Financial Management and Accounting Fundamentals for Construction

DANIEL W. HALPIN is Professor Emeritus and former head of the Division of Construction Engineering and Management at Purdue University. The author of more than ten books, he is a member of the National Academy of Construction, a recipient of ASCE's Peurifoy Construction Research Award and the Carroll H. Dunn Award of Excellence from the Construction Industry Institute (CII). BOLIVAR A. SENIOR is an Associate Professor in the Department of Construction Management at Colorado State University. He has extensive professional experience in the management of construction projects. Dr. Senior has published many articles relating to construction financing as well as time planning and control. He is a member of the American Society of Civil Engineers and the Dominican College of Professional Engineers, Architects and Surveyors.

• Preface ix1 INTRODUCTION 1The Big Paradox 1What Is Financial Management? 2First Stop: Financial Accounting 2Why Construction Accounting Is Different from Accounting in Other Business Sectors 4Who Is at Risk? 5Projects: The Output of the Construction Process 6Project-Level Controls 7Time Value of Money 8Entrepreneurial Issues 8Review Questions and Exercises 92 UNDERSTANDING FINANCIAL STATEMENTS 11Introduction 11Why Should You Care about Accounting? 12Generally Accepted Accounting Principles 12Cash and Accrual Bases: Two Ways to Look at Accounting 13Cash Basis of Accounting 14Accrual Basis of Accounting 15Accounts 16Account Hierarchy 16Financial Reports 17Bookkeeping 19The Balance Sheet 20Balance Sheet Layout 21Balance Sheet Account Categories in Detail 21The Fundamental Accounting Equation 22Asset Values 23The Fundamental Equation and Owners’ Risk 24Balance Sheet for Fudd Associates, Inc. 24Key Accounts 26The Income Statement 29Components of an Income Statement – More Details 32The Statement of Cash Flows 35Contract Backlog 37Public Corporations 38Review Questions and Exercises 393 ANALYZING COMPANY FINANCIAL DATA 43Introduction 43Vertical and Horizontal Analyses 44Vertical Analysis: Financial Ratios 44Liquidity Indicators: Can This Company Get Cash in a Hurry? 45Current Ratio 45Quick Ratio 46Working Capital 47Profitability Indicators: Is This Company Making Enough Profit? 48Return on Equity 48Return on Revenue 50Return on Assets 51Earnings Per Share 51Efficiency Indicators: How Long Does It Take a Company to Turn over Its Money? 52Average Age of Inventory 53Average Age of Accounts Receivable (Collection Period) 55Average Age of Accounts Payable 56Other Average Ages 57Operating Cycle 57Turnover Ratios 58Revenue to Assets Turnover 58Capital Structure Indicators: How Committed Are the Owners? 59Debt to Equity 60Assets to Equity (Leverage) 60Other Indicators 60Horizontal Analysis: Tracking Financial Trends 62Time Series Graphs 62Index-Number Trend Series 63Conclusion 63Review Questions and Exercises 644 ACCOUNTING BASICS 71Introduction 71Transaction Processing 71Journalizing the Transaction 73A Transaction to Enter Initializing Capital 74A Vendor Billing Transaction 74A Billing to the Client 76Posting Entries to the Ledger 78Relationship of Work-in-Progress and Revenue/Expense Accounts 80Closing the Accounting Cycle 82Recognition of Income 83Percentage-of-Completion Method of Income Recognition 83Completed-Contract Method of Income Recognition 85Transactions during a Period 86Posting to the General Ledger during the Accounting Period 88Closing Actions at the End of the Period 91Review Questions and Exercises 935 PROJECT-LEVEL COST CONTROL 97Objectives of Project-Level Cost Control in Construction 97Unique Aspects of Construction Cost Control 98Types of Costs 99The Construction Estimate 99Cost Control System 101Building a Cost Control System 101Cost Accounts 103Cost Account Structure 104Project Cost Code Structure 106Cost Accounts for Integrated Project Management 110Earned Value Analysis 113Labor Data Cost Collection 122Review Questions and Exercises 1256 FORECASTING FINANCIAL NEEDS 129Importance of Cash Management 129Understanding Cash Flow 129Retainage 131Project Cost, Value, and Cash Profiles 131Cash Flow Calculation—A Simple Example 133Peak Financial Requirements 136Getting Help from the Owner 137Optimizing Cash Flow 138Project Cash Flow Estimates 141Using Software for Cash Flow Computations 144Company-Level Cash Flow Planning 145Strategic Cash Flow Management: “Cash Farming” 145Project and General Overhead 146Fixed Overhead 148Considerations in Establishing Fixed Overhead 149Breakeven Analysis 151Basic Relationships Governing the Breakeven Point 154Review Questions and Exercises 1557 TIME VALUE OF MONEY AND EVALUATING INVESTMENTS 161Introduction 161Time Value of Money 162Interest 162Simple and Compound Interest 163Nominal and Effective Rate 165Equivalence and MARR 166Discount Rate 167Importance of Equivalence 167Inflation 168Sunk Costs 169Cash Flow Diagrams 169Annuities 171Conditions for Annuity Calculations 173Calculating the Future Value of a Series of Payments 174Summary of Equivalence Formulas 175Worth Analysis Techniques: An Overview 176Present Worth Analysis 179Investments with Different Life Spans 180Equivalent Annual Worth (EAW) 181Internal Rate of Return 183Limitations of the IRR Method 185An Example Involving Cost Recovery 186Comparison Using EAW 188An IRR Example—Owner Financing Using Bonds 191Review Questions and Exercises 1948 CONSTRUCTION LOANS AND CREDIT 199Introduction 199The Construction Financing Process 200A Sample Developmental Project 202The Amount of the Loan 204How Is the Cap Rate Determined? 205Mortgage Loan Commitment 206Construction Loan 206Commercial Lenders 208Lines of Credit 209Interest Paid on Outstanding Balance 210Commitment Fees 211Compensating Balances 211Clean-Up Requirement 212Collaterals 212Accounts Receivable Financing 213Trade Credits 213Long Term Financing 215Loans with End-of-Term Balloon Payments 216Review Questions and Exercises 2189 THE IMPACT OF TAXES 219Introduction 219Types of Taxes 220Income Tax Systems 221Alternatives for Company Legal Organization 221Sole Proprietorships 222Partnerships 222Corporations 222Limited Liability Partnerships and Companies 223Other Options 224Taxation of Business 224Business Deductions in General 227Taxable Income: Individuals 227Itemized Deductions, Standard Deductions, and PersonalExemptions 228The Tax Significance of Depreciation 229Calculating Depreciation 230Straight Line Method 231The Production Method 232Depreciation Based on Current Law 233Marginal Tax Rates 235Tax Credits 238Tax Payroll Withholding 239Tax Payment Schedules 239Marginal, Average, and Effective Tax Rates 239Net Operating Losses 240Taxes on Dividends and Long-Term Capital Gains 242Alternative Minimum Tax 242Summary 243Review Questions and Exercises 243APPENDIX A TYPICAL CHART OF ACCOUNTS 247APPENDIX B FURTHER ILLUSTRATIONS OF TRANSACTIONS 251APPENDIX C COMPOUND INTEREST TABLES 275References 301Index 305