Construction companies face the complexity of revenue management in turbulent times
With fears of a looming recession and an uncertain market, construction companies need to be nimble in how they contract with their customers. For many, their back office is unprepared for the complexity this will create.
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Despite a looming recession, recent labor market reports have good news for the construction industry. AIA Consensus Construction of the American Institute of Architects provide predicts that building construction spending will increase by just over 9% this year and another 6% in 2023. With fears of a looming recession and an uncertain market, construction companies need to be nimble in how which they enter into contracts with their customers. For many, their back office is unprepared 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 multi-faceted deliverables. The main benefit of staged invoicing is that it spaces out invoices and payments to allow businesses to maintain a steady cash flow while maintaining a goal-oriented relationship with the customer. This method can help structure budgets and ensure that all parties stick to them even if the project takes longer than expected.
Amount types (percentage, dollar value, etc.) and milestones (project phase completed, goods shipped, etc.) are determined by the parties involved and will reflect the unique needs of the agreement. For this reason, the details of milestone billing plans are often project-specific and determined on a case-by-case basis. However, companies need to pay more attention than ever, not only to their ability to manage flexibility in constructing these schedules, but also to ensure appropriate invoice presentation with high accounts receivable activity to ensure that 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 ASC 606 in the United States (known as IFRS 15 abroad). This standard represents one of the most significant changes in revenue recognition history. It replaces over 200 industry-specific guidelines in the United States 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). The complexities of the standard include the need to separate the timing of revenue recognition from that of billing, but with disclosure guidelines requiring companies to report the amount of revenue billed before and after execution (the disclosure requirement contract assets/liabilities). It also introduces new complexity in how contract changes are handled.
Milestone billing and other risks in construction
Unfortunately, these two events, the need to be nimble in creating and modifying complex milestone billing structures over time, and the requirements of ASC 606 revenue recognition guidelines create pressure on the back office that is greater than the sum of each individually. Businesses in growth mode, or looking to maintain a competitive advantage, should evaluate back-office systems.
More the accounting systems used today were designed before ASC 606 was created. They contain a flaw because they were designed to trigger revenue recognition from invoice events. Separating these schedules under ASC 606 breaks the architecture of these legacy systems. The new contract asset/liability disclosure requirement requires the maintenance of additional general ledger accounts that these systems do not contain. For these reasons, many companies have moved core revenue accounting processes to spreadsheets or customizations, sacrificing agility and incurring risk along the way.
Risk Mitigation in the Construction Industry
The simplest is to assess whether implementing a modern revenue management system designed for the new world is warranted. Such systems help both track milestone billing for long-term projects and manage revenue recognition under new guidelines. They added the benefit of moving key processing from data centers to the cloud. The return to a higher level of automation preserves optionality in the construction of contracts, freeing the front office to react to the market. Modernizing the system can deliver a triple win by managing the certain increase in back office complexity from a “liberated” front office, while simultaneously mitigating the risk of late or lost payments as well as the risk of incorrect revenue recognition. These systems typically provide capabilities for:
- Create custom billing schedules for orders and contracts
- Schedule, generate and send 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 deleted or added milestones, credits, undoes, and a host of other post-processing events until revenue recognition
The National Association of Home Builders estimates over the past year, prices for residential building materials have increased by almost 20%. This comes as rising interest rates squeeze new buyers out of the market. The trends seem contradictory and signal that supply and demand can vary depending on the type of project, the materials used and the geographic location.
Milestone billing is a necessary way for a company’s bottom line. A billing system can also be an essential part of ensuring customer satisfaction. Consistent, error-free billing systems tied to contract terms and easy to navigate can increase customer confidence in a business. Preserving flexibility in how milestone billing is leveraged can be a way to build that trust during long-term, multi-faceted projects involving payment throughout the lifecycle of an engagement. Proper revenue recognition is essential to reduce risk, including comment letters, valuation impact, possible delisting, and even criminal proceedings. Modernizing the revenue management portion of the back office can help with cash flow, long-term growth, and risk reduction in these turbulent times.