Quantity surveying fundamentals: project financial reporting

This week’s article concludes our QS fundamentals mini-series, and we finish with a look at project financial reporting.

Given the perilous state of financial performance in the construction industry, accurate and reliable project financial reporting has never been more important. In this article, I will share my thoughts on why you do them, the rules you are required to follow, the importance of revenue and share some top tips.

As always, I am challenging myself to do this in 5 minutes, so you get maximum information return for a nominal time investment.

Let’s go.

Why do we do them?

Most construction businesses achieve most, if not all, of their revenue and cash receipts through their performance of construction contracts, which means the financial performance of a construction business is largely driven by its financial performance of those contracts.

The purpose of a project financial report is to obtain a snapshot of the project’s financial performance at a point in time so that it can be consolidated with other projects to prepare a business wide view of financial performance.

This information is useful to numerous stakeholders who have an interest in that information, including management, board directors, shareholders, and financial stakeholders (e.g. banks).

The rules

The rule that governs the financial reporting of construction contract is “IFRS 15 Revenue from Contracts with Customers”, effective from 01 January 2018.

As construction contract prices are variable rather than fixed, because they contain mechanisms such as variation clauses, the transaction price reported in the business accounts is estimated based on the expected value, or the most likely amount, and this estimate is constrained to an amount that is 'highly probable'.

In a construction context, a 'highly probable' amount of revenue would include contract sum plus variations and / or loss and expense but should be only those that have been acknowledged by your client in the payment notice.

This is the test applied by auditors when end-of-year audits are carried out so, if you want to get ahead of the year-end rush, then maintain accurate and reliable project financial reports.

Revenue, revenue, revenue

As a contractor’s QS, for me, revenue is your raison d’etre.

You are the one that can make a difference when it comes to prosecuting time and cost entitlements under the contract thereby protecting from revenue reduction (in the form of damages) and securing revenue improvements (variations, loss and expense etc). Yes, you may be reliant on others to provide information that enables you to perform that responsibility, but it is up to you to establish a framework that ensures you obtain that information.

As I have established, the constraint on your financial reporting is the ‘highly probable’ transaction test applied to the amount which will be paid through the contract. Your primary opportunity to satisfy this test, and report revenue, is the monthly application for payment and interim payment certificate process. You should now be able to connect this to the infromation I shared in the applications for payment article that the process is more than just a mechanical process where numbers are put together and thrown to your QS counterpart on the client side.

If I stop for a moment and reflect on this point, I do worry that there is a shift in the QS role over the last ten or so years. I see QS’s who are good at cost spreadsheets or administering NEC contracts, but struggle when it comes to getting paid their entitlements. I can’t put my finger on why but, as I see some excellent commercial people in the generation before me leaving the industry, I do wonder what this all means for the future of the contractor QS profession.

Top tips

The first tip is simple. Every day when you come to work think about which issues you are going to turn into revenue. And at the end of the day reflect on how much additional revenue you generated. A simple KPI to measure your impact and contribution.

The second tip is to think about how you are measuring cost against revenue.

The end position should be relatively simple but make sure you are doing this in the detail and that your cost and revenue align so that you have accurate measures of forecast gain and loss.

The interim position (i.e. the revenue and cost position to the date of the report) can be trickier. You can use an internal measure of revenue or an external measure of revenue, if you are very diligent, you would measure both.

An internal measure of revenue will constrain the measure to actual project performance whereas an external measure of revenue will use the payment certificate received from your client.

The latter is easier because you would use the interim payment certificate you receive each month, whereas the former is harder because you need to do more work, but it gets you a more accurate measure.

Ultimately, the measure should tell you where your cost position is ahead, or behind, the revenue and allow you to investigate why.

The third tip is always to report your project position compliant with the rules. If you receive pressure from management to change your report, then my simple advice would be not to do it. The management team can take a different position in the accounts if they choose but that would be their view.

Final reflections

If you can connect your actions with the reason why project financial reports are produced, you will enhance the quality of the work you perform. As a follow-on to that, you will produce reports which achieve their purpose in that they are accurate and reliable and provide an early opportunity for business stakeholders to understand and make appropriate interventions.

The next article will see the start of a new mini-series which builds on the theme of this article and will look at financial difficulties in the construction industry.

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