Structure 104

Project Cost Code Structure 106

Cost Accounts for Integrated Project Management 110

Earned Value Analysis 113

Labor Data Cost Collection 122

Review Questions and Exercises 125

6 FORECASTING FINANCIAL NEEDS 129

Importance of Cash Management 129

Understanding Cash Flow 129

Retainage 131

Project Cost, Value, and Cash Profiles 131

Cash Flow Calculation—A Simple Example 133

Peak Financial Requirements 136

Getting Help from the Owner 137

Optimizing Cash Flow 138

Project Cash Flow Estimates 141

Using Software for Cash Flow Computations 144

Company-Level Cash Flow Planning 145

Strategic Cash Flow Management: “Cash Farming” 145

Project and General Overhead 146

Fixed Overhead 148

Considerations in Establishing Fixed Overhead 149

Breakeven Analysis 151

Basic Relationships Governing the Breakeven Point 154

Review Questions and Exercises 155

7 TIME VALUE OF MONEY AND EVALUATING INVESTMENTS 161

Introduction 161

Time Value of Money 162

Interest 162

Simple and Compound Interest 163

Nominal and Effective Rate 165

Equivalence and MARR 166

Discount Rate 167

Importance of Equivalence 167

Inflation 168

Sunk Costs 169

Cash Flow Diagrams 169

Annuities 171

Conditions for Annuity Calculations 173

Calculating the Future Value of a Series of Payments 174

Summary of Equivalence Formulas 175

Worth Analysis Techniques: An Overview 176

Present Worth Analysis 179

Investments with Different Life Spans 180

Equivalent Annual Worth (EAW) 181

Internal Rate of Return 183

Limitations of the IRR Method 185

An Example Involving Cost Recovery 186

Comparison Using EAW 188

An IRR Example—Owner Financing Using Bonds 191

Review Questions and Exercises 194

8 CONSTRUCTION LOANS AND CREDIT 199

Introduction 199

The Construction Financing Process 200

A Sample Developmental Project 202

The Amount of the Loan 204

How Is the Cap Rate Determined? 205

Mortgage Loan Commitment 206

Construction Loan 206

Commercial Lenders 208

Lines of Credit 209

Interest Paid on Outstanding Balance 210

Commitment Fees 211

Compensating Balances 211

Clean-Up Requirement 212

Collaterals 212

Accounts Receivable Financing 213

Trade Credits 213

Long Term Financing 215

Loans with End-of-Term Balloon Payments 216

Review Questions and Exercises 218

9 THE IMPACT OF TAXES 219

Introduction 219

Types of Taxes 220

Income Tax Systems 221

Alternatives for Company Legal Organization 221

Sole Proprietorships 222

Partnerships 222

Corporations 222

Limited Liability Partnerships and Companies 223

Other Options 224

Taxation of Business 224

Business Deductions in General 227

Taxable Income: Individuals 227

Itemized Deductions, Standard Deductions, and Personal

Exemptions 228

The Tax Significance of Depreciation 229

Calculating Depreciation 230

Straight Line Method 231

The Production Method 232

Depreciation Based on Current Law 233

Marginal Tax Rates 235

Tax Credits 238

Tax Payroll Withholding 239

Tax Payment Schedules 239

Marginal, Average, and Effective Tax Rates 239

Net Operating Losses 240

Taxes on Dividends and Long-Term Capital Gains 242

Alternative Minimum Tax 242

Summary 243

Review Questions and Exercises 243

APPENDIX A TYPICAL CHART OF ACCOUNTS 247

APPENDIX B FURTHER ILLUSTRATIONS OF TRANSACTIONS 251

APPENDIX C COMPOUND INTEREST TABLES 275

References 301

Index 305