BCSA Financial Handbook - Secured Final V2

FINANCIAL
HANDBOOK

for

Steelwork
Contractors

Publication No 33/01

THE BRITISH CONSTRUCTIONAL
STEELWORK ASSOCIATION LTD

BCSA is the national organisation for the Constructional Steelwork Industry; its Member
companies undertake the design, and erection of steelwork for all forms of construction in
building and civil engineering. Associate Members are those principal companies involved in
the purchase, design or supply of components, materials, services etc., related to the industry.

The principal objectives of the Association are to promote the use of structural steel-work; to
assist specifiers and clients; to ensure the capabilities and activities of the industry are widely
understood and to provide members with professional services in technical, commercial,
contractual and quality assurance matters.

The Associations aim is to influence the trading environment in which member companies
have to operate, in order to improve their profitability.

A current list of members and a list of current publications and further membership details
can be obtained from:
The British Constructional Steelwork Association Ltd.
4, Whitehall Court, Westminster, London SW1A 2ES
Telephone: +44 (0) 20 7839 8566 Fax: +44 (0) 20 7979 1634
E-mail: postroom@steelconstruction.org
Website: WWW.steelconstruction.org

ACKNOWLEDGEMENT
This publication has been produced with support from the Department of Trade and Industry,
under whose auspices the document has been drafted and published.

Publication Number 33/01
First Edition October 2001

ISBN 0-85073-036-8

British Library Cataloguing-in-Publication Data

A catalogue record for this book is available from the British Library
c The British Constructional Steelwork Association Ltd.

CONTENTS

Section/Para Content Page

Foreword 1
How to use this book 2

PART A AN INTRODUCTION TO FINANCIAL TERMS AND CONCEPTS

1 Background 3
2 Basic Accounting Reports 3
3 The Profit & Loss Account 3
4 The Balance Sheet 4
5 Cash Flows 7
6 More Complex Accounting Areas 9
7 Work in Progress 9
8 Fixed and Variable Costs 13
9 Depreciation 13

PART B - BLOCK SECTIONS FOR EMPLOYEE GROUPS

Block 1 SHOP FLOOR AND SITE USERS 14-15
1.1 Basic Finance 14
1.2 Essentials 14
Block 2 SUPERVISORS 16-18
2.1 Basic Finance and Accounting Concepts 16
2.2 Constructional Steelwork Industry Essentials 16
Block 3 OTHER MANAGERS 19-27
3.1 Finance and Accounting Concepts 19
Block 4 THE SALES FORCE 29-32
4.1 Finance and Accounting for Selling 29
Block 5 ACCOUNTS AND ESTIMATORS 33
5.1 Finance and Accounting Concepts 33
5.3 The effect of taxation 51
5.4 The Role of Insurance 52
5.5 Contract accounting 53
5.6 Understanding the profit and loss account 54
5.7 Understanding the balance sheet 56
Block 6 DIRECTORS 60-81
6.1 Basic Finance and Accounting Concepts 60
6.3 Avoiding Corporate Failure/Insolvency 75
6.4 Analysing Company Performance 79
6.5 Analysing the Profit and Loss Account 79
6.6 Analysing the Balance Sheet 80

7 INDEX 82

FOREWORD

This book has been commissioned by the BCSA with a major contribution to funding from
the Department of Trade and Industry (DTI). It is one of a series of projects being undertaken
by the BCSA to improve quality and profitability in the constructional steelwork industry.

The aim of this project and this book is to give companies a better understanding of their
finances overall and the profitability of individual contracts in particular. The objectives are
to improve competition in the market place, and to reduce the single largest cause of low
profitability: suicidally low tenders.

This handbook reflects the financial and legal situation extant at the start of the 2001-2002
Tax Year. Certain specific elements are likely to become dated as Government brings in new
or amending legislation, tax and budgetary provisions. Nevertheless, the fundamental
principles of sound financial practice will continue to apply, and this handbook should
continue to provide guidance for the steel construction sector.

A J Fairweather BSc Eng, ACGI, MIAB

HOW TO USE THIS BOOK

This book is set out as two complementary elements. Part A provides an introduction to basic
financial terms and concepts. It is recommended that readers should be aware of these
concepts before addressing the main body [Part B] of the book.

Part B of this handbook is arranged in a series of building blocks making up the financial and
business knowledge required at each level within the constructional steelwork industry.

The intention is that as a person is promoted through the industry he would need to read
further section(s) as appropriate to his new level. To allow each section to standalone,
reminders of key messages from prior sections are included in italics.

New readers should read all the sections building to their current level, as this will provide a
refresher of knowledge, which they should have acquired already.

The more ambitious reader may of course go beyond his or her current level in anticipation of
promotion.

This book covers the financial aspects of constructional steelwork. Legal and technical
aspects are included, in limited detail, where they are relevant for understanding the financial
detail. For full coverage of technical and legal aspects, please refer to other BCSA or SCI
publications.

In common with standard industry usage contract will be used to describe a particular job in
all its aspects and legal contract will be used to refer to the actual legal documents
comprising the legal contract. There are a number of forms of contracts in common use in the
industry and the appropriate legal contract will depend on the size and nature of the particular
contract. In addition, many contracts are non-standard. Where relevant, differences between
legal contracts are referred to in the text.

This book is current at time of publication, but statute, case law and best practice change
regularly in both steelwork construction and accounting. Care should be taken to ensure that
subsequent changes are taken into account.

Although every care has been taken in the preparation of this financial handbook neither the
author, haysmacintyre, nor the British Constructional Steelwork Association Limited can take
any responsibility for any action taken or not taken as a result of using any information
contained in this financial handbook, nor accept any responsibility for loss or damage arising
directly or indirectly there from.

PART A AN INTRODUCTION TO FINANCIAL TERMS AND CONCEPTS

1. Background

1.1 To enable users of this book to understand the terms and concepts discussed in
Section B, this introduces some of the basic terminology and concepts used in
the book.

1.2 Once the basic terminology and concepts are mastered, there is a wide range of
excellent textbooks to grow a reader's knowledge base beyond the concepts
discussed in this handbook

2. Basic Accounting Reports

The three most important reports are:

! The profit and loss account,
! The balance sheet,
! Cash flows.

3. The Profit and Loss Account

3.1 The profit and loss account is the financial report showing the financial effect of
a period of trading by a trading entity (which, in this handbook, we will assume
is a company).

3.2 Let us look at a simple example of a profit and loss account for the following
activities:

(1) A company fabricates and erects an order worth 10,000.
(2) It buys steel worth 3,000.
(3) It has direct wage costs of 2,000
(4) It has overheads of 4,500.

The profit and loss account would look as depicted below. [Numbers shown in
brackets are negative. The profit and loss account normally depicts all
transactions occurring over the period of one year.]

Turnover - 10,000

Direct Costs - Wages 2,000
- Steel 3,000
--------
(5,000)
--------
Gross Profit 5,000
Overheads (4,500)
--------
Profit for period 500
=====

4. The Balance Sheet

4.1 A balance sheet is a record of the assets and liabilities of the business on a
particular day. It is a snapshot taken at a particular time, unlike the profit and
loss account, which records the transactions taking place over a period of time.

4.2 Assets are those things owned by a company or owed to a company such as:

Fixed Assets, e.g. Land
Buildings
Machinery
Cars
Computers

Debtors, e.g. Amounts due from customers not yet paid
Retentions

Stock, e.g. Steel

Bank Balances: Money in the companys bank account

4.3 Liabilities are those things that the company owes to other people or companies,
who are known as creditors. Examples of creditors and liabilities are:

Creditors Liabilities

The bank Overdrafts
HM Government Taxes incurred but not yet paid, e.g.
VAT
PAYE
National Insurance
Corporation Tax
Trade creditors (e.g. a steel supplier). Amounts due to people who have
supplied goods or services to the
company.
Finance company Hire purchase - usually due to someone
who is helping finance a piece of plant
or equipment, e.g. a car.

4.4 The balance sheet records all the assets and liabilities of a business. When the
liabilities are deducted from the assets, the result is known as the net assets.

4.5 The net assets of a company are balanced by the total of its share capital and
reserves (known as shareholders funds).

4.6 A simple balance sheet is explained below and is based upon the following
information:

(1) Shareholders start the company with 100,000, which is known as share
capital. They give this money to the company by putting it into the
companys bank account.
(2) The first thing they do is to buy some plant and machinery for 50,000
(fixed assets).

The balance sheet then looks like this:

Fixed Assets 50,000

Cash at bank 50,000
----------
Assets 100,000

Liabilities ( -- )
-----------
Net Assets 100,000
=======
Share Capital 100,000
Retained Earnings --
-----------
Shareholders Funds 100,000
=======
Notes:

(1) The balance sheet balances by net assets equalling shareholder funds.
(2) The company has not yet traded so it has no retained earnings (i.e. profits
from contracts).
(3) The company has no liabilities yet.

4.7 Taking the example in 4.6, let us now assume that the profit on the contract
referred to in 3.2 has been earned and has been paid for by the customer. The
balance sheet will now look as follows:

Fixed Assets 50,000

Cash at bank 50,500
----------
100,500

Liabilities ( -- )
-----------
Net Assets 100,500
=======

Retained Earnings 500
-----------
=======

Notes:

(1) The balance sheet still balances.
(2) The trading profit of 500 is shown as 500 in retained earnings.
(3) The cash balance has gone up by 500 as a result of the 500 profit earned
on the contract being converted into cash.

4.8 Again using the example above, let us assume that the customer has not yet paid
the 10,000 on the contract referred to above.

This does not change the profit shown on the contract but it does alter the
balance sheet as follows:

(1) The 10,000 instead of being cash is shown as a debtor.
(2) The cash balance is 10,000 lower. (Remember that the company will
have to have paid for the steel, wages and overheads set out in 3.2 and so
the initial cash balance will have gone down by the 9,500 of payments
made).

Fixed Assets 50,000

Debtors 10,000
Cash at bank 40,500
--------
50,500
----------
100,500

Liabilities ( -- )
-----------
Net Assets 100,500
=======

Retained Earnings 500
-----------
=======
Notes:
(2) The total of the balance sheet, 100,500, remains unchanged.
(3) The split of net assets between different types of assets has changed.

4.9 Using the same data as in 4.8, we can introduce the concept of liabilities.

Let us assume that the company has not yet paid the steel supplier the 3,000 for
the steel.

The balance sheet would look as follows:

Fixed Assets 50,000

Debtors 10,000
Cash 43,500
--------
53,500
----------
Assets 103,500

Liabilities Due to Steel Supplier (3,000)
-----------
Net Assets 100,500
=======

Retained Profits 500
-----------
Shareholder 100,500
=======

Notes:

(2) The profit on the contract is unchanged despite the timing of the payments
under that contract charging.
(3) The make up of the top half of the balance sheet is becoming
increasingly complex.

5. Cash Flows

5.1 Cash flows are used to predict, monitor and control the flows of money arising as
a result of business.

5.2 From the examples in Section 4 it can be seen that profit does not equal cash.

5.3 Using the data in 3.2, and if we assume that the contract takes 4 months, the cash
flows could be represented as follows:

Monthly Accumulated
cash flow () cash flow ()
Month 1 Order secured
Pay overheads (4,500 4) (1,125)
-------
(1,125)

Month 2 Buy steel (3,000)
Pay overheads (1,125)
----------
(4,125)
----------
(5,250)
Month 3 Fabricate and erect steel work
Pay direct wages (2,000)
----------
(3,125)
----------
(8,375)
Month 4 Customer pays 10,000
----------
8,875
--------
Contract cumulative cash flow 500
=====
Notes

(1) The contract cash flow only equals profit when the customer finally pays.
(2) The contract absorbs cash resources of 8,375 at the end of month 4 before
any monies are received from the customer.

5.4 The above cash flows would become even worse if a retention were taken into
account. A 5% retention would be 500 (10,000 x 5%), but it would represent
all of the profit and cash flow involved in the contract.

5.5 This cash flow problem would become even worse if the profit margin on the
contract fell.

5.6 Summary

The example set out in 5.3 illustrates some key aspects of business in the
steelwork construction industry:

(1) Cash flow is as important to the health of the company as profits.
(2) A company needs to have significant resources to fund a contract.
(3) The profit margin earned (500 on the 10,000 contract referred to in this
section) is very low. Very small improvements in efficiency or price can
therefore have a big impact on the reported profit.

For example if the order had been won at a price of 10,100 instead of
10,000 then the profit would have been 600 - 20% higher.

6. More Complex Accounting Areas

6.1 Sections 2 5 above illustrate, in simple terms, how the figures in the profit and
loss account, the balance sheet and cash flows are built up and in outline what
those three financial reports are telling us.

6.2 The steel construction industry is however a complex one. To enable readers to
build up their knowledge to take advantage of the modules in Part B, it is
necessary to introduce some more complex concepts.

6.3 The following sections address three further concepts:

! Work in progress
! Costs and the split between fixed and variable costs.
! Depreciation.

7. Work in Progress

7.1 This is probably the most important topic when understanding accounting in the
steel construction industry.

Work in progress is the accounting value placed on contracts which have been
won but which have not been completed.

Given the variety of types of work carried out in the industry (in terms of size,
complexity, location, duration etc), each contract will have its own issues. In
addition many companies have different approaches to how to account for work
in progress.

This section therefore covers only the broad concepts involved. It is
intended to set down a way things must be done.

7.2 At this point it is helpful to relate work in progress to the contract cycle.

Clearly this is a much-simplified flowchart and many contracts will have very complex
stages in them.

Work in progress is relevant to the job from the contract won to when the final
account is settled.

The work in progress account for each contract is often referred to the contract
account or job list.

7.3 Why do we value work in progress?

Work in progress is valued to give the people running the business key pieces of
information such as:

(1) How are individual contracts progressing?
(2) How is the company doing overall?
(3) What financial resources are contracts absorbing and what are the likely
cash flows from those contracts?

Design
Contract
Won
Fabrication
and
Erection

Final Account
Agreement of
Extras and
Variations

Billing
Certification
of Work
Done

Variations
Invitation
to
Tender

Tender

7.4 To illustrate these points, let us assume that the company has two contracts in
progress. They are both exactly as in the example referred to above. The first
contract starts 1 month earlier than the second.

Notes Contract Contract Work in
1 () 2 () Progress
Total ()
Month 1
Pay overheads (1) 1,125 1,125

Month 2
Buy Steel 3,000 -- 3,000
Pay overheads (1)(2) 562.50 562.50 1,125
---------- --------- --------
Subtotal (3) 4,687.50 562.50 5,250

Month 3
Buy Steel -- 3,000.00 3,000
Pay overheads (1)(2) 562.50 562.50 1,125
Pay direct wages 2,000.00 -- 2,000
---------- --------- --------
Subtotal (3) 7,250.00 4,125.00 11,375

Month 4

J ob complete & transferred from WIP (7,250) (7,250)
Pay overhead (1) 1,125 1,125
Pay direct wages 2,000 2,000
---------- --------- --------
Subtotal (3) NIL 7,250 7,250

Month 5

J ob complete & costs transferred from WIP (7,250) (7,250)
---------- --------- --------
Subtotal (3) NIL NIL NIL
====== ====== =====

Notes:

(1) The overhead which is being "absorbed" is being apportioned to live jobs
on a monthly basis (for example by labour hours etc).
(2) As the company gets busier (in months 2 & 3) the amount of overhead
each job has to "absorb" falls because of the greater activity.
(3) At the end of each month the company can see the value of the work in
progress by job and for the company overall.

7.5 Accounting carefully for work in progress on a job-by-job basis becomes even
more important when the issue of a variation arises. For example let us assume
that Contract 1 in 7.4 had a variation with a sales value of 1,000 and a cost of
900. As a result, the company should earn an additional 100 in profit.

Let us also assume however that the extra work was recorded incorrectly in
month 3 to Contract 2

The error was not picked up until Contract 2 was billed in month 5 and by then,
Contract 1 was finished and had been paid for.

The company then had to try and go back and bill the 1,000 to Customer 1.
Until that was successful, the company had paid out the 900 and overall
Contract 1 had cost the company money (remember the contract had a profit of
only 500 initially).

The time spent trying to recover the 1,000 was all "dead" time and all these
problems arose from one error in booking work to the wrong job in month 3.

7.6 A company will have work in progress if it has contracts in progress. To an
extent therefore it is a healthy sign. However, it can also indicate a need for
caution because work in progress is not cash or profit. J ust because the costs on
a job are higher does not mean the company will make more money.

For example if the steel in Contract 1 were ordered at a price of 3,500 not
3,000, the contract would show work in progress of 500 more from month 2
onwards. The contract was priced however with steel at 3,000 and the customer
would not pay any more than 10,000 in all for the job. Overall the company
would make 500 less but this would not necessarily be known until month 4
when the job would be billed and the contract closed.

7.7 Conclusions

It is essential to measure value and account for work in progress, but the numbers
produced must be evaluated carefully to ensure that they are interpreted
correctly. Great care should therefore be taken at all stages.

8. Fixed and Variable Costs

Many different definitions are given for these but the easiest way to understand them is:

8.1 Fixed Costs

A fixed cost is one that has to be incurred and paid regardless of the level of
activity in the company. Examples of fixed costs are:

! Rent
! Rates
! Equipment
! Administration costs
! Computers
! Design office

8.2 Variable Costs

A variable cost is one that varies depending on the level of activity in the
business. For example:

! Electricity
! Overtime
! Transport costs
! Paint

The more flexible a business is the more variable its costs are.

9. Depreciation

Depreciation is the term used to describe how the cost of assets used by a company is
spread over a number of years to avoid these issues distorting the company's accounts.

For example, a car is bought for a salesman. It costs 12,000 and is expected to last for
4 years. It would be unfair to apportion all that cost to one year's profit and so what is
done is to spread the cost over the 4 years of ownership. This is the process known as
depreciation.

In our example here, the asset would be depreciated over 4 years and each year would
have 3,000 charged against profits (12,000 4).

The asset would be valued at 9,000 to the business at the end of year 1; 6,000 at the
end of year 2; 3,000 at the end of year 3 and NIL at the end of year 4.

These figures are not intended to be the value the asset could be sold for at each point,
but are merely a mechanism for spreading the cost of buying the asset over more than
one year in as fair a way as can be estimated.

PART B - BLOCK SECTIONS FOR EMPLOYEE GROUPS

1. BLOCK 1 - SHOP FLOOR AND SITE USERS

1.1 Basic Finance

1.1.1 What is a profit?

Profit is a measure of the success of a business. It is one of the most important measures. A
company that does not make a profit will not survive for very long.

A profit can be simply explained as the amount of money left over from the sales after paying
all the costs of providing the product. This includes not only the direct costs, for example the
obvious labour, steel and machine time, but also the less obvious indirect costs such as the
office staff and council tax. The cost of providing the office and factory has to be met by a
contribution from each of the sales a company makes.

If all the costs cannot be met out of sales, then the business makes a loss. If a company
continues to make losses, it will eventually run out of money and stop trading. This might be
because the owners decide to close the business or because the company goes into liquidation
or other insolvency process.

A profit is not the only measure of success. However profitable a company is on paper, if it
cannot collect the cash from its customers, it cannot pay its bills or wages.

It is essential to understand that if a company is profitable it can continue to employ
people, but to pay them, it needs to convert sales into cash.

1.1.2 Who owns the profit?

The owners of the profit are the owners of the business. They have put up the initial
investment to buy the machinery and have provided money to use in the business. Money
used to run the company on a daily basis is known as working capital.

The owners need to be rewarded for the risk that they have taken in putting money into the
company.

Investors can put their money in the post office or building society and receive interest with
no risk of losing their money. If they invest in a business, they run the risk that it will make a
loss or go out of business. Investors therefore require a higher return on their money if it is
invested in a company than if it is put in the bank where it can earn interest. This is true
whether the investors manage the business or are completely separate people.

1.2 Essentials

1.2.1 The reason for accounting

The main reason for accounting is to keep the score of sales and costs and to work out if the
company has made a profit or loss on each contract. It also keeps track of available cash and
other assets, including, for example, the value of plant and money owed to the company.
Accounts also keep track of amounts owed to suppliers.

1.2.2 Get it right first time

For a company to be able to collect all the money due to it for work done, it should hold a
complete record that can be used to prove that the customer requested the work, and that it
was completed as requested.

This is normally going to be the responsibility of managers and supervisors, but everyone
should do paperwork accurately when asked to do it.

If a task has to be repeated, it will at least double the cost compared to doing it correctly first
time.

There is nothing worse, at the very end of a job, after the site work is finished, than trying to
sort out poor quality paperwork to collect money due.

1.2.3 Day Works

Day work is when the customer is requesting specific work on site and is paying an agreed
hourly rate for that work.

All work should be accepted, tendered and priced in advance and properly recorded so that
the money can be collected from the customer. The most important aspects of this are:

1.2.3.1 All work should be ordered in advance

Only work which has been accepted by the company, and for which the price has been agreed,
should be performed. In general, this is the responsibility of managers and supervisors.
Except in an emergency, instructions should only be accepted from managers and supervisors
and not from the customers staff.

1.2.3.2 All work to be advised on completion

All day works will normally be advised to the customer on completion and invoiced as soon
as possible. To assist with this process, report all completed work so that it can be checked
and recorded immediately.

1.2.3.3

Variations can be a large element of the contract value (10-15% typically) but can be as high
as 100%. This is therefore a vital area for all employees to understand.

2. BLOCK 2- SUPERVISORS

2.1 Basic Finance and Accounting Concepts

2.1.1 Why accounting?

Accounting is the scorecard for business. Without accounts, it is not possible to ascertain if
the company has made a profit or if it has sufficient cash in hand to pay its wages and bills.

Accounts have to be kept to run the business and to meet legal and tax requirements. A little
extra effort will turn the accounting function into a valuable resource rather than an
unproductive expense. It will contribute to the efficient running of contracts and the business.
It may also contribute to winning profitable contacts by allowing more accurate pricing of
tenders.

2.1.2 The Business Cycle

The demand for goods and services goes up and down over time. Demand for different goods
and services changes in relation to each other but generally, there are good times and bad
times for all. The relative demand for goods, against each other and against available
capacity drives prices. Thus, if there is too much of something (or if people do not see
something as desirable or necessary) its price will be lower than if there is a scarcity of that
item.

The constructional steelwork industry is more affected by the business cycle than most other
industries. When times are good, companies buy shops, offices and warehouses to expand,
but when times are bad, companies can continue to use their existing buildings. If companies
still want to expand, existing buildings can be purchased for less than the cost of building
new.

An opposite example is supermarkets. They are much less affected by the business cycle;
people might cut down on luxuries, but they have to eat whether times are good or bad.

2.2 Constructional Steelwork Industry Essentials


[The section below, in italics, is a repeat of information given in Section 1. It is
included here for completeness, and may be used as revision, if required.]

The main reason for accounting is to keep the score of sales and costs and to work out if
the company has made a profit or loss on each contract. It also keeps track of available cash
and other assets, including, for example, the value of plant and money owed to the company.
Accounts also keep track of amounts owed to suppliers.

In a large business, this is the only effective way of managing. The government and
particularly the tax authorities require all businesses to keep proper records of transactions. It
is not possible for one person to remember all the details of a modern business.

A good accounts department will add value by identifying the least costly way of doing
business. In constructional steelwork, a particular benefit can be obtained by identifying
clearly the costs of individual tasks. It is then possible to tender more accurately and help
ensure contracts that are won are profitable.

2.2.1.1 Accurate records cost less

Poor accounts and lax record keeping are bad business. The profit on steelwork contracts is
usually small and therefore the final payment on a contract is often larger then the profit on
the whole contract. The receipt of this final payment is therefore vital. If accurate records
have not been kept, it might not be possible to get paid for all the work done. The total
payments might be too low, so losing part or all of the profit for the job. The loss of profit
might not be obvious until the final payment is received.

2.2.2 Variations, Extras and Day Works

2.2.2.1 All work should be agreed in advance

Some contracts include an amount of steelwork, for which the price is agreed in advance,
following a tender process; other types of contract include clauses to provide for re-
measuring. On all types of contract however, as construction proceeds, there may be changes
to the design or extra work required. The extra work may be known as variations, extras
or day works. Each variation tends to have its own price fixed by agreement whereas day
works will have a fixed hourly rate depending on the type of labour plant and materials
involved.

2.2.2.2 All records to be kept

It is not commonly recognised that much of the actual profit on contracts is determined by the
companys ability to prove and be paid for variations. For the company to be able to prove to
the customer that the work has been done, the contract records have to be in good order. If
records are not properly kept, the company is put in a weak negotiating position. The
company will find it more difficult to collect all amounts due, as it will not be able to prove
that the work was done. The customer could take advantage of any weakness to reduce the
amounts agreed and subsequently paid.

2.2.3 Monitoring and collecting Retentions

2.2.3.1 Record keeping is the key for collecting retentions

Retentions are amounts withheld from payments due from a customer to a supplier; e.g. from
the main contractor to the steelwork sub-contractor. They are withheld in case of defects
being discovered. They are normally 3 or 5% of the total contract price but this can vary, and
may be held for more than a year after practical completion of the main contract. There are
also likely to be retention provisions between the client and the main contractor. Payment of
retentions by the main contractor might be linked to them receiving the retention from their
customer.

The industry has moved away from retentions towards retention bonds, but they remain a
factor in some contracts.

There are benefits to the steelwork contractor in using bonds:

! all cash is received earlier,

! it reduces the incentive for the customer to argue about minor problems to delay the
final payment, and,

! it reduces the amount of record keeping and chasing of payments required.

! they are considerably cheaper than financing retentions

Remember on many constructional steelwork contracts, the final net profit [i.e. after allowing
for overheads] is low. These contracts are usually cash negative until the final payment is
received. Collection of the retention is essential for profitability and cash flow because
most or all the profit may be in the retention.

Good record keeping and attention to diary and detail are essential. The customer should
have no illusion that you regard the collection of retentions as unimportant.

3. BLOCK 3- OTHER MANAGERS

3.1 Finance and Accounting Concepts

3.1.1 Why accounting?

Accounting is the scorecard for business. Without accounts, it is not possible to ascertain if
the company has made a profit or if it has sufficient funds to pay its bills as they fall due.
Accounts inform the shareholders, if they are separate from the management, of the financial
position of the company. They are required by law under the Companies Act and in more
detail under stock exchange regulations for listed companies.

[The paragraph below, in italics, is a repeat of information given in Section 2.1.
It is included here for completeness, and may be used as revision, if required.]

Accounts have to be kept to run the business and to meet legal and tax requirements.
Considerable effort has to be expended in maintaining accounts to the minimum legal
requirement. A little extra effort will make the accounting function into a valuable resource
rather than an unproductive expense. It will contribute to the efficient running of contracts
and the business. It will also contribute to winning profitable contacts by allowing more
accurate pricing of tenders.

3.1.2 Profit is not cash

This is probably the most important lesson for non-financial managers to learn about finance
and accounts.

Profit is essential to a business it cannot survive long term without it. However profit alone
does not pay the bills - only cash can do that.

Profit is the measure of all the income from a project or business minus all the costs. It
includes all items whenever they arise. However there are timing differences in all
businesses. Materials have to be bought, and normally have to be paid for, before saleable
items can be produced. Then, after the items have been produced, there is often a wait for
sale and then for payment. If there is not enough cash in the business, the material cannot be
paid for until cash is received from sales, and the suppliers might act to recover what is owed.

Cash flow is a particular problem for steelwork contractors. Projects are often of long
duration and two major factors help delay the receipt of cash:

! The first is the retention element of many steelwork contracts. Retentions are the
portions of the contract payments that are held back by the customer [i.e. the main
contractor or client] as surety against any defects in the contract work. The final
elements of retentions may not be paid for a year or more.

! The second factor is the large amount of extra work, over and above the original
contract, which is required on many jobs, because of either an incomplete or an
incorrect specification in the original documentation, or subsequent changes
requested by the customer. In either case, there is a risk that changes and extra work
are not properly recorded. Arguments over the price of work are a major cause of
delay in obtaining payment.

A business has to be managed both to ensure profitability and to ensure a sufficient cash flow
to pay suppliers, taxes and wages as they fall due.

3.1.3 Tonnes of steel are not profit

This is probably the second most important lesson for non-financial managers to learn about
finance and accounts for the constructional steelwork industry.

The tender driven and very competitive nature of the constructional steelwork market means
that profit margins are usually low. Low margins mean that even small increases in cost or
small amounts of work unpaid can turn an originally profitable contract into a loss maker.
Care needs to be taken when tendering for work to ensure that the contract will really be
profitable.

The other consequence of very low margins is that much greater attention has to be paid to
controlling costs and collecting amounts due than in other business with higher profit
margins.

For example a contract for 1000 tonnes of steel at an average price of say 1,000 per tonne is
worth 1,000,000. At a gross margin of 20%, the maximum gross profit, if there are no
unexpected problems, is 200,000. After paying for the fixed costs, the remaining profit, at a
margin of 5%, would be only 50,000, again assuming no unexpected problems.

In a higher profit industry the gross margin might be 50%, which, on the same sales value,
would produce a profit of 500,000 therefore leaving more room for error.

3.1.4 The Business Cycle

[The paragraphs below, in italics, is a repeat of information given in Section 2.1.

and services changes in relation to each other, but generally, there are good times and
bad times for all. The relative demand for goods, against each other and against available
capacity drives prices. i.e. If there is too much of something (or if people do not see
something as desirable or necessary) its price will be lower than if the item is scarce.

One reason for this is improvements in technology. For example, when cars were invented
the demand for petrol went up, but the demand for horse feed went down. The other reason is
that when a business opportunity arises, several companies will spot it at the same time. They
will all invest in new factories and machines thus creating new jobs. People become more
optimistic and spend more money and other opportunities arise. When all the factories have
been built, there may well be too much supply for the available market. Therefore, costs have
to be cut, people become pessimistic, and opportunities dry up. This happens over many
businesses all over the country and creates the business cycle.

but when times are bad, companies can continue to use their existing buildings. Even if
companies still want to expand, existing buildings can be purchased for less than the cost of
building new.

people might cut down on luxuries, but they have to eat.

3.1.5 Fixed and Variable Costs

A steelwork company has some costs that vary directly with the company output, e.g. steel
purchased, labour and machine use. These are known as variable costs or direct costs.
Some other costs do not vary in relation to the level of output, e.g. cost of buildings or the
accounts department. The latter are known as fixed costs or overheads.

The definition of fixed and variable costs changes between companies. It will depend on the
view of the best split taken by the directors and the ability of the accounting system to provide
information.

For the business overall to make a profit, all of the costs, both fixed and variable, have to be
recovered from margins earned on the sales. To ensure that this happens, all of the costs have
to be allocated. The variable costs can be easily allocated directly to contracts, but fixed costs
have to be allocated by indirect means. The more costs that can be directly allocated the more
accurate the process is likely to be.

Two common ways are:

! Overheads are allocated on direct hours (shop, site or drawing office as appropriate).
! Overheads are allocated to materials and hours.

The table below shows the difference between fixed and variable costs:

Description Examples
Fixed Costs

Costs which do not charge with
production levels
Payments to acquire or rent a
factory
Purchase or hire of fixed plant.
Rates

Variable Costs

Costs which do change with
production levels
Overtime
Electricity
Paint


3.2.1 Accounting

Though accounting may seem to be less exciting than watching a building take shape, it is just
as important to the companys ability to complete its contracts and to compete for new ones.

A first class accounts department can give that extra edge to a companys ability to compete.
A poor finance department will not be able to give the support necessary to allow, effective
monitoring of contracts and accurate pricing of tenders, and to ensure the collection of all
sums due to the company.

3.2.1.1 Keep it simple and cheap

Accounting systems that are too complicated tend to be expensive to maintain and difficult to
use. They can also trigger excessive training costs and create extra costs due to the mistakes
they induce. It is often better to set up the simplest system that is capable of recording the

accounting information in sufficient detail to allow timely collections and proper analysis and
reporting to be performed.

Spend some of the time and money saved to check the information and ensure it is of the
highest quality.

3.2.1.2 Get it right first time

When you perform a task, it will take time and effort to ensure that it is done properly, that all
the paperwork is in order, and that necessary documents have been retained and filed
correctly. You may think this incurs unnecessary expense.

However, if any task has to be repeated, its cost will at least double. Often it will cost
considerably more, because the event being recorded will not be fresh in peoples minds or
the information may not readily at hand. The paperwork might have been mislaid or lost, and
the effort might be even greater. If the task needs to be recreated much later, it might not be
possible at all.

On the other hand, if proper records are kept, then any subsequent reference to the records
will be simple, easy and cheap. No time will be wasted searching for mislaid documents or
trying to work out what happened a long time before.

Claims for day works and variations will be made with less effort and a higher possibility of
success. As most of the profit in some jobs relies on these recoveries, this can be a major
contributor to the overall profitability of the company.


The minimum cost of correcting most paperwork and accounting errors is the same as doing
the original work. Thus, the overall cost of that particular process is doubled. This assumes
that there is no additional cost in detecting the error, and that the correction involves only re-
doing the work.

In reality, paperwork and accounting errors often remain undetected until the contract is
closed. At this stage, it will be much more expensive to track down the exact nature of the
error, to find the person who made the error (if he is required), to work out how to correct it
and then to make all the consequential changes.

Regular and thorough financial reviews of the contracts with adjustments made to correct
errors are essential to reduce the risk of major problems remaining undetected.

There is further risk that it may not possible to track the error or recreate the paperwork. This
is particularly the case for day works and extras. If the work is not documented when it is
done, there may be no record at all. Worse still, the customer may have the only record. He
would have little reason to help complete the steelwork contractors records, to allow the
latter to bill him for previously unrecorded work.

The risk is that the cost of work done cannot be recovered. A charge for work done, but for
which no payment is received, is lost profit. On a low margin contract [i.e. most of them],
this can be a substantial proportion of the final profit.

3.2.2 Financial aspects of contract management

This section describes the roles that can have major impact on the financial performance of a
constructional steelwork business. These roles are also critical to the technical performance.

An appreciation of the financial impact should help to improve both aspects of the job. The
roles are defined separately here, but the number of people performing these functions and the
exact split of responsibilities will depend on the size of the company and the knowledge and
skills of the people concerned. A small company may combine several roles but a larger one
may split them further.

3.2.2.1 Role of buyer

The role of the buyer is to find suppliers, sub-contractors, and supplies for all of the steel and
other materials that are used in the fabrication of the steelwork structure. Price is obviously a
major factor in purchasing decisions, but delivery time is sometimes more important. Other
factors to be considered include quality, reliability of supply, payment terms, financial
stability of supplier and availability of items in excess of order if subsequently required. All
contribute to the final decision.

The buyer will also be required to provide inputs into tenders made for new contracts. This
needs as much skill and judgement as actually making purchases. The buyer should make
allowances for any anticipated price movements before the orders are to be placed. Estimates
need to be made of the price for sub-contract purchases based on prices obtained for similar
items.

The ability to estimate the final purchase price is crucial to the success of the tender. Over-
estimating the purchase price will give a tender that is too high and may not win the contract.
Under-estimating will lead to a contract that is not as profitable as anticipated or that may
make a loss.

The chief buyer, or the person taking that role, is normally responsible for negotiating prices,
arranging physical delivery and for the overall financial performance of the buying function.

3.2.2.2 Role of drawing office manager

The drawing office manager is responsible for managing the drawing office, and often for the
overall quality of the designs, and the fabrication and build cost of those designs.

A good design will meet the specification of the contract It will also be the least costly to
complete, taking into account the cost of steel and other material, cost of fabrication and cost
of erection. The design will work within the capacity of the fabrication plant, available sub-
contractors and transport requirements.

The drawing office will also have to participate in the preparation of outline designs for
pricing tenders. The ability to identify innovative cost-saving approaches to the required
structure, where this is allowed, is of particular value. As before the accuracy is essential to
winning profitable tenders.

3.2.2.3 Role of works manager

The role of the works manager is to run the fabrication works. He is responsible for the
efficiency and cost of operations, and the timely delivery of fabricated items to site. This
includes ensuring that the correct levels of manning exist to carry out the scheduled work.

During tender preparation, it will normally be necessary to compute the likely cost based on
the complexity of fabrication, steel tonnage and special factors for the contract. If similar
work has been carried out before, the relevant costings can be used to provide some guidance.
This is helped considerably if detailed accurate records are readily available for reference.

The use of estimating norms for pricing fabrication work based on a cost per tonne and the
complexity of the work is sometimes appropriate for companies producing large volumes of
simple and standardised structures.

The works manager is also responsible for the maintenance of machinery and for planning its
replacement and any increase in capacity. When new plant and machinery is proposed, it
should be justified by detailed financial and technical analyses covering:

! the likely ability to sell the output,

! the ability of the rest of the works, erectors and design office to cope with the
increased throughput, and

! any consequential investment required or costs incurred.

The financial analysis should include the life cycle costings of the plant/machinery, including
the payback period and a comparison with existing costs.

In companies with good records and, perhaps, where virtually standard structures are
produced, an estimate of the value of the output can be used to compare costs and benefits.
Where very substantial investment is required it is best to prepare a financial model of the
whole business to ensure all relevant costs and benefits are considered. The analysis of
investment in new machinery is covered in more detail in Section 6.2.9.

In most organisations, the works manager also fulfils the role of transport manager, ensuring
that fabricated items are delivered to site at the correct time and at the lowest cost.

3.2.2.4 Role of contract manager

The role of the contract manager depends on the company organisation. It can encompass a
wide range of responsibilities, ensuring the smooth running of the contract (including on site
operations). This may embrace:

! Planning monitoring and controlling the project

! managing the erectors,

! liasing with the main contractor, client and other sub-contractors on site,

! liasing with the professional team,

! agreeing valuations including prices for day works, variations etc and other extras,

! collecting cash,

! resolving conflicts,

! agreeing final accounts, including snagging lists,

! costs and contract programme.

In larger organisations, a contract/project manager often has overall responsibility for the
completion of the contract and a successful financial outcome. In smaller organisations, the
managing director often fills this role.

3.2.2.5 The role of the finance/accounts department

The main roles of the accounts department are:

! to monitor each contract from a financial perspective,

! to prepare regular, at least monthly, contract accounts,

! to provide feedback immediately if a contract is not performing,

! to produce monthly management accounts and annual financial accounts for the
company as a whole, and

! to provide the financial backup for other operations, for example, payment of
suppliers and wages, billing of debtors and preparing budget and financial
projections for future years.

The estimator/contracts manager should prepare a budget for each contract. Initial estimates
should be based on the tender, but detailed budgets can be drawn up when the design is
complete. Any significant differences between the tender price and the detailed budget
should be investigated.

When the budget has been set, the financial performance should be closely monitored to
identify any financial problems as soon as they arise. Early identification will give the best
opportunity to take effective corrective action. However, it will be much harder to identify
financial problems if there are many or major variations to the contract.

The monitoring method will depend on the quality of accounting systems in place. Ideally
there should be at least a monthly cost update for each job and that should include
commitments for goods ordered, invoices for materials delivered, labour hours and any
variations etc that have been agreed. In organisations with less sophisticated systems, the
update will be on a less frequent basis. The longer the period between updates, the lower the
level of control and the higher the risk that problems will not be identified before they become
serious.

The accounts department, or the contract manager, is responsible for maintaining all records
that support the work done.

3.2.2.6 Overall responsibility

In most steelwork contracting companies, overall responsibility for the contract lies with a
director, normally the managing or contracts director. This responsibility is frequently
exercised through regular review meetings, at which each of the main departments is
represented. As with any data, financial information is more relevant if it is produced rapidly
as well as accurately. It can then be responded to.

3.2.3 Recording of Variations and Day Works

Given the pressures that arise during the course of a contract, it may seem like the counsel of
perfection, but it is vital that all additional works should be agreed in advance and properly
recorded. This applies to additional works known as variations, extras, or day works. Careful
and accurate recording is required to support the full value claimed. Any defects in the
documentation relating to these additional works done may mean that the work will not be
paid in full.

3.2.3.1 All orders to be evidenced in writing

To ensure orders can be turned into cash, it is essential that the customer issues all orders in
writing. If this does not happen before work begins, it may be difficult to obtain payment.
The customer could claim that the work had not been ordered or was not done to the required
specification.

3.2.3.2 Orders to be costed before acceptance, if possible

As far as possible, any variations, extras or day works that may be requested must be properly
estimated, agreed by both parties and documented before the steelwork sub-contractor begins
the work. Some forms of contract provide for the work to start immediately with the value
agreed after completion.

3.2.3.3 All work to be agreed when complete

To ensure payment is received, and without unnecessary delay, completion of each element of
work should be agreed as soon as practical after it is finished. This will allow the work to be
examined most easily, as it will not have been covered by subsequent parts of the structure.

3.2.3.4 Maintain all documents

All documents relevant to each contract from the invitation to tender to the final negotiations
should be maintained and filed in a logical and consistent manner. This will ensure easy
access to any required document.

3.2.4 How to get paid

There are four important requirements for being paid:

! First, understand the exact mechanism for payments for each contract in progress.
Payments from the main contractor to the steelwork sub-contractor will be governed
by the terms of the legal contract and by the provisions of the Housing Grants,
Construction and Regeneration Act 1996 [also known as the Construction Act].

! Second, allocate clear responsibility for collections

! Third, ensure that the people responsible have enough time set aside to keep on top
of chasing cash.

! Fourth, maintain a central diary of key dates (application for payment date,
valuation date and payment date) for all contracts and monitor that the appropriate
actions have been taken.

3.2.4.1 Applications for payment

The steelwork contractor prepares his applications for payment to cover work done and any
other payments due under the contract. The application details work carried out up to a cut-
off date before the payment due date and should be submitted by the application for
payment date. The customer must provide a notice within a stipulated number of days of the
final date for payment advising how much he intends to pay. If he intends to set-off, he must
provide a notice stating how much and why before the final date for payment. Payment
should be made by the final date for payment, which is a specified number of days after the
payment due date.

Note:
! Payment due =an accepted debt.
! Payment due date =when the payment due should be paid.

It takes skill to produce accurate applications for payment in accordance with the payment
timetable. Accurate records in good order make the task easier.

3.2.4.2 Measurement

During the progress of a job, interim payments are often made based on the value of work
done to a particular date. For this to happen in a controlled and easily understood way, there
are standard mechanisms in place for measuring the work done and valuing it on an interim
basis.

3.2.4.3 Cash flow and profitability effect of payment delays

For some contracts, most of the off-site fabrication will be completed and the bulk of the
steelwork will be erected before the first payment due date. This means that the steelwork
contractor will be financing the entire cost of the steelwork before payment is received.

The effect of any delay in payment is to reduce profits for the steelwork contractor. First he
loses potential interest on the payment and secondly, with less cash in hand, he has less
financial capacity to accept further contracts.

For example, the effect on a 1,000,000 contract of a single 100,000 payment delayed by 60
days is significant. Assuming a 10% cost of overdraft funding the delay would cost 1,666 in
bank interest. This may be a large part of the final profit on the contract.

3.2.4.4 Contract accounting

Contract accounts are designed to report on the financial position over current contracts.
They are designed to show the results for each contract over the life of the contract. For some
contracts, they might cover several years and for others only weeks.

The form and format of these will vary from company to company, but should be designed to
assist the smooth operation of the contract.

3.2.4.5 Write off uncollectable amounts

This might seem a strange side heading within a section entitled How to Get Paid. However,
there is no point in wasting time trying to collect money that you will never receive. It is far
better to focus your energy on worthwhile activity.

Leaving uncollectable amounts on the contract or debtors ledgers gives a false impression of
the financial position of the company. It will overstate profitability, possibly over a period of
several years, and will overstate the asset base. If this information were used to mislead
people outside the company e.g. suppliers or bankers, it would be dishonest and possibly
criminal. On the other hand, if the directors were misled, the effect could be disastrous. They
could over-commit the company to new contracts, resulting in corporate failure.

4. BLOCK 4 THE SALES FORCE

4.1 Finance and Accounting for Selling

4.1.1 Sales are not profits

In the long run it is essential that all sales, which are made, and tenders that are won are at
prices that allow a realistic possibility of a profit on the contract after payment of all relevant
costs and overheads.

It is easy to sell constructional steelwork if the price does not make a profit. However, these
sales are bad business. Only a few bad sales could be enough to cause the failure of an
apparently secure company.

In order to monitor the short-term all sales and tenders should be subjected to the test: Does
this contract exceed the current required profit margin of the business?.

A constructional steelwork company should not normally be operating a sales commission or
bonus scheme that rewards the acquisition of loss making contracts.

4.1.2 Focus on profit and cash

There is a fundamental conflict in some companies - the sales force wants to sell but takes no
responsibility for the subsequent delivery of the contract and collection of the amount due.
This is understandable but inefficient. An approach more focussed on profits and cash
collection as well as sales will be to the long-term benefit of the sales staff and the rest of the
companys employees.


4.2.1 What are you Selling?

The most effective sales force will have a clear understanding of the type of contracts and
customers [i.e. main contractors or clients] that are being targeted. The focus may be on:

! the type of work that has been most successful for the company,

! the type of business sector that has provided the best customers, or

! the sector that is providing the most work in the current market.

It will be for the board to determine, with input from the sales force, what contracts and
customers should be the companys targets.

4.2.2 Basic Credit Control

4.2.2.1 The objectives of credit control.

The primary objective of credit control is to reduce the business risk taken when credit is
extended to customers. In the case of structural steelwork, the customer is the client or the
main contractor.

However profitable a contract looks on paper, the profit can only be certain when cash has
been received for all of the amounts due. If you arent paid, you make a loss.

When contracts are being sought, the ability of the customer to pay the steelwork contractor
should be taken into consideration. There is no point in submitting the winning tender if the
customer is about to go bust.

In a high margin business, the cost of providing the service that is at risk from non-payment
may be so small that continuing to supply failing customers is good business. Telephone
companies are a good example. The marginal cost of switching a telephone call using current
technology is close to zero. Thus, any payment received for the supply of telephone
connections is more or less all profit. There is no point in refusing supply until there is no
possibility of being paid. Although non-payment reduces profit compared to being paid, any
payment increases profit compared to not making the supply.

However, constructional steelwork is different. Net margins are low and the marginal cost of
most work is a significant proportion of the amount invoiced. Therefore, any significant
underpayment for work carried out will have major impact. In some cases, a significant under
recovery will lead to a loss on the contract.

4.2.2.2 Credit checking and monitoring

If you deal regularly with a customer, you come to know how quickly he pays what he owes
and his general credit-worthiness. Care should be taken with known bad payers - in the worst
cases, it might be better to not deal with them.

It is possible to make enquiries from specialist credit-check organisations about the credit-
worthiness of trading companies. The best known is Dun & Bradstreet, but there are several
other similar organisations. They will normally give a credit rating based on their assessment
of the companys financial position and its reported performance in paying its bills.

Credit ratings are not guaranteed, but they do give a good indication, particularly at the
highest levels of risk. If a potential customer has a bad rating, you would be ill advised to
seek work from him, except as a last resort. Credit ratings should be obtained and evaluated
for potential new customers before the tender process commences.

In steelwork construction, payment depends to some extent on the financial stability of both
the client and the main contractor, whatever the contractual arrangements. If either fails,
there is a risk that the failure will bring down the other. Some contracts used to make
payment from the main contractor dependent on receipt of payment from the client.
Following recent changes in the law, such provisions are no longer enforceable unless they
relate to the ultimate customer becoming insolvent. However, failure of a client is likely to
delay payments up the supply chain.

4.2.2.3 Credit insurance (If the insurance company will not take a risk should you!)

It is possible to obtain insurance against non-payment of bills in the UK and overseas. The
risks overseas may include the political risk that the government will dictate who can be paid
or not or that they might declare war.

The cost of credit insurance has to be weighed against the companys estimate of the risk.
This might be assessed overall or on a contract-by-contract basis. There are valid financial
arguments for either approach. However, if insurance is normally taken, and if cover were
refused for a particular company, it would be perverse to proceed with the contract. Insurance

companies are in business to take this risk. If they will not do so, it would be foolhardy for a
steelwork contractor to try.

4.2.2.4 Try to avoid retentions

Retentions are becoming less common as more use is made of retention bonds to cover the
customer against non-performance by the steelwork sub-contractor.

Steelwork contractors derive a number of benefits from the use of retention bonds:

! Cash flow is generally improved; the delay in receiving the final payment should be
substantially reduced,

! There is less incentive for the customer to argue about spurious minor defects to
delay the final payment.

! There will be lower administrative costs without having to pursue retentions.

A possible problem with retention bonds is that bank charges will continue to run until the
bond is physically returned to the bank or insurance company unless the bond specifically
states otherwise. The administration system should be amended to ensure that the return of
bonds is standard procedure at the completion of each contract.

Where possible insurance bonds should be used they will normally be more economical than
bank bonds and carry much less risk.

Note that bonds in themselves do not reduce a companys working capital and may reduce the
companys bank borrowing facilities.

4.2.3 Recording of Variations, Extras and Day Works

4.2.3.1 All orders to be costed before acceptance

Most contracts will require some amendments to the work agreed after the design is finalised.
This could be to address unexpected problems or from changes requested by the customer.
The description of the extra work depends on its exact nature, but it may be known as
variations, extras or day works.

Variations should be properly costed to ensure that they are profitable. The price must be
agreed with the customer and the order confirmed in writing by a properly authorised person
before work commences. Any extra work should be included within the main contract and
not as a separate contract. This will ensure that all of the standard terms apply.

For contracts and changes, the pricing must be timely and accurate. The customer must agree
all changes, and the steelwork contractor must maintain proper records.

This goes back to the point made at 4.1 above, selling is very important, but collecting the
money and making a profit are even more important.

4.2.4 Monitoring business performance

It is very important to monitor both profitability and cash flow. By doing so, you will be able
to identify any financial problems on contracts early enough for corrective action to be taken.
The information will also assist effective cash flow planning, so that investment and contracts
that would exceed the cash limits of the company are not taken on.

Good quality monitoring also corroborates the accuracy, or inaccuracy, of costings and
tenders. Careful analysis of costs actually incurred will allow more accurate tendering for
future contracts.

4.2.4.1 Plan bids with a clear understanding of the current position (how much spare
capacity)

When preparing a contract tender, it is essential to know the capacity utilisation already
planned for the period that the tender covers. This will include:

! tenders won with an allowance for lost tenders

! tenders already submitted and likely to be won.

! programme stoppage on existing contracts.

If most of the capacity is committed, a higher tender might secure a good profit for the last
slice of capacity without risk if the tender is not won. If however the capacity utilisation is
projected to be low then a lower bid might be justified to get some work in.

The other capacity that is equally important is the financial capacity of the steelwork
contractor. The work in progress [WIP] and debtors have to be financed until cash is
received. For many contracts, all of the off-site fabrication will be completed and the bulk of
the steelwork will be erected before the first payment is received. Care must be taken to
ensure sufficient cash flow to finance all current and planned contracts in addition to any
projects which are to be tendered.

5. BLOCK 5 ACCOUNTS AND ESTIMATORS

5.1 Finance and Accounting Concepts

5.1.1 Fixed and Variable Costs [This section amplifies detail given at Section 3.1.4]

A steelwork company has some costs that vary directly with the company output they are
known as variable costs or direct costs. Other costs continue irrespective of output; they are
called fixed costs or overheads.

Variable costs include all items that are bought in for and can be directly allocated to a
contract, e.g. steel, sub-contract items and paint. Intangible costs such as finance are also
included. Direct labour and machine time for the contract are generally allocated as variable
costs, but some companies would argue that wages and machine cost are fixed in the short
term.

Fixed costs include all other costs of the business. Typically, they include the costs of the
sales office, property, administration and cleaning. Each contract has to pay a contribution
out of the direct profit towards the fixed costs. However, it is worth noting that if there is a
substantial increase in production, more buildings and a larger accounts department will be
required; so the fixed costs will vary in the long-term.

Different companies split their fixed and variable costs in different ways. Most of them will
produce acceptable accounting solutions, but some will be more accurate than others. There
is no one correct solution. Companies will use the system the directors believe is most
appropriate for their business, management style and, to some extent, the accounting systems
in place.

All of the costs, both fixed and variable, have to be recovered from the sales for the business
to make a profit. So, when contracts are budgeted or profitability calculated, all of the costs
have to be allocated. Almost by definition, the variable costs can be allocated directly to
contracts, but fixed costs have to be allocated by indirect means.

The most common methods of allocation would be based on the number of tonnes of steel or
the number of man-hours for each contract. The fixed cost to be charged per tonne or per
man-hour is derived by dividing the total annual fixed costs by the total annual budgeted
throughput in tonnes or man-hours.




[The section below, in italics, is a repeat of information given in Section 3.2.1.2.

When you perform a task, it will take time and effort to ensure that the job is done properly,
that all the paperwork is in order, and that necessary documents have been retained and filed
correctly. You may think this incurs unnecessary expense.

However, if any task has to be repeated, its cost will at least double. Often it will cost
considerably more, because the event being recorded will not be fresh in peoples minds. The

paper work might have been mislaid or lost and the effort might be much greater. If the task
needs to be recreated significantly later, it might not be possible at all.

5.2.1.2 Perfect planning prevents pathetic performance (PPPPP)

This rather slick acronym does actually convey a very useful message. A small amount of
time allocated to planning will often save large amounts of time later. A well-run company
will allocate part of management time to making plans for the future. Of course, in a
competitive and fast moving market, any planning must be flexible.

5.2.1.3 In a low margin business, profit is won and lost in the office

This is not intuitively obvious, but in a low margin business attention to detail, cost control
and collection of outstanding amounts quickly has much more effect on the final profit than in
a high margin business.

By way of comparison, in a high margin business the cost per individual sale is low in relation
to the sale value. In extreme cases the cost of a sale is almost nil, for example a single
telephone call or sale of software over the Internet. In this case, the best approach to a
prospective sale is to do a very basic credit check and make the sale. Any money received is
almost all profit, and the true cost of bad debts is, at most, pennies.

However, in a low margin business such as constructional steelwork, the opposite is true.
Any significant non-payment or bad debt will adversely affect profitability, as the costs
incurred for each sale are substantial. Also as each element of the contract has to agreed and
billed separately, supported by all the correct paperwork, there are many opportunities for
delaying or missing payments. Remember the customer may take the opportunity to delay or
even to avoid payment.

In these circumstances, whilst performance of the physical aspects of the contract is
paramount, the performance of office tasks is more important to profitability than is
commonly recognised. If they are performed particularly badly, the company could fail.

5.2.2 The importance of credit control

The construction industry tends to be highly competitive and tender driven. This leads to low
profit margins and high levels of business failure. Exposure to failure of the client or main
contractor is an inevitable risk factor in doing business. Care needs to be exercised to reduce
the risk to an acceptable level by focussing on the credit risk.

5.2.2.1 If you dont get paid you make a loss

It doesnt matter how good the contract price is; if you arent paid then you will make a loss.
In a low margin industry such as steelwork construction, the loss of even a small part of the
payment will severely affect profit. So will a long delay in receiving payment, because of the
costs of financing the outstanding debtor until payment is received.


The payment record of any long-term customer [i.e. main contractor or client] can be kept
under review by comparing due and received dates for undisputed invoices, and the numbers
of spurious disputes can be monitored.

However, this is not the full picture. It should be supplemented by external checks on, for
example, trade references, credit references and company accounts. Special care should be
used for new customers.

5.2.2.3 Credit insurance

It is possible to obtain insurance against non-payment of bills in the UK and overseas.
Company policy will determine whether credit insurance is used.

5.2.2.4 Collection techniques

The most important point in credit collection is to ensure that the work done meets the
specification and the client is satisfied. The next most important is record keeping. This
relates both to the original records of work done and records of collection attempts.

It is essential to agree with the debtor the amounts outstanding. Collection is difficult or
impossible if they are in dispute. Responsibility for agreement of amount outstanding,
collections and chasing debts should be clearly allocated. It is preferable to allocate
responsibility to a named person.

If a cheque is promised on a date then chase the same day if it is due to be hand delivered but
chase the next day if it is a postal delivery and it does not arrive. Let the customer know by
constant chasing that the receipt of payment is important. Keep up the pressure; dont allow
them to think that you are an easy touch. Try to collect interest from persistent late payers.
Note that if a company is paying 10% interest to borrow money, a six-month delay in the full
contract payment may wipe out the profit on a contract.

In most types of businesses, it is relatively easy to suspend supply if customers fall too far
behind in their payments. However, in constructional steelwork, much of the cost of a
contract is incurred before any payment is due. In a small or medium sized contract:

! all of the drawing office cost, fabrication cost and much of the erection cost will
have been incurred before the first valuation date,

! most of a further months work before the first payment is received,

! there is a second months work before the first payment is overdue.

On many smaller contracts, the work will be complete or substantially complete at this point.
There is little, if any benefit in taking staff off site and there is a risk of penalties for delay
and/or non-completion if work is not finished. Reference will need to be made to the contract
before any decision is taken. Specialist legal advice might be appropriate. In some cases, it
would be cheaper for the main contractor to get another steelwork sub-contractor to finish the
work and seek to avoid payment altogether. Given the weakness of what, in many cases, is
the most effective remedy against late payers, extra care should be taken to ensure that the
main contractor would be able to make payments as they fall due.

Where there are opportunities for repeat business, the payment record of the customer can be
taken into account when deciding to whether to tender for the project at all. It is also possible
to consider if the pricing should include an element to reflect the payment record. However,
this will not be a common occurrence for most steelwork companies, as by increasing the
tender price the contract may be lost.

5.2.3 Selection of contracts for tender

The selection of contracts for tender will be driven by the directors view of the type of
business that the company can currently undertake and the type of work that they wish to
undertake in the foreseeable future. It will also be driven by shorter-term consideration such
as work currently available and the current and projected capacity utilisation.

Most tenders have to be prepared very quickly. Therefore, it helps if everyone involved in
tender selection and preparation understands what types of contracts the company is seeking,
and those that it does not want.

Factors that will drive the selection process will include:

5.2.3.1 Size of contract

The size of contracts to be considered depends on the physical capacity of the plant, including
available sub-contractors, and the ability of the company to finance work in progress [WIP]
and debtors.

As noted at 5.2.2.4, cash flow on most contracts is negative for 2-3 months from the start of
fabrication until the first payment is received and overall the contract will not be cash flow
positive until the last payment is received. It can be even longer if there are problems with
the contract. It is essential therefore, that the company has the financial capacity [i.e. cash
reserves and agreed borrowing limits] to be able to finance the contract even if payments are
delayed. It will be easier to decide whether to accept the contract if the accounts department
is able to produce credible overall cash flow projections.

The second financial aspect to be considered is the level of risk in the contract. If the
company loses money on a contract, the company reserves will fall by the amount of the loss.
If the loss exceeds the reserves, the company will have a negative value this could lead to
failure of the company. It follows that the larger a contract is compared with the size of the
business, the greater is the risk that problems on the contract will cause the failure of the
company.

The risks involved in steelwork contracting are greater than in many other commercial
activities. Many steelwork contracts could result in losses big enough to sink the company.
Those companies that carry out the largest contracts take this risk each time, but they will
have systems in place to control the risk. Smaller companies have to balance the size of
contract, technical risk and commercial risk to keep the overall risk to an acceptable level.

There is no correct size of job for any given company, but there should be a broad band
covering different levels of size and risk. When considering tender opportunities, it will save
valuable time to ignore those well outside the broad band.

5.2.3.2 Customer (wanted / not wanted)

The company will not always have direct experience or hearsay knowledge of a potential
customer. However, where possible, such knowledge or experience should be taken into
consideration. Customers known to be in financial difficulties or known bad payers would be
less attractive than substantial companies with good payment records. Nevertheless, the
construction industry is notable for the speed at which a customer can change from being a
good to a bad risk.

5.2.3.3 Physical capacity

Physical capacity is the capability of the plant and/or known sub-contractors to accommodate
the job at a reasonable price.

This is essentially a technical issue but is mentioned here for completeness. It becomes a
financial issue if there is cost overrun on fabrication because the contact cannot be completed
on time due to capacity constraints.

5.2.3.4 Bright ideas to reduce costs

Occasionally, tender preparation will indicate that it is possible to reduce steel or labour costs
by using innovative design fabrication and erection techniques. Where it is possible to
produce a structure at a significantly lower cost than competing bidders, this tender should get
the highest priority because it is likely to be successful and profitable. Not all of the saving
has to be given away to the main contractor, just enough to win the tender.

5.2.3.5 Need to fill production capacity

An important short-term consideration in tendering is the availability of capacity both in-
house and with known sub-contractors. If in-house capacity is predicted to be nearly full,
then opportunities can be taken to seek the most profitable work for the final slice of capacity.
However, if the capacity utilisation is projected to be low, and few tenders are likely to be
available in the near future, then a broader approach to tendering has to be taken. A wider
range of contract types and sizes of work will need to be reviewed for tender possibilities.

Careful monitoring of projected workshop capacity utilisation and the likely available tenders
will allow the correct tender strategy to be pursued.

5.2.3.6 Contract types which are profitable

It is necessary to monitor all contracts in detail to establish the profitability of each type
accurately. Analysis of this data will reveal:

! the type of jobs that are profitable and unprofitable for the company

! trends in contract profitability, and

! the customers impact on the company.

This information can then be used to identify the types of contracts that should be focussed on
or discarded.

On the other hand, if there are many opportunities for contracts of a type that have been
unprofitable in the past, the reasons for the overruns should be identified. If the reason for the
overruns is within the control of the company, it might be possible to prevent them recurring
by training or changes in work practice. A change of sub-contractor might be necessary.
However, if the problems cannot be prevented or are completely outside the companys
control - these contracts are probably best avoided.

5.2.3.7 Variations

Different companies have different attitudes to variations. Some regard the possibility of
significant variations as an unacceptable risk, whereas others regard it as an excellent profit
opportunity. The approach will depend on the skills of the company, its attitude to risk and
variations and experience of different contracts. Remember most forms of contracts dictate
that the company may be compelled to perform variations.

Some companies will have had successful outcomes and good profits from contracts with
high levels of variation. Others will have found that high levels of variations lead to under
recovery of costs and or actual losses on contracts.

At one extreme, some companies actively seek out ill-prepared and inaccurate tender
documents. They will aim to put in a low bid to win the contract and then force a high level
of variations at prices that ensure the contract is profitable. They will be comfortable working
with awkward and ambiguous contract terms. This approach requires high levels of skill in
contract management, costing and administration to minimise risk, together with negotiating
expertise to get the variation proposals agreed.

At the opposite extreme are companies that want contracts with only the minimum level of
variations. These companies may be just as well run as their opposites, but their skills and
attitude are fundamentally different. Their technique involves careful planning, tender
documents with complete specifications that minimise contract variations, and efficient
project management. On this basis, the tender can be extremely accurate and low, as there is
no need to allow much margin for error. However, if the customer introduces substantial
variations, there may be insufficient resources to cost the variations accurately or to negotiate
terms advantageously.

Both approaches to variations are equally valid provided they are backed up by the requisite
skill sets and supported by the management decision-making process. The reality is that most
companies will fall somewhere between the two extremes. A few companies will actively
seek out poorly drafted tender documents but there are probably not enough of these to run an
entire business on this basis. On the other hand, few tender documents are so accurately
drawn that there is no possibility of variations arising. Consequently, it is impossible to run a
steelwork business to carry out only risk free work. Companies should determine their
attitude towards variations and risk, and establish the management and support to meet the
level of variations they are likely to encounter.

5.2.3.8 Expansion of range of work

Many companies will wish to expand the range and size of work that they are able to
undertake. In some cases, this expansion will be in a series of incremental increases of size
and skill toward the goal(s) of being able to tender for the largest jobs.

The company should carry out regular reviews of its current successful projects and of market
trends in relation to contracts that are slightly larger or more complex than currently
undertaken. These reviews will help to identify the types of contract that will give the best
opportunity for expanding the range of work in a profitable way.

The expansion should focus on types of work where the market is likely to show the most
growth in the short term. It should also focus on areas where the company believes that its
skills give it a competitive advantage or where few other companies have experience of the
type of project.

A clear vision of the type of project that is being sought will help identify suitable projects.
However, this should not rule out an opportunistic bid if an unexpected good fit arises in a
different sector.

Of course all the other caveats against financial and management over-stretch need to be
heeded.

5.2.3.9 Intangible factors

In a competitive and tender price driven industry, intangible factors such as image and
appearance will be relatively unimportant, but they cannot be discounted entirely. Companies
need some profile to attract further work and invitations to tender. The more invitations
received the more selective a company can be in tendering, and the more likely they are to be
successful and profitable.

The most prestigious and technically interesting jobs are often featured in construction and
steelwork newspapers and magazines. They give companies the opportunity to show off their
skill and performance to the most likely customers. Nevertheless, there will be few prestige
jobs on which it will be worth taking a loss.

5.2.4 Tender preparation and costing

5.2.4.1 Include all fixed and variable costs

Every tender should include fixed (direct) and variable (overhead) costs. It is not enough to
include the direct costs only as the fixed cost of running the business have also to be
recovered, otherwise the business overall will make a loss despite each contract appearing to
be profitable.

The concept of fixed and variable costs are covered in more detail in 5.1.1.

5.2.4.2 Finance costs are project specific

There is a specific and separate cost to financing the expenditure on the contract until
payment is received. It can be estimated by comparing the proposed cost and payment
profiles and calculating the amount being financed each week, possibly with an allowance for
late payment. The finance cost can then be estimated, based on the companys standard
interest rate, which should not be less than the cost of funds to the company.

In this way, unusual and long payment profiles can be accommodated with the cost of
financing properly included in the tender price.

5.2.4.3 Use estimating norms to speed preparation

The use of estimating norms for routine tasks and operations will speed the preparation of
tenders.

The simplest and probably the best way to prepare an estimating norm list is to base it on
actual times incurred on recent contracts.

If a major change does occur, e.g. a new, more efficient machine is acquired, all existing
estimating norms may be invalid.

5.2.4.4 Use supplier price list or costings for bought in items

It saves time and improves accuracy to hold a list of prices for items that are bought-in, or
sub-contracts that are placed on a regular basis. However there is a cost associated with
maintaining price lists. This includes both the time taken and the risk of inaccuracy if the lists
are not properly maintained. Lists should only be maintained for the most frequently used
suppliers and items.

The method of maintaining the price will depend on the nature of the items being bought in.
Where suppliers publish price lists, with volume discounts if appropriate, it will be necessary
only to obtain and hold up-to-date price lists.

Where the items are bought on a tender or negotiated basis, it will not be possible to be as
exact. Nevertheless, a record of recently obtained prices will allow more accurate estimating
for tendering. Care should be taken, because prices can vary widely according to when the
order is placed. Very short notice orders may command premium prices. On the other hand,
if a supplier is desperate for work, he may accept a price well below the market average.

5.2.4.5 Back of an envelope cash flow

There is no point in preparing a detailed tender for a contract that cannot be undertaken
because the company does not have the necessary financial capacity.

Before starting any detailed work, a quick, rough estimate should be made, using the actual
cash flows in the potential contract or similar rule of thumb to determine the likely maximum
combined WIP and debtors for the contract. This should then be added to the estimated cash
flow from definite contracts and a % estimate for contracts tendered but not won, to estimate
the overall future financial position of the company.

This is easier to do if cash flow estimates are already prepared on a regular monthly basis.
Two direct benefits are:

! all that has to be done to estimate the overall position is to add the estimate for the
new tender(s) to the latest cash flow,

! the infrastructure of spreadsheets and other estimating tools are in place and copies
can be used for this purpose.

If the tender is won, a detailed cash flow for the contract should be calculated from the final
design and payment schedule, and should be included in the companys overall cash flow.

5.2.4.6 Can the inputs be ordered at standard price in the time available?

All contracts rely to some extent on bought-in and sub-contracted items. If the bought-in
items are required at shorter than usual notice, or are known to be in high demand and or short
supply, the buyer should check or estimate the likely effect on prices. Any price changes
should be incorporated into the tender.

5.2.4.7 Will changes in design or corrections of specification be properly
compensated?

If the specification is seen to be incomplete, incorrect, or likely to be changed in the course of
construction, make sure that the contract will allow for the recovery of all costs associated
with design changes and corrections.

A contract that allows for the recovery of the costs of variations is only of benefit if company
takes the necessary steps to collect the excess costs from the customer.

5.2.4.8 Will variations be profitable?

An assessment should be made of how profitable the projected variations are likely to be,
taking into account the company's policy on variations and its ability to deal with them. This
is dealt with in more detail in Section 5.2.3.7.

5.2.4.9 Profit margin

When all the costs have been calculated, and other factors have been taken into account, the
target profit appropriate for the job should be added to reach the initial, detailed estimate of
the tender price.

This should be carefully checked to ensure that it does not contain any errors. Over-pricing
will make it harder to win the contract; under-pricing will make it harder to make a profit or
will cause a loss.

5.2.4.10 Adjustments to win tenders

All of the above elements will give a good estimate of the companys likely overall costs and
profit margin for the tender. They offer a good basis for the purely commercial judgement
that has to be applied at this stage. As priced, is the tender likely to win the job?

The initial, detailed estimate should be compared to the likely tenders from competitors. Any
adjustments to win the contract should then be considered.

This final adjustment is normally the responsibility of the directors.

5.2.4.11 Cost of giving retentions vs. bonds

Retentions are amounts withheld from payments due from a customer to a supplier; e.g. from
the main contractor to the steelwork specialist, or from the client to the main contractor. They
are withheld in case of defects being discovered during the defects liability period. They are
usually between 3% and 5% of the total contract price, and are released on completion
(whether that be of the main contract or the sub-contract). They are usually released in two
parts the first half on practical completion of either the sub-contract or the main contract, and
the second half on final completion of the main contract.

On many constructional steelwork contracts, the final net profit [i.e. after allowing for
overheads] is less than 5%. Therefore, in many cases the entire profit is held by the customer
as a retention, long after completion of the steelwork.

The cost to the steelwork contractor is that the retention has to be financed by bank
borrowings or loss of interest until it is received. If interest rates are high, a significant
proportion of the profit will be eaten up by the cost of financing even a short period of
retention.

Inevitably, suspicion has arisen that some main contractors abuse the retention system.

Because of this possible abuse, the industry is moving away slowly from actual retentions
towards a system of retention bonds. Since J uly 2000, BCSA members have not accepted
retentions for any size of contract, but will give bonds for contracts over the value of
100,000. Retention bonds are provided by a substantial financial institution, typically a bank
or insurance company and are essentially a guarantee that if a company is unable to do the
work that would be covered by retention, then the guarantor would provide funds up to the
value of the bond.

However, the best approach will depend on the exact circumstances of the company and
prices quoted.

Bonds obviously have a cost, but this will generally be less than the cost of financing the
retentions. The lower the risk for the bond provider, the less the bond will cost. The cheapest
option [bond or retention] will depend on the financial circumstances of each company.

The retention bond is not a universal panacea to the retention problem but it will be cheaper in
most situations. The total costs of different bond providers and the cost of financing
retentions should be compared before any decision is taken. It should be reviewed on an
occasional basis thereafter, as the comparative costs will vary over time with the overall
business climate and the financial condition of the company.

5.2.4.12 Payment terms

Most contracts for substantial works will allow for interim payments, based on an estimate of
work done to date. For contracts where the work (all work not just work on site) is 45 days or
more, interim payments are required by law.

In general, the valuation is agreed between the main contractor and sub-contractor. The main
contractor will be going through the same process with the client.

In many standard forms of contract, the main contractor will value the work. The main
contractor should then issue the notices required by the Construction Act before payment is
made.

In reality, leaving the measurement of work done to the main contractor can often lead to
under-valuation and/or late payment. Notwithstanding the contractual requirement, it is in the
best interest of the sub-contractor to note the relevant date for valuation and to be proactive in
valuing the work done to the relevant date. First class records of all variations, extras and day
works will allow them to be included in the valuation at the first opportunity, when there is
the best chance of the work being remembered and agreed.

This information is also required for the sub-contractor to prove the value of work done to
date. It will show the main contractor what work has been done, and it reduces the scope for
and likelihood of under valuation and dispute.

5.2.4.13 Agreement of valuation dates in advance

One of the easiest ways to improve payment and cash flow is to agree the payment dates and
terms as part of the contract negotiations. This ensures that there can be no argument about
the dates for submission of valuations, architects certificates and payments. These dates can
then be recorded by the sub-contractor and used to proactively manage the payment process.

5.2.4.14 Retentions and retention bonds

See section 5.2.4.13 for detail on retentions and retention bonds.

5.2.4.15 Performance bonds

Performance bonds are provided by a substantial third party, normally a bank or insurance
company. The bond provider agrees to pay the customer up to a fixed sum if the steelwork
sub-contractor defaults on the contract or is subject to an insolvency process.

Like other forms of insurance, the cost of the bond will vary according to the likelihood of it
being called. Care needs to be taken to ensure that the basis on which the bond can be called
is clearly defined, and the same comments apply to performance bonds as apply to retention
bonds (see 5.2.4.11).

There are a number of standard forms, but most will require some sort of counter-guarantee
from the steelwork sub-contractor, which will reduce the financial capacity of the company.

5.2.4.16 Third party warranties

A warranty is an undertaking given by the steelwork contractor to bridge the gap and to
create a contractual liability between the steelwork contract and the third party

Some clients will require third party warranties to be given to purchasers, tenants and funders
as well as to the client, and obligations and liabilities will often be put in the warranty that do
not exist in the sub-contract. Care should be taken that unduly onerous terms are not
accepted, and decisions regarding warranties should be taken in consultation with insurers.

Strictly, third party warranties should not be necessary since the coming into force of the
Contracts (Rights of Third Parties) Act 1999, but their use shows no signs of diminishing.

These types of warranties create a financial risk to the Company and similar care should be
taken when entering into them as with other contract terms.

5.2.4.17 Liquidated damages

Liquidated damages are damages for breach of contract where the amount of damages has
been pre-decided. They are most commonly used for delay, where a rate will often be set for
each week of delay in completing the contract.

Once a rate for liquidated damages has been set in the contract, that is the rate of damages
recoverable whether actual damages are more or less is irrelevant.

A distinction needs to be made between liquidated damages and penalties. Liquidated
damages must be a genuine pre-estimate of the loss likely to occur if the particular breach
takes place. Penalties however, are sums set merely to punish a breach of contract and UK
courts will not enforce them.

5.2.5 Monitoring of contracts and contract profitability

It is essential to monitor the financial position of contracts closely, to identify financial
problems and tackle them as soon as they arise. The appropriate method for monitoring will
depend on the size and complexity of the contracts and the overall size of the company.

5.2.5.1 Regular monitoring of costs

All companies need to carry out regular reviews of their contracts. This takes the form of a
regular meeting to identify any unexpected cost arising on any current contract. Their cause
should be sought and remedial action taken as necessary.

5.2.5.2 Monthly Accounts and completed contracts

With good systems in place and an accurate daily update of costs and income, it should be
possible to produce accurate contract accounts to a fixed monthly timetable. This will enable
a formal review of the position of all of the uncompleted contracts.

5.2.5.3 Valuation of work in progress

Most systems value WIP by adding all the costs and deducting all payments certified and due.
Adjustments for extra payments and sums that cannot be collected are made formally during
the annual audit. However, informal estimates of these adjustments will enhance the benefit
of the rolling WIP valuations.

5.2.5.4 Monthly monitoring of progress against budget

The risk of a contract going seriously wrong increases as the frequency of review decreases.
Progress reviews should take place at least once per month.

5.2.5.5 At the interim stage, good contracts can show a loss, bad contracts can show a
profit

Most contract valuations can give perverse results at an interim stage. The contract accounts
will show all of the costs incurred to date less all payments received.

! Loss making contacts that have high costs and low collections will, on the standard
basis of valuation, have a high WIP. This should not be confused with a profit, as
the collection may be less than the costs incurred.

! Profitable contacts that have low costs and high collections will on the standard
basis of valuation have a low value. Highly profitable contracts may show
collections that exceed costs incurred and have a negative work in progress. This
should not be confused with a loss.

One must be careful when reviewing contract accounts, to ensure that the correct
interpretation is placed on the results. They are a tool that gives usable valuations for average
contracts, but for contracts outside the norm, the valuation can be misleading to the
inexperienced. The true value and likely final profit or loss on each contract can only be
estimated by a detailed review of all the information about likely future costs and collections.
As with any intermediate valuation the future cannot be predicted with certainty.

Adjustments to reflect likely future outcomes will normally be made in preparation for the
annual accounts. Normally future losses would be provided immediately but future profits
would not be recognised until the contract is complete.

5.2.6 Recording of work done, Including Variations, Extras and Day Works

The impact of variations on contracts is discussed at Section 5.2.3.7.

It is essential that all work done, including variations etc, is accurately recorded. Poor
documentation risks part-payment or non-payment of that particular element of the work.

5.2.6.1 Written instructions

[The paragraph below, in italics, repeats information given in Section 3.2.3.1. It
is included here for completeness, and may be used as revision, if required.]

It is essential for the security of subsequent collections, that the customer issues all
instructions should be in writing. If this does not happen before work begins, it may be
difficult to obtain payment. The customer could claim that the work had not been ordered or
was not done to the required specification. For variations issued during the course of the
contract the contractual machinery should be followed to the letter. On-site, with deadlines
to meet, there may be great pressure on site staff to work on without written instructions.

As far as possible, any variations, extras or day works that may be requested must be properly
estimated, agreed by both parties and documented before the steelwork sub-contractor begins
the work.

It is not always possible for variations to be costed before acceptance. Some forms of
contract provide for work to be started as soon an instruction to do the work has been issued.
The work is then valued often after the work has been completed.

To meet this situation, the steelwork contractor must have systems in place to price requests
for extra work quickly and accurately. The relevant paperwork must also be produced
without delay being attributable [and chargeable] to the steelwork contractor.

The quality of these systems should be monitored regularly. Calculated prices should be
compared with actual costs, and the results used to refine the estimation tools. In this way,
quoted prices will be realistic, profitable and recoverable.

5.2.6.2 Apply for payment for all work on completion

Applications for payment should be made at the earliest opportunity after work is completed
and agreed. This action will help ensure payment of the amount due.

5.2.6.3 Maintain all documents

Failure to keep proper records is a frequent reason for diminished profit on a contract.
Without a full set of documentation, it might not be possible to collect payment for all work
performed. It must be stressed therefore, that all documents relevant to a contract, from the
invitation to tender to the final negotiations, must be maintained and filed in a logical and
consistent way. This will ensure easy access to any required document.

Even when a contract is complete and all outstanding amounts have been collected, the
documentation should be retained in good order (e.g. for CDN regulations etc). It will then be
available in case of any unexpected late claims in relation to the work done.

5.2.7 How to get paid

[The section below repeats and amplifies information given in Section 3.2.4.]

There are five important requirements for being paid:

! First - understand the exact mechanism for payments for each contract in progress.
Payments from the main contractor to the steelwork sub-contractor will be governed
by the terms of the contract, and by the provisions of the Construction Act. The
contract terms must be known and understood to obtain full payment at the earliest
opportunity.

! Second - allocate clear responsibility for collections. Without this there is always
the risk that collections will not be handled with sufficient vigour. The blame for
late collections could be passed around.

! Third - ensure that the people responsible for receiving payments, either the contract
manager or the accounts staff, have enough time set aside to keep on top of chasing
cash. As noted earlier, the conversion of work to debtors and debtors to cash is
essential to allow the wages and suppliers to be paid. There is a tendency to under
estimate the importance of this task and the time it takes to do it.

! Fourth - maintain a central diary of key dates, due date, architects certificates due
payment date for all contracts and monitor that the appropriate actions have been
taken. It is essential that the monitoring is regular and consistent. The knowledge
that collections are closely monitored will normally improve performance.

! Fifth - be prepared to use adjudication for late payments or under valuation, it is
quick effective and inexpensive.

Keeping a consistent focus on collections will not only help to ensure you receive payments
promptly but also that they are actually received.

5.2.7.1 Applications for payment

[The paragraph below, in italics, repeats information given in Section 3.2.4.1. It

The steelwork contractor prepares his applications for payment to cover work done and any
other payments due under the contract. The application details work carried out up to a cut-
off date before the due date for payment. The main contractor/client must provide a notice
within 5 days of the due date advising how much he intends to pay. If he intends to set off he
must provide a notice stating how much and why before the final date for payment. Payment
should be made by the final date, which is a specified number of days after the due date for
payment.

It takes skill to produce accurate applications for payment in accordance with the payment
timetable. Accurate records in good order make the task easier.

The exact form of the application for payment will depend on contract in use.

Some standard forms of contract require that an application for payment be made, and often in
that case, if no application is made, there will be no payment. However, even if an
application for payment is not required by the contract, it is good practice to submit one. The
steelwork contractor knows in detail what work that has been done. His detailed application
will help the main contractor to agree the amount due for payment, and will reduce the risk of
under-valuation in assessing interim payments.

Note that export contracts may not be covered by the Construction Act, although if a standard
form is used, the company may have similar protections contractually.

5.2.7.2 Measurement

[The section below repeats and amplifies information given in Section 3.2.4.2.]

Interim payments are normally made on contracts lasting over a month and are now legally
required for contracts lasting in excess of 45 days. Where made, they are normally based on
the value of work done to a specified date(s) or milestones. There are standard mechanisms
for measuring the work done and for valuing it on an interim basis.

Interim payments do not affect the overall contract payment. Their effect is solely on the cash
flow; they determine when money is received. When the contact is completed satisfactorily,
all amounts, except retentions [if applicable], become payable. However, cash flow
consequences can be severe as described in Section 5.2.9.6 below.

5.2.7.3 Payment cycle

The payment cycle will vary between contract types and the exact number of days and due
dates will be part of the contract negotiation. The outline payment cycle below relates to the
standard form of domestic sub-contract DOM/1/2. But it is a good approximation for the
payment cycle for most standard forms.

Payment cycle for the DOM/1 and 2 standard contracts

This payment cycle will repeat every month until the contract is complete. If retentions are
used the final payment in this cycle will be subject to the final retention. This will normally
be paid in two tranches after practical completion of the sub-contract and after issue of the
Final Certificate under the main contract.

5.2.7.4 Negotiation of amounts due

The approach to negotiation of amounts due will depend on the circumstances of the contract
and the attitude of the customer and any history in the negotiations.

Quite often, there will be genuine difference of opinion on the value of variations done or
how long it took or should have taken. In these circumstances, it is normally best to discuss
all such items as soon as possible. Resolution by negotiation is always the best option where
it is possible.

Where it is not possible to resolve disputes by negotiation, consideration should be given to
adjudication (see Section 5.2.9.3). Some specialists believe that adjudication should be
sought promptly from the first problem that arises, to show that disputes are going to be taken
seriously. This can work, but it is a high-risk strategy as it risks alienating the other party to
the contract.

5.2.7.5 Cash flow and profitability effect of payment delays


For some contracts, most of the off-site fabrication will be completed and the bulk of the
steelwork will be erected before the first payment due date. This means that the steelwork
contractor is financing the entire cost of the steelwork before payment is received. This is
effectively dead money - it cannot be used for anything else. When payment is received, the
capital is then freed up to finance further contracts.
Commencement
of Contract on
site
Due Date for 1st
payment
Final date for 1st
payment
One Month 17 Days
7 Days 5 Days 5 days
Valuation
Date
Payment
Notice to
Subcontractor
Witholding
Notice to
Subcontractor
Elapsed t ime on contr act

The effect of any delay in payment is to reduce profits for the steelwork contractor. First he
loses potential interest on the payment and secondly, with less cash in hand, he has less
financial capacity to accept further contracts.

The effect of payment delay is to reduce profits. Credit interest will be lost or overdraft
interest must be paid on the outstanding balance, from the due date until the day the payment
is received.

However, for most companies there is more at stake. The longer the delay, the greater the risk
that the customer may face unexpected financial difficulties. For the steelwork contractor
there is the consequent risk of further delay or non-payment. In some cases, the loss could be
substantial.

Even if the payment delay does not lead to non-payment, losses could be much greater than
they would appear at first sight. Every contract where there is significant delay in payment
reduces the financial capacity of the company to take on new work. If it prevents a highly
profitable contract being taken, the impact could be considerable. In a worst case, so much
capital could be tied up in unpaid invoices and in financing current contracts, that there would
be insufficient to finance new work. The result could be corporate damage or worse.

The underlying message is to pursue all outstanding payment with vigour as soon as they are
due. At the same time, it may become necessary to decide whether to accept a smaller
payment immediately rather than wait indefinitely for the full amount.

5.2.8 Monitoring and collection of retentions

The increasing use of retention bonds is reducing the importance of monitoring and collecting
retentions.

5.2.8.1 Record keeping is the key for collecting retentions [See Section 2.2.3.1 for
detail.]

Good records are the key to collecting retentions. An effective diary system will warn of
retentions becoming due for repayment. When they are, they should be requested and then
chased actively.

5.2.8.2 Allocate clear responsibility for collections

For each contract, the collection of retentions should be clearly allocated to a single person.

5.2.8.3 Monitor retentions monthly

The monthly review meetings should monitor the collection of all outstanding retentions.
Appropriate action should be taken to ensure that they are collected as promptly as possible.

5.2.9 Monitoring of retention bonds

There are two types of retention bonds commonly used in the industry.

First - a company can give a bank bond which acts as collateral and is treated as a facility
given to the company by the bank. It is effectively treated as a borrowing facility for which a
fee is paid to set it up and for which a second fee is paid if it is drawn on.

Second - a company can arrange a bond to customers via an insurance facility. This is the
mechanism which is recommended by the BCSA. It does not normally mean the company
being involved in a credit facility in the way a bank bond is.

In the case of both insurance and bank bonds, the company needs to monitor the positions
carefully to reduce the cost of bonds. They are normally charged for on a basis that is related
to time and total value of the bonds given.

Please note that these comments apply to all forms of bonds.

5.2.9.1 Record keeping

Detailed records of all bonds in issue must be maintained. Each record should include the
date of issue, issuer, value, other parties, date due for return, costs and assets on which the
bond is secured.

5.2.9.2 Return of bonds

The charge for the provision of bonds continues whilst they are in issue. They normally have
to be returned to the issuer for the charges to stop accruing. Procedures need to be in place to
ensure that as soon as a bond is no longer needed, it is collected from the customer and if
appropriate returned to the issuer.

This gives two benefits:

! the charges stop running, and,

! it releases finances for other uses or as security for further bonds.

It is increasingly common that bonds expire on a set date or event. However, it is still good
practice to have a clear record of these bonds.

5.2.10 Budgeting and cash flow forecasting

A business must be managed to ensure that it is profitable and that its cash flow is sufficient
to pay its debts as they fall due. This includes for example suppliers, taxes and wages.

An essential element is the preparation of monthly budgets and cash flow projections. They
should take account of the timing differences between making a profit and the payment and
receipt of cash.

5.2.10.1 Profit is not cash

[The section below, in italics, is a repeat of information given in Section 3.1.2. It

Profit is the difference between all the costs and all the income from a project or business. It
includes all items, whenever they arise. However, costs and income occur at different times
in all businesses. Materials must be bought, and usually have to be paid for, before saleable
items can be produced. After an item has been produced, there is often a wait for before it is
sold, and again before payment is received. If there is not enough cash in the business, the
material cannot be paid for until cash is received from sales, and the suppliers act to recover
what is owed.

This is a particular problem for steelwork contractors because long duration projects are
common and payments are often delayed.

5.2.10.2 Setting up budgets

All budgeting should start with an estimate of the work that the company will perform over
the next six months at least. The projection should be broken down into weekly or monthly
blocks. The length of projection may be set at anything from a few months to a few years; it
will depend on the size of the business and the length of the order book.

Sophisticated accounting and contract management packages can produce budget figures, but
many companies prefer to use a Microsoft Excel type of spreadsheet. In the hands of an
experienced user, they are good enough for all but the most complex and sophisticated
budgets. Additionally there are software packages specifically for producing budgets and
projections, some of which integrate with PC-based accounting systems.

5.2.10.3 Converting budgets to cash flows

Having established the future activity of the company, each element of the budget should be
reviewed to see when the cash flow for each item will occur. To do this: Large items, such as
receipts due on contracts have to be projected individually. These will need to be updated
regularly as new information becomes available and new contracts are added. Regular
payments such as lease and HP can be easily projected but; watch the start and end dates.
Wages can be similarly projected but; watch out for overtime, starters and leavers. For small
purchases, it is better to use projected purchases and an average number of days credit taken
rather than to try to try to predict each supplier individually.

The cash flow can then be projected on a periodic basis. For longer-term cash flows a period
of one month gives a reasonably accurate projection without excessive work. Some
companies will use weekly cash flows for the immediate future. The value of this degree of
precision will depend on the number and size of the receipts and payments and their
relationship to the bank balance or overdraft facility.

Each projected receipt and payment can be allocated an anticipated date. Thus for each
month the cash increase or decrease can be projected by adding all the receipts and deducting
all the payments to show the net movement. If the projection starts with the current bank
balance or overdraft, the cash balance or overdraft for each week or month end can then be
projected by adding or subtracting the net movement in the month.

The layout of a simple cash flow is shown in Part A, Section 5.

Cash flow projections are a useful tool, but care should be taken to ensure that any large items
occurring during the period would not drive the balance to an unreasonable level. For
example: Cash flows would typically show the cash or overdraft balance at the month end. If
1m is paid out at the start of the month and 1m is received at the end of the month. The
month end figures will look fine but there is 1m less in the bank or 1m extra overdraft for
most of the month. In the case of an increased overdraft, the bank might not allow this.

5.2.10.4 Cash is king

Companies dont call in the receivers or go into liquidation because they are making losses.
They fail because they cannot pay what they owe when it is payable.

The money to pay the bills could come from an in credit bank account or from an overdraft.
However, overdrafts are not an unlimited source of funds they will be limited to the assets

available to secure them normally by what is called a debenture on the on the companys case.
An additional risk is that most overdrafts are repayable on demand this includes all
overdrafts from the major clearing banks. These overdrafts can often be withdrawn at short
notice if the bank changes its mind. This is likely to happen if the bank becomes concerned
about the financial condition of the company, or occasionally the industry as a whole.

5.2.10.5 Monthly monitoring of budgets and cash flows

The projected budgets and cash flows should be reviewed regularly. As a minimum, they
should be reviewed formally each month, in association with the contract and tender review.
Current contract performance is the dominant factor in drawing up the budgets, achieving
satisfactory cash flow and assessing the capacity of a company to take on further work.

Producing budgets without monitoring performance means that the company does 75% of the
work for only 5% of the benefit.

5.2.10.6 Cash management and treasury

The company needs sufficient cash or borrowing capacity to pay bills as they become
payable. At the same time, surplus cash should be invested to get the best return without
locking it up for too long. Balancing these two requirements can be a substantial task; in a
large company, it is likely to be the main responsibility for a nominated individual or
department.

5.3 The effect of taxation

Company managers must consider the effect of taxation on every aspect of the business.
There are substantial cash flows associated with the tax system. Apparently similar actions
can sometimes have quite different tax consequences. Where transactions are contemplated
which are outside the normal business and outside the expertise of company directors or
employees, specialist advice should be sought at the earliest opportunity. Preferably, before
the transaction is started in order to maximise flexibility in structuring the transaction.

5.3.1 Basic Corporation Tax

Corporation tax is payable on all profits of a company.

Adjustments are made for capital expenditure and disallowable items such as entertaining.

For a small company, the tax is payable 9 months after the companys year-end. For larger
companies, a system of payments on account is being introduced and payments have to be
made based on estimates of the companys current years profits with a final adjusting
payment after the year end. Penalties and interest payments are levied on the almost
inevitable errors that will occur on the payments on account.

For Financial Year 2001/2002, the rate of corporation tax for small companies with profit less
than 300,000 is 20%. For companies with profits over 1,500,000 it is 30%. For companies
with profits in excess of 300,000, and less than 1,500,000, there is an effective marginal
rate of 32.5%. [Such companies pay tax at 20% on the first 300,000 of profits, and 32.5%
on any additional profit up to 1,199,999.] Where a company is part of a group the upper and
lower limits for each company are divided by the number of companies in the group.

5.3.2 Basic Value Added Tax [VAT]

VAT is chargeable on most goods and services provided to or by the constructional steelwork
industry. This is a complex tax with several different rates, including Zero Rating and
Exempt Goods. Different rates may be chargeable for goods that have only very small
differences between them.

The standard rate is 17.5%, but other rates are 5% and 0%. Some goods or services can be
exempt or out of scope.

VAT is added to sales invoices and collected from customers. At the same time, it is added to
suppliers' invoices and paid to them. Most companies account to HM Customs and Excise
every three months for the VAT amounts collected less the amounts paid.

5.3.3 Basic Pay-as-you-earn [PAYE]

Employers are obliged to deduct income tax from wages and salaries paid to employees.
[This system is known as Pay-as-you-earn (PAYE)]. The deductions are based on tables
supplied by the Inland Revenue, although most payroll systems are now computerised.

Employers also have to deduct money as the employees contribution to cover National
Insurance. Again, deductions are based on tables supplied by the Inland Revenue and in most
cases integrated into computerised payroll systems. In addition, there is an employers
contribution of 12.2% of all wages.

The PAYE income tax and National Insurance contributions should be paid to the Inland
Revenue by the 19
th
day of the following month. Final returns and payments for the year have
to be made by 19 May.

There are complex provisions relating to non-cash benefits, which are subject to tax, National
Insurance and employers contribution. These are reported on a P11D.

5.4 The Role of Insurance

Insurance is an important factor to the constructional steelwork industry. Some types of
insurance are required by law and by the standard forms of contract.

Companies may wish to take out insurance other than the minimum required by law and
contract.

5.4.1 Legal requirements

Employers liability, public liability and road traffic act insurance are all required by law.

5.4.2 Employers liability

Employers liability insurance is required under the Employers Liability (Compulsory
Insurance) Act 1969. The legal minimum cover is 5,000,000, but it is normal to insure for
larger sums.

5.4.3 General

Contract insurance matters, including the area of design liability, are both highly complex and
rapidly changing. Expert advice should be sought regularly to ensure adequate and
appropriate cover is in place for all the companys activities.

5.5 Contract accounting


Until now, we have considered only financial accounts. Financial accounts are normally
prepared on an annual basis and provide a snapshot of the current situation once a year.

However, we have a tool contract accounts designed for keeping financial control over
current contracts. Contract accounts are designed to show the results for each contract over
the life of the contract. For some contracts, they might cover several years and for others
only week s.

Contract accounts are often used to project future cash flow for individual contracts. These
projections can be combined to project cash flow for the entire company.

Contract accounts are separate from but closely related to the main financial accounts.
Indeed, all source figures used in contract accounts are also used in the financial accounts.

The method of constructing contract and financial accounts depends on the accounting
systems employed. Sophisticated systems will construct both contract and financial accounts
simultaneously. Other systems may construct the financial accounts from the contract
accounts or vice-versa. However, it would unwise to try to prepare contract and financial
accounts independently of each other.

5.5.1 Accounts for life of contract not for accounting year

The method for maintaining the contract accounts will vary from company to company. The
most sophisticated accounting systems will have integrated contract ledgers (also known as
project ledgers). In these systems, the costs and income are entered once only, and are posted
to both the financial and contract accounts at the same time. This saves time as items are only
posted once, and the financial and contract accounts are always aligned.

Many accounting systems can make orders and hold them in the system as commitments
(goods not delivered) or accruals (goods received not invoiced). In this way, the overall
financial position is always available. Budgets can be held at both a financial and a contract
level, which allows easy identification of projects that are over budget.

5.5.2 Records of all income and costs on a contract

The contract accounts contain records of all direct income and costs on a contract. These in
turn give the direct profit on the contract, also known as the contribution to overheads, after
adjusting for WIP.

5.5.2.1 Different method of allocation

The definition of fixed and variable costs changes between companies. It will depend on the
view of the best split taken by the directors and the ability of the accounting system to provide
information.

At one extreme, some companies will price all individual design costs, employee hours,
machine time, transport and individual materials.

At the other extreme, all works costs except direct steel purchase are treated as an overhead.
They are allocated to jobs on a price per tonne of steel basis.

5.5.2.2 Not one right way

There is no correct way of allocating overheads. As long as all of the costs are recovered over
the contracts then the method is suitable.

However, the more complex the mix of work, the less effective the price per tonne basis
becomes.

5.5.2.3 Most will come to same result but will affect tender prices

Some systems of overhead allocation have to be used with caution. They can generate poor
tenders. If labour is included as an overhead, allocated on a price per tonne basis, it will give
accurate tenders if the contracts are for similar structures. If, however, the contracts are very
different, inaccuracies will occur.

For example, if a company allocated labour to contracts as overhead based on their tonnage
assuming them to be of medium complexity. A few heavy but simple jobs would be allocated
unreasonably high labour overheads whereas a similar number of light but complex jobs
would be allocated very low labour overheads. In each case, some adjustments would have to
be made to ascertain more accurately the true cost of each contract and the likely profit or loss
on each.

In this example: If adjustments were not made then heavy simple contracts would tend to be
overpriced and light complex contracts would tend to be under priced.

5.5.3 Management accounting

This will not include standard costing as defined but is a consolidation of the results of all of
the contracts and other costs to give a reasonably accurate but timely snapshot of the financial
state of the business.

5.5.4 Monthly accounts needed

Management accounts should be produced at least monthly. Over a longer period, the
financial position could change adversely by more than could be easily corrected. The
management accounts would normally be created from contract accounts, after all of them
have been reviewed and adjusted for WIP.

5.6 Understanding the profit and loss account

The Profit and Loss Account shows the financial performance of the company for the period
under review. Profit and loss account might be from the management accounts or from the
annual financial accounts. They are separate but produced from the contract accounts and
management accounts.

5.6.1 Sales/turnover

In most industries, the concept of sales turnover is an easy one. It is the amount of sales in the
year or accounting period. In constructional steelwork, for smaller companies, working on
smaller jobs, this simple concept works equally well. Contracts in progress are included as
work in progress and the sale is recorded in the next period. However, quite a number of

contracts can last many months, possibly well over a year. The larger steelwork contractors,
who usually handle such contracts, have to adjust their turnover figures to take account of the
long duration of these contracts. The sales have to be adjusted for the changes in Work In
Progress to give turnover.

5.6.1.1 What are sales (invoices, WIP movement, retention movement)

For companies with significant long-term contracts, the sales figures in their accounts could
be distorted if the sales were reported only on the completion of each contract. To cater for
these long-term contracts, sales should be adjusted to reflect the movement of WIP. This
should be noted on the accounts.

5.6.1.2 Valuation of WIP in relation to sales

For short-term contracts, the WIP should be valued at cost. For longer-term contracts where
the profit is reasonably certain, the WIP should include an element of profit. This allows the
profit to be recorded in the correct year.

5.6.2 Cost of sales

The cost of sales is the cost of all items that are directly attributable to the production of
articles that have been sold. In the production of constructional steelwork, this will include
steel purchases and coatings. It might also include labour hours or machine time, but as
described below, different companies account for costs of sales in different ways.

5.6.3 Gross profit

Gross profit is the turnover less the cost of sales.

5.6.4 Overheads

In simple terms, overheads are the costs of the business that are not included in the cost of
sales. The split between the cost of sales and overheads varies between companies. Some
companies allocate a high proportion of costs to cost of sales whereas others allocate the
majority as overheads.

There is no correct way to allocate between cost of sales and overheads. Companies have
developed their practices over time to give the best cost/benefit solution for their business.
The greater the cost of sales element, the more accurate will be the allocation to any given
job. However it demands greater effort, more accurate accounting systems and generally
costs more. The balance of advantage will depend on the range of work undertaken. If all
contracts are for standard designs, with only minor changes for clients requirements, there
will be only limited benefit in detailed allocation. On the other hand, if the work were very
varied, with large differences in design and fabrication techniques, the company would
benefit from the accuracy that the detailed allocation of costs would bring.

5.6.5 Profit before tax

Profit before tax is turnover less the cost of sales and overheads.

5.6.6 Net profit

Net profit is also known as Profit after Tax. It is the turnover less the cost of sales, overheads
and corporation tax. It can also be thought of as the gross profit less the overheads and
corporation tax.

5.6.7 Dividends

Dividends are sums of money paid to shareholders in return for their investment in the
company. Dividends are normally paid from a portion of the profits for the current year. The
remainder of the years profit is retained in the business as reserves for future use.

The dividends and sum retained will depend on the profits for the year and future capital
requirements of the business.

If the business makes a loss in a given year, dividends can still be paid against past profits;
they cannot be paid against share capital if no reserves are left.

Dividends are normally paid either annually after the profits or losses have been finalised or
twice a year. In the latter case, the first [or interim] dividend is based on estimated profits for
the year, whereas the second [or final] dividend is based on the actual profit figures.

5.6.8 How does profit get into the balance sheet

The amount of profit remaining, after the dividends have been distributed, is known as the
retained profit. Retained profit is added to the reserves declared at the start of the current year
or accounting period to give the reserves for the end of the year. The end of year reserves are
included in the balance sheet, and provide the starting figure for the reserves for the next
accounting period.

5.6.9 Detailed profit and loss vs. the published accounts

The law requires that a companys accounts be published in a standard form. Larger
companies are required to give more detail than small ones. All published account are
summarised to make them more comparable, easier to understand and to preserve some
commercial confidentiality.

Most privately owned companies produce an extra sheet or section that amplifies, but is not
part of, the published accounts. It gives much greater detail than is available from the
published accounts. The objective is to keep the directors, and sometimes the shareholders,
more fully informed.

5.6.10 Extraordinary and exceptional items

Profit before tax [Section 5.6.5] may also include exceptional and extraordinary items.
Such items are outside the normal run of costs or income, and are reported separately. In the
past, there was a perceived abuse of these items to increase reported profits. In response, new
rules were introduced, and it is now almost impossible to include exceptional and
extraordinary items.

5.7 Understanding the balance sheet

The balance sheet is a financial snap shot of the state of the business on a particular day.
Balance sheets are usually produced to cover the last day of the financial year or period. It is
normal to produce a balance sheet for the financial accounts in statutory form annually and to
produce monthly management accounts including a balance sheet. Exceptionally, balance
sheets may be prepared to other dates in order to meet specific objectives; for example the
sale of the business.

5.7.1 Fixed assets

Fixed assets are resources, such as machinery and equipment, which are held for the long-
term, and are used in the business.

Fixed assets comprise tangible items such as land, buildings, machinery and cars, and
intangible items such as patents, trademarks and rights of way.

Some fixed assets [e.g. machinery] wear out or become obsolete over time, so the reduction in
value has to be accounted for. The reduction in value is normally spread evenly over the
expected useful life of the asset. This is known as depreciation. The original cost less the
depreciation give an estimate of the value of the asset; it is known as the written down
value.

Occasionally the value of the asset will be so far above or below the book value that an
adjustment or revaluation will be made to bring the two into line. Recent rules restrict the
circumstances in which adjustments can be made to the published accounts.

Some parts of assets wear out while the asset is in use, e.g. machine tools and steel mill rollers
etc., which wear out as the machine is used. Where these items are significant, they are
accounted for separately as consumable tools.

5.7.2 Current assets

Current assets are assets held for a short time. They would include stock, work in progress,
cash at the bank and in hand, prepayments and accrued income and amounts due from
customers, i.e. debtors.

Prepayments are amounts paid for goods or services not yet received for example advance
rental payments or pro-forma invoices.

Accrued income is where goods or services have been provided and payment is due in the
future but an invoice has not been raised.

Some current assets will only be held for short periods possibly a few days but in general
current assets would be held for periods of less than one year. Conservative accounting
would review all items over one year old to check if the value was correct. Where the value is
less than the book value then the value in the accounts would be written down to the current
value. Any write down reduces the profit for the year.

5.7.2.1 Work in progress (WIP)

This includes a valuation for contracts where work is in progress. It includes work
performed, which has not been invoiced or written off as uncollectable. Work performed,
which has been invoiced, will be included in debtors.

5.7.3 Current liabilities

Current liabilities are amounts that would fall due for payment within one year of the balance
sheet date.

They would include trade creditors, group creditors, corporation tax, other taxes and social
security, accruals and deferred income, short-term loans, bank overdrafts and obligations
under finance leases.

5.7.4 Long-term liabilities

Long-term liabilities are amounts that would fall due for payment more than one year after the
balance sheet date.

They might include longer-term bank loans, obligations under hire purchase agreements and
finance leases falling due after one year, group creditors, secured or unsecured loan stock,
pension loans and directors' loans.

5.7.5 Shareholders funds

The total value of the business is also the value of shareholders funds, this is also known as
the net worth of the business. This is also known as share capital and reserves on the balance
sheet. Although all of the business is owned by the ordinary shareholders, this part of the
balance sheet shows which element of the value is derived from what source. The use to
which element of the share capital and reserves can be put is also determined by the way it
arose.

The different elements of the share capital and reserves are described below.

5.7.5.1 Share capital

The share capital is the nominal value of all the shares issued by the company. In many
companies it is the amount subscribed by the shareholders to buy the initial shares. However,
if the shares are sold later, they are usually sold at a premium to their nominal value. Further
shares can be issued against profits or against further payment.

5.7.5.2 Authorised capital

The authorised capital is the amount of capital that the company has been authorised to issue
by the members in a general meeting. It does not all have to be issued.

5.7.5.3 Issued capital

Issued capital is the amount of shares that have actually been issued. The maximum amount
is the authorised share capital

5.7.5.4 Share premium

The difference between the issued share capital and the amount subscribed for the shares.

5.7.5.5 Retained profits

This item is more commonly referred to as the profit and loss account. This is the element of
the shareholders funds, which derive from the profits of the business. It is a cumulative
balance which, at the formation of the company, starts at nil and to which each year profits
less dividends paid are added. Any losses are deducted.

In management accounts, the current years profit will normally be shown separately. But in
the financial accounts, it will include the profits or losses made in the current year less any
dividends paid to the shareholders.

5.7.5.6 Revaluation reserve

If assets are re valued upward then the value of the company increases and this is reflected by
an increase in the revaluation reserve within shareholders funds. This reserve has to be
retained in the company and cannot be used to pay dividends.

6. BLOCK 6 - DIRECTORS

6.1 Basic Finance and Accounting Concepts

Directors are required by law to have a reasonable understanding and appreciation of the
finances of their company.

It is recommended that, as a minimum, directors understand profit and loss and the balance
sheet, as explained in Sections 5.6 and 5.7, in Block 5 of this handbook.

6.1.1 The business cycle

[The section below, in italics, is a repeat of information given in Section 3.1.3. It

and services changes in relation to each other, but generally, there are good times and bad
times for all. The relative demand for goods, against each other and against available
capacity drives prices. This has been the case since trade began.

One reason for this is improvements in technology. For example, when cars were invented
the demand for petrol went up but the demand for horse feed went down. The other reason is
that when a business opportunity arises, several companies will spot it at the same time. They
will all invest in new factories and machines thus creating new jobs. People become more
optimistic and spend more money and other opportunities arise. When all the factories have
been built there may well be too much supply for the available market. Therefore, costs have
to be cut, people become pessimistic and opportunities dry up. This happens over many
businesses all over the country and creates the business cycle.

but when times are bad, companies can continue to use their existing buildings. Even if
companies still want to expand, existing buildings can be purchased for less than the cost of
building new.

people might cut down on luxuries, but they have to eat, however miserable they feel.

6.1.2 Contract/project accounting

Financial accounts are normally prepared on an annual basis and provide a snapshot of the
current situation once a year.

We have another tool contract accounts designed for keeping financial control over
current contracts. Contract accounts are designed to show the results for each contract over
the life of the contract. For some contracts, they might cover several years.

The method for maintaining the contract accounts will vary from company to company. The
most sophisticated computer based accounting systems will have integrated contract ledgers
(also known as project ledgers). In these systems, the costs and income are entered once only,
and are posted to both the financial and contract accounts at the same time, so these accounts
are always aligned.

Many systems can make orders and hold them in the system as commitments (goods not
delivered) or accruals (goods received not invoiced). In this way, the overall financial
position is always available. Budgets can be held at both a financial and a contract level,
which allows easy identification of projects that are over budget.

These systems are however expensive to buy and to run. They attract an annual licence fee,
and the underlying computer hardware and software systems require significant money and
effort to maintain.



The roles of a modern finance and accounts department are:

! to provide financial and business support to the mainstream activities, and,

! to record them for future reference.

The most significant activities are amplified in the following paragraphs.

6.2.1.1 Keep it simple and cheap


Accounting systems that are too complicated tend to be expensive to maintain and difficult to
use. They also generate excessive training costs and can create extra costs due to the
mistakes they induce. It is often better to set up the simplest system that is capable of
recording the accounting information in sufficient detail to allow timely collections and
proper analysis and reporting to be performed.

Spend some of the time and money saved to check the information and ensure it is of the
highest quality.


[The section below, in italics, paraphrases information given in Sections 3.2.1.2
& 5.2.1.1. It is included here for completeness, and may be used as revision, if
required.]

Although it might seem to take more time and effort, it is more cost effective to perform a task
correctly the first time. This includes ensuring that all the paperwork is in order and that the
necessary documents have been retained and filed.

If proper records are kept, subsequent reference to the records will be easy and cheap. No
time will be wasted searching for mislaid documents or trying to work out what happened a
long time before.

Claims for day works and variations will be made with less effort and a higher possibility of
success. As most of the profit in some jobs relies on these recoveries, this is a major
contributor to the overall profitability of the company.


[The section below, in italics, paraphrases information given in Section 3.2.1.3.

The minimum cost of correcting most paperwork and accounting errors is the same as doing
the original work. Thus, the overall cost of that particular process is doubled. This assumes
that there is no additional cost in detecting the error, and that the correction only involves re-
doing the work.

In reality, paperwork and accounting errors often remain undetected until the final
accounting is done. At this stage, it will be much more expensive to track down the error, to
find and contact the person who made the error, to work out how to correct it, and then to
make all the consequential changes.

It may be impossible to track the error or recreate the paperwork. This is a particularly risk
for day works and extras. If the work is not documented when it is done, there may be no
record at all. Worse still, the customer may have the only record. He would have little
reason to help complete the steelwork contractors records, to allow the latter to bill him for
previously unrecorded work.

The worst case would be that the cost of work done could not be recovered. A charge for
work done, but for which no payment is received is lost profit. On a low margin contract [i.e.
most of them], this could be a substantial proportion of the final profit.

6.2.1.4 Perfect planning prevents pathetic performance (PPPPP))


A little time allocated to planning will often save a lot of time later. A well-run company will
allocate some management effort to making plans for the future. This need not be prolonged
nor involve large numbers of people. Occasional planning sessions, taking into account board
directions and market and technological developments, will ensure that the company has clear
short and long-term goals. These goals should be communicated to all levels in the
organisation, to point up future business decisions.

In a competitive and fast moving market, any planning must be flexible. Planning should
probably take place at three levels, longer term conceptual and strategic planning, medium
term tactical plans including outline financial plans, and short term detailed consideration of
current market and available contracts with detailed financial plans including cash flows.

6.2.2 The importance of credit control

The construction industry generally is tender-driven, and the barriers to entry are few.
Competition is very keen, and for much of the economic cycle, profit margins are low. In
addition, constructional steelwork is usually sub-contact work. The upshot is that steelwork
contractors are very exposed to the risk of business failure either their own, the main
contractor's, the customers or their own suppliers'.

Exposure to failure of the customer is an inevitable risk factor in doing business. The aim
should be to reduce the risk to an acceptable level and to minimise the damage caused if a
customer does fail.

The risk can be reduced by cutting down the credit risk in individual contracts.

6.2.2.1 If you dont get paid you make a loss


It doesnt matter how good the contract price is; if you arent paid then you will make a loss.
In a low margin industry such as steelwork construction, the loss of even a small part of the
payment can severely affect profit. So will a long delay in receiving payment, because of the
costs of financing the outstanding debtor until payment is received.



The payment record of any long-term customer [i.e. main contractor or client] can be kept
under review by comparing due and received dates for undisputed invoices, and the numbers
of spurious disputes can be monitored.

However, this is not the full picture. It should be supplemented by external checks on, for
example, trade references, credit references and company accounts.

When considering supplying a new customer for the first time, his ability to pay for the
contract should be determined. The same considerations should apply to established
customers without a recent payment record.

It may be possible to estimate the credit risk by obtaining the latest copy of the companys
accounts from Companies House. For larger companies, the accounts will give a good view
of the companys ability to pay its debts as they fall due. For smaller companies, there is less
detail and the accounts are not as useful.

The company accounts may be up to ten months old and therefore should be viewed with
caution. Credit reference agencies should be able to provide more recent information on
payment records.

6.2.2.3 Credit insurance


It is possible to obtain insurance against non-payment of bills in the UK and overseas. Most
insurers will wish to review a client list before offering a price. The cost of insurance should
be compared to the risk of loss. In high-risk situations, the cost of insurance can be
prohibitive.

If your company normally takes credit insurance, and if cover for a particular customer were
to be refused, it would be perverse to proceed with the contract. Insurance companies are in
business to take this risk. If they will not do so, it would be foolhardy for a steelwork
contractor to try.

Credit insurance does not normally cover disputed items, until they are agreed or settled in
court.

6.2.2.4 Risk/insurance should include all extras

If credit insurance is used, then it is prudent to ensure that the cover includes an amount to
cover the likely level of variations etc.

6.2.3 Selection of contracts for tender

Tenders normally have to be prepared very quickly, but the process is labour intensive. It is
necessary, therefore, to limit the number of contracts for which tenders are prepared. This
will allow the maximum time to prepare detailed tenders for the preferred contracts. In
selecting the preferred contracts, one should consider:

! the type of contracts that the company is seeking as an ideal,

! the type of contracts that have been historically unprofitable,

! the current financial position of the company, and,

! the future available capacity.

The type of contracts selected for tender will vary over time for most companies. This will
depend on internal and external factors as well as short and long-term considerations.

Short-term considerations will be driven by the work available in the market, and how busy
the plant is projected to be when the job is due.

Long-term considerations will include the type of work that the company is seeking even if it
does not currently have the capacity or the expertise.

Key elements of the selection process include:

6.2.3.1 Size of contract

The size of contracts to be considered is determined by both the physical capacity of the plant,
including available sub-contractors and by the financial capacity of the company.

Companies have a range of work that they are comfortable with and most will be seeking to
extend the range at the top end.

The company must be able to finance the work in progress and the debtor for a contract until
payment is received. At the same time, it will have to finance all other work in progress and
debtors. A contract that is too large will expose the company to extra financial risks, the
largest of which is running out of money and being unable to pay bills as they fall due. In
addition, if a large contract goes wrong, the risk of large losses is greater and the company
might not be able to absorb them. In a worst case, the losses could eventually consume all the
capital of the business. Far better, in most cases to have risk spread over several jobs so that
if one goes wrong there is a better chance of absorbing the loss.

Some companies specialise in the largest jobs which, they hope, could give better margins
because of more limited competition. In effect, they bet the company every time they take
on a large job like these. To do this, the company must have a risk-seeking culture, even by
the standards of constructional steelwork. It must also have risk control and management
systems in place that allow it to be confident that all problems will be identified and
controlled before they have adverse financial consequences.

There is no correct size of job for any given company but a clear view of the size band of
suitable jobs will save valuable time when viewing tender opportunities. It is a matter for

judgement on each individual company, but a contract that represents more than say 20% of a
company as turnover should be reviewed at the highest level before being accepted.

6.2.3.2 Client (wanted/not wanted)

With many one-off jobs, it is not always possible to take a view on a client from direct or
hearsay experience. However, one should always try to assess the desirability of working for
a particular client.

Factors that would be likely to support a particular client are financial stability, availability of
future work, prestige, good payment record, and reasonable attitude to negotiation of
variations.

Factors that would be likely to weigh against a prospective client are poor financial condition,
credit warnings, poor payment record, and a very aggressive or litigious attitude to variations.

These factors, taken together as far as possible, will shade the attitude to the potential job.
The more plus factors, the keener the tender price could be. If there are many negative
factors, the job should not be tendered for or the price should be raised to take account of the
extra risk. For a particularly high risk, the tender price is likely to be so high that there is very
little likelihood of the contract being won. At this stage, it is better to stop working on the
tender and do something more productive.

6.2.3.3 Physical capacity

One must consider the physical capacity to undertake the contract. That is the capacity of the
plant and/or known sub-contractors to fit the job at a reasonable price.

This is essentially a technical issue, but is mentioned here for completeness. It becomes a
financial issue if there is cost overrun on fabrication.

6.2.3.4 Bright ideas to reduce costs

Sometimes a review of the specification in the tender documents will reveal that innovative
design, fabrication and erection techniques would reduce the steel or labour costs. All tender
documents within the target range should be reviewed to see if there is scope for such
innovative cost saving. The scope for savings will depend on the flexibility of the company
and the flexibility available within the tender.

Companies focussing on cost savings by offering standard solutions will be unlikely to find an
advantage of this type. However, companies offering a flexible approach may well do so.

An extra risk associated with this strategy is that the innovation will not lead to the anticipated
cost saving. The best way to contain this risk is to know the capabilities of the business. This
is not a purely technical matter. Most steelwork contractors have a clear vision of technical
capacity but a less clear view of the financial result of different ways of performing a task.
The financial success or otherwise of technical processes can only be ascertained by detailed
financial monitoring and financial analysis of all contracts. See Section 6.2.5.

6.2.3.5 Need to fill production capacity


The essential short-term consideration in tendering is the availability of capacity both in-
house and with known sub-contractors.

If in-house capacity is predicted to be nearly full, based on contracts that have already been
won, then opportunities can be taken to seek the most profitable work for the final slice of
capacity. Effort can be focussed on those tenders that are likely to lead to the best financial
result. This will be a combination of factors including, close fit with the companys skill set,
job types that have been successful previously and contracts where a high bid might be
successful.

If the work currently contracted is much lower than capacity, a broader approach to tendering
has to be taken. Extra effort has to be concentrated on tendering to utilise the capacity. The
aim is to achieve sufficient volume at a sufficient margin to pay the overhead costs. This will
require all possible contract opportunities (including those at the edge of the range of
preferred projects) to be followed up with a tender.

If the factory is predicted to be substantially over capacity, the availability of suitable sub-
contract capacity and the likely price should be considered as part of the tender review
process.

Careful monitoring of projected workshop capacity utilisation will allow the correct tender
strategy to be pursued.

6.2.3.6 Contract types that are profitable

Constructional steelwork companies tend to be engineering led. Such companies know what
they can make, and they tend to sell their products on the basis of their wide ranging expertise
and their particular specialist facilities, expertise or successes. If this is not backed by
rigorous analysis of performance and profitability, companies will continue to mis-price
tenders and suffer unprofitable contracts.

The best way to establish the profitability of contracts is to monitor in detail all contracts to
establish the profitability of each accurately. Monitoring should identify both cost savings
and cost overruns compared to original estimates, and the reasons for them. Over time, this
will build up information about the type of jobs that are profitable and unprofitable for the
company. Analysis of the data will show:

! trends for the types of jobs and clients that have been most profitable,

! the types of contracts that should be focussed on or discarded, and,

! the type of jobs where action needs to be taken to ensure profitability of future
contracts.

An alternative option is to take a more strategic approach, reviewing the market for possible
competitive advantage arising from the combination of skills and plant within the company.
This might lead to focussing on particular types of work and/or to seeking to improve the
overall efficiency and quality of the company.

6.2.3.7 Variations

[The section below paraphrases some information given in Section 5.2.3.7.]

Different companies have different attitude to variations. Some regard the possibility of
significant variations as an unacceptable risk whereas others regard it as an excellent profit
opportunity.

The attitude is likely to depend on the type of steelwork normally produced, the quality of the
systems in place and past experience of the companys ability to deal with high levels of
variations.

Companies with a product range based on standardisation to reduce cost, might believe that
high levels of variations would disrupt the standard process at great cost and with a knock on
effect on other jobs. Such firms could be reluctant to tender for jobs with a high risk of
variations and/or could price their tenders high in anticipation.

Other companies might have found that contracts with a high level of variations are not
profitable. Possible reasons are: mis-pricing of the work done for variations, unsuccessful
negotiation of the final price due to poor technique, or poor control and record keeping
including:

! performing extra work without agreement from the client,

! failing to get work signed off as complete when it is finished, and,

! losing records of work done and accepted.

On the other hand, some companies view a poorly specified invitation to tender with lots of
errors, as an opportunity not a threat.

The initial bid would be made at a very competitive price, possibly at minimal profit, based
on the tender documents with a view to first winning the contract, then making a substantial
profit on the variations, extras and day works.

This approach entails extra risk and depends on a high degree of skill in critical areas. It also
requires financial strength to withstand the wait for payment, if negotiations are protracted.
Particular skills might be pricing and recording of extras, flexibility in the works and on site
and robust negotiating skills.

Both approaches to variations are equally valid provided they are backed up by the requisite
skill sets and supported by the management decision-making process.

6.2.3.8 Expansion of range of work

If a company wishes to extend its range of work, in most cases it will be better to expand on
an incremental basis. Thus for example if a company wished to develop expertise in stadium
construction, but had never built a stadium before, it would be unwise to start with a complex
national or international arena requiring techniques completely new to the company. New
ventures of this type are sometimes successful but more often are unprofitable or worse. Far
better to start with a small and simple stadium based on familiar techniques or where existing
expertise can be effectively employed on likely problems.

Analysis of market trends and the companys skill set will suggest the direction that the
expansion of the range of work should take. This will determine the type of contracts that the
company should seek out, to expand the range of work without excessive risk. The financial
and technical results of these contracts should be reviewed to assess if:

! further expansion should be sought,

! if more, similar contracts should be sought, or,

! the expansion should be abandoned or changed.

6.2.3.9 Intangible factors


In a competitive and tender driven industry, intangible factors will be of much less concern
than in sectors driven by image and appearance. It is likely that intangibles will play only a
small part in the decision making process, and only in a limited number of tenders. However,
they cannot be discounted entirely.

Factors that might be considered include work for prestige clients and work on prestige
projects. These are important for smaller companies seeking to establish themselves as
providers of high quality work. If skilfully publicised, such contracts can raise the profile of
the company, and can lead to more invitations to tender and to more work.

The converse is that if a high profile contract is unsuccessful, it can lead to poor publicity for
all involved, even those without blame in the project.

The publicity value/risk ratio should be considered for all contracts with a high profile. The
value of the publicity/market visibility is likely to have sufficient value to justify an
adjustment to the tender price only in exceptional circumstances. However, if the chance of a
breakthrough contract occurs, a downward price adjustment might exceptionally be justified.

6.2.3.10 Profit margin


The whole point of being in business is to make a profit. When all the costs have been
calculated and other factors have been taken into account, the target profit for the job should
be added to reach the initial estimate of the tender price.

If many different types of work are undertaken then different profit rates might be
appropriate. The least complex might justify a low margin whereas the most complex and
highest risk work would attract the highest margin.

When the initial tender estimate has been made, it is time to exercise commercial judgement.
The calculated price should be compared to the likely tenders from competitors, and any
adjustments essential to win the contract should be considered.


The commercial judgement starts with a basic question. How does the initial tender estimate
compare with the current market and the possible bids from competitors? Is the tender as
priced likely to win the job?

If the price looks too high, the bid should be reviewed to check if any cost savings could be
made. Other factors should then be revisited to decide if it is better to adjust the price or to
stick with the estimate.

Conversely, if the price looks too low compared with the likely competitive bids, the
calculations should be re-checked to ensure nothing has been missed. Consideration should
be given to raising the price to increase profitability.

All of this will need to be combined with the other factors considered above to come to the
final tender price.

6.2.4 Tender preparation and costing

6.2.4.1 Increase of skill base


If the company has a selected a contract to tender as part of a strategy to expand its range of
work then some time should be calculated for the learning element in the job. Pricing of the
tender should take this into account, but not if recovery would overprice the tender and cause
the job to be lost.

In principle, no job should be tendered which will incur a loss but the final pricing decision
will include a calculation of what if any of the learning costs can be recovered without loss of
the job.

6.2.4.2 Profit margin [See also Section 6.2.3.10.]

The whole point of being in business is to make a profit. After all the costs have been
calculated and other factors have been taken into account the target profit for the job should
be added to come the initial estimate of the tender price.

If a wide range of different types of work is undertaken then different profit rates might be
appropriate to the different types of work. The least complex work might justify a low
margin but the most complex and highest risk work would justify the highest margin.

This should be carefully checked to ensure that it does not contain any errors. As noted
elsewhere, over-pricing will lead to not winning the tender, but under-pricing could lead to
losses on the job.

Once the initial calculation has been made this is the time for the exercise of commercial
judgement. The calculated price then should be compared to the likely tenders from
competitors and any adjustments to win the contract should be considered.



All of the above elements will give a good estimate of the companys likely overall costs and
target profit for the tender. They form the necessary background and a good basis for the
purely commercial judgement has to be applied at this stage.

How does the tender price as calculated compare to the current market and the possible bids
from competitors? Is the tender as priced likely to win the job?

If the price looks too high then the bid should be revisited to check if any cost savings could
be made. Other factors should then be revisited to determine if it is worthwhile to adjust the
price, or better to stick with the estimated price.

Conversely, if the price looks too low compared with the likely competitive bids then the
calculations should be re-checked to ensure nothing has been missed. Consideration should
be given to raising the price to increase profitability.

All of this will need to be combined with the other factors considered above to come to the
final tender price.

6.2.5 Monitoring of contracts and contract profitability

Most constructional steelwork companies monitor the technical side of their business to a
high standard, but their financial monitoring is not as advanced.

Close financial monitoring of the company contracts is essential to maintaining profitability
and to identifying and tackling financial problems as soon as they arise.

The appropriate method for monitoring will depend on the size and complexity of the
contracts and the overall size of the company.

The most sophisticated accounting systems will allow maintenance of financial and contract
accounts from the same core data. They will also produce contract reports on request.
However, these systems although falling in price are not appropriate for smaller organisations.
Alternative arrangements need to be made.

6.2.5.1 Daily update of costs

Updating costs each day might seem like overkill, but it will help to achieve efficient contract
monitoring within the company.

6.2.5.2 Weekly monitoring of costs


The full benefit of maintaining a daily update of costs is lost if the update is purely
mechanical and not subject to objective review on a regular basis. For most companies, this is
probably met by a weekly review of costs incurred, including commitments against original or
amended budget.

This review, which need only be brief, should be carried out to identify any unexpected items
that have arisen on any contract. Explanations for the cause of any items identified should be
sought. The nature of the explanation will inform the choice of action taken. Timing
differences are unlikely to require any action. Minor differences should be flagged, but no
action taken unless they are part of a pattern that indicates that tenders are being consistently
miss-priced. Major differences should be bought to the immediate attention of the responsible
manager or director to allow corrective action to be taken.

6.2.5.3 Monthly accounts (immediately)

This is a rare case in accountancy of speed being more important than absolute accuracy.
However, with good systems in place and an accurate daily update of costs and income, it
should be possible to produce reasonably accurate contract accounts to a fixed monthly
timetable.

The purpose of producing the accounts is to allow a review of the financial position of all of
the uncompleted contracts. There is little point in producing them if they are put in a file and
forgotten. The other benefit is that it allows the cash requirement of the business a whole to
be projected and, along with physical capacity, allows the position of the company in relation
to new work to be known.

6.2.5.4 Valuation of work in progress


Most contract valuations can give perverse results at an interim stage. The contract accounts
will show all of the costs incurred to date less all payments received.

! Loss making contacts that have high costs and low collections will, on the standard
basis of valuation, have a high value. This should not be confused with a profit, as
the collection may be less than the costs incurred. However,

! Profitable contacts that have low costs and high collections will on the standard
basis of valuation have a low value. Highly profitable contracts may show
collections that exceed costs incurred and have a negative value. This should not be
confused with a loss.

One must be careful when reviewing contract accounts, to ensure that the correct
interpretation is placed on the results. They are a useful tool that gives usable valuations for
average contracts, but, for contracts outside the norm, the valuation can be misleading to the
inexperienced. The true value and likely final profit or loss on each contract can only be
estimated by a detailed review of all the information about likely future costs and collections.
As with any intermediate valuation the future cannot be predicted with certainty.

Adjustments to reflect likely future outcomes will normally be made in preparation for the
annual accounts. Normally future losses would be provided immediately but future profits
would not be recognised until the contract is complete.

6.2.5.5 Monthly monitoring of profitability and progress against budget


The risk of a contract going seriously wrong increases as the frequency of review decreases.
Progress reviews should take place at least once per month.

6.2.5.6 Immediate action if not profitable

Any problems identified on contracts, or in the business overall, must be addressed
immediately. Action should be taken to find the cause of the problem and, as far as possible,
to reverse it.

The longer a problem is left the more difficult and expensive a solution is likely to be.

6.2.6 Monitoring and collection of retentions

Where retentions bonds are not in use, a contract with a low profit margin might not realise
any profit at all until the retentions have been recovered. It is important, therefore, to monitor
carefully the recording and collection of retentions.

6.2.7 Monitoring of bonds

Where retention bonds are used on contracts systems need to be in place to ensure that bond
that are given are collected as soon as they no longer required on completion of the contract.

Where the issuer requires the return of a bond, systems need to be in place to ensure the bond
is returned as soon as practically possible to the issuer. Where return is required the issuer
will normally continue to charge for the bond until it is returned.

6.2.8 Budgeting and cash flow forecasting

The production of budgeted profit and loss, cash flow and balance sheet is an important part
of managing a business. The inclusion of known contracts provides a good basis for
estimating the available technical and financial capacity for undertaking new contracts.

6.2.8.1 Profit is not cash

The need for such detailed future projections arises because the relationship between profit
and cash is not direct. As described in Sections 3.1.2 and 5.2.12, sales must be converted into
cash for the profit to be certain.

6.2.8.2 Budgets for the accountants targets for the sales force (They should be
different)

The budgets for the business should be prepared on a careful and conservative basis to show
the most likely outcome and allow realistic assessment of capacity to make investments or
show if any cost cutting is required. However, there is no need to restrict the target to this
level. It is better to have a target that is higher and more difficult to achieve in order to drive
the business forward.

6.2.8.3 Cash is king (why companies fail)


Companies dont call in the receivers or go into liquidation because they are making losses.
They fail because they havent enough money to pay what they owe when it is due.

Thus it is vital to distinguish between accounting profits and losses, which are an important
measure of the business in the long term, and cash flow, which is an equally important
measure, particularly in the short term. Profits and losses can be viewed with some
subjectivity. How much is that asset worth? What is the profit on the contract in progress?
However, cash flow is more objective. Has the cash been received into the bank account?
Has the cash been paid from the bank account?

This does not mean that the company has to have cash in hand to pay all outstanding creditors
at all times. Nor does it mean that a company has to have a credit balance in its bank account
at all times. Some well-run businesses rely on overdraft financing for long periods. Beware
an overdraft or loan arrangement can be withdrawn or restricted at short notice, for reasons
unconnected with the conduct of the account. This is described more fully in Section 6.3.5.

Monitoring of all incoming and outgoing cash will allow a better chance of avoiding cash
shortfalls and consequent problems.

6.2.9 Investment appraisal

Investment is wasted if it does not produce as much value as it costs.

Major investments in the constructional steelwork sector have not always been supported by
rigorous financial analyses. The speed and pressure under which the sector operates means
that decisions have had to be made quickly. From time to time, large investments have been

made because the technology was wanted or to match investment being made by a
competitor. In these cases, financial justification has tended to take second place.

There is a further problem for the constructional steelwork sector. Companies tend to invest
in the economic good times, but if they cannot afford to pay for the investment when the
market turns down; the company fails. The machinery is, in general, of use only for
constructional steelwork. When sold off by the liquidator, it commands a low price.
Consequently, it is readily recycled back into production, thus maintaining the over-capacity
and low margins that characterise the industry.

6.2.9.1 Comparison of alternatives

Most potential investments will have a number of options, with different specifications,
offered by different suppliers. Further alternatives include continuing to use the existing
machine or process, refurbishing or improving it.

The financial consequences of each course of action should be examined, however briefly.

For constructional steelwork companies that do not have the requisite knowledge in-house,
BCSA offer a simple to use Investment Appraisal software package. This takes users though
entering the key information needed to make a realistic appraisal and automatically produces
an initial assessment of advisability of an investment.

6.2.9.2 Basic payback

This is a method of appraisal of the value of an investment. The concept of payback is the
period, which it takes to generate enough cash to repay the cost of the investment. The
shorter the period the better the investment.

In an ideal world, the best way to calculate payback is to use the value of the output from an
investment. However, where the value of the output from an investment cannot be
determined then the payback can be calculated by reference to the savings over the existing
costs.

Companies need to set targets for payback based on the business risk and possible future
changes in technology. In the constructional steelwork industry, a payback period of more
than 5 years would probably be too long.

6.2.9.3 Basic internal rate of return

The internal rate of return is the return that should be made on an investment. It is set by the
company, and should reflect the cost of funds and the risk inherent in business.

The internal rate of return is, in effect, an interest rate that can be compared with the rate
available from other investments. As a minimum, it should equal the interest that could be
earned by putting the money in a building society.

6.2.9.4 Basic net present value

The net present value of an investment is the value of the income generated by the investment
compared to the minimum return expected. This is produced by discounting future income by
the time value of money.

6.2.9.5 Cash flow considerations

The purchase of a new machine will have a cash impact that needs to be considered. There is
no point in buying a machine, however useful and profitable, if the company does not have
the financial capacity to finance it in the short term. Factors that might give negative cash
flow could include:

! disruption to production during installation, training and bedding down,

! lack of HP type finance during an acceptance period,

! redundancy of unwanted operators, and

! VAT at the wrong time might take 3 months to recover.

Even if contracts continue to be won at good prices, the peak cash outflow might occur
several months after the initial investment.

6.2.9.6 Can you use/sell the extra capacity

It is unlikely that all the capacity from a new machine could be utilised immediately, so any
appraisal should allow for this in the calculations.

Partly because of the time it will take to get the machine functioning at full capacity and
partly because of the lead-time in wining new tenders.

6.2.9.7 Will the extra capacity require increases in output of other machines?

If a substantial new machine is put in place, one must consider the ability of the rest of the
works and the office functions including the design office to service it. If the machine only
replaces bought in or subcontracted work then this is unlikely to be a problem.

If extra investment in other areas is required, the appraisal should be increased in scope
accordingly.

6.2.9.8 Will the extra capacity require an increase in overheads to support it?

A very substantial investment will require extra investment not only in other parts of the
works but also in overhead departments such as the design office. In this case, a fully detailed
appraisal of the whole business is needed to ensure that the effect of the investment is fully
understood.

6.2.9.9 Will the borrowing force you out of business

An investment, made with heavy borrowing, may not be utilised sufficiently to pay the
interest on the borrowings made to finance it.

Excessive investment at the peak of the economic cycle followed by a market slow down
might lead to insufficient contracts to fully utilise the machinery or such low tender prices
that the costs are not fully recovered. In extreme cases this might lead to the failure of the
business.

A realistic cash flow should be prepared for the proposed investment and for large
investments the entire business, to ensure that the purchase does not exceed the financial
capacity of the business.

6.2.10 Dealing with risk

Constructional steelwork is a risk business and any business in the industry should have
realistic strategies for managing and controlling risk.

Recognising the main risk factors and monitoring for changes on a regular basis will greatly
assist in controlling the impact of increased risk. Many of the factors are dealt with in detail
in other sections of this book.

6.2.10.1 Risk profile of business

Monitoring the risk of all of the contracts will allow the risk profile of the company to be
assessed.

6.2.10.2 Risk profile of work

The risk of all of the contracts can be assessed, taking into account all the relevant factors,
e.g. technical risk, financial risk and risks with the customer.

6.2.10.3 Layered contract profile

A range of contract types ranging from lower risk lower margin to high-risk high margin will
according to standard business theory give a better and lower risk return than contracts of one
type.

6.2.10.4 Effect of variations

As noted in Section 6.2.3.7, a companys experience of variations will inform its attitude to
this type of risk.

6.3 Avoiding Corporate Failure/Insolvency

Corporate failure and insolvency is a risk of being in business. In constructional steelwork,
the risk mainly arises in extending credit to the customer, and there is an additional
transferred risk in relation to the client. There are many other risks including the business risk
that the activities are unprofitable, cost overruns on contracts, legal actions, fines, etc.

Companies do not become insolvent because they are unprofitable, but because they run out
of cash to pay their bills as they fall due. The most common reasons for this are failing to
collect amounts due on a timely basis, failing to recognise that amounts in debtors are not
collectable, unprofitable contracts and the insolvency of a customer. Keeping a weather eye
open for these risks will help to reduce the possibility that they will permanently damage the
company.

6.3.1 Do all the above

A well-run business is much less likely to go out of control than is a business where the
managers, accountants and directors do not know what is going on. If proper monitoring and
control systems are in place there should be plenty of warning signs well in advance.

If all of the management tools that are described in this handbook are in place, the risk will be
much reduced. Any problems should be detected in sufficient time to allow avoiding action
to be taken.

6.3.2 Plan for the unexpected

Almost by definition, the most difficult thing to plan for is the unexpected. However, in
reality, the range of unexpected events that can have a significant effect on a steelwork
business is limited.

Let us look at an unexpected event from another business area. Occasionally, railway
companies appear surprised by heavy snowfalls that disrupt services severely. In reality, they
have not appreciated the likelihood of an unpredictable event, and have not made plans and
preparations to meet it. In Switzerland, much larger amounts of snow cause much less
disruption because proper contingency plans are in place.

Financial and other planning should include some allowance for unlikely events and/or events
the timing of which is unpredictable.

More sophisticated planning might allow advantage to be taken of some
unlikely/unpredictable events, turning them to profit when they do occur.

6.3.3 Keep your head

If corporate failure looms, it is quite often possible to avoid it, but only if the managers and
directors of the business keep their heads, get proper advice and take decisive action to turn
the company round.

Unfortunately, the most common reaction to this type of bad news is to ignore it. If this is the
reaction, you can guarantee that the news will get worse and worse until, eventually, the
company fails.

6.3.4 Monitor your suppliers/customers/competitors

Monitoring your suppliers and customers should give some early indications of problems
ahead. The problems may be specific to that company, may affect the wider construction
industry, or could reflect the UK economy as a whole. Monitoring can also give valuable
early warning that will permit avoiding action in case of failure of a supplier or customer.

This kind of monitoring is useful in a wider context. It will identify main contractors that are
growing, and are likely to be good sources of work in the future, as well as those in decline
that are less likely to offer attractive contracts. It will also identify potential new sub-
contractors and track the quality and size of work available in the market.

The reason for monitoring your competitors is different. It allows you to benchmark your
companys performance, and should help you to pick up earlier signs of market downturns
and other problems that could cause difficulties for your company.

6.3.5 Do not rely solely on your bank

There is much in the old adage that bankers are happy to lend you an umbrella when it is
sunny but want it back when it starts to rain. What this means is that in economic good times
and when your company is doing well banks are very happy to lend. However, at the first
sign of trouble, they will want their money back.

Lending money is a fundamental part of the banks business. It is not surprising, therefore,
that banks sometimes seem very keen to provide your company with a loan. Nevertheless,
few concessions will be made on the banks standard terms and conditions, which are heavily
weighted in the banks favour. The two most onerous terms are:

! that the loan is repayable on demand, and

! the requirement for a fixed and floating charge over all of the assets and the business.

In some cases, a personal guarantee from the directors, backed by second mortgages on their
houses, will be required. Although this may appear a simple formality, circumstances may
change and the surety could be called in. It is difficult to recommend giving a personal
guarantee if you and your family own 100% of the shares. If there are significant third party
shareholders, it is wholly unjustifiable.

If the company prospers and the countrys economy stays sound, there are likely to be few
problems. Even so, before embarking on a loan from the bank, ensure that you have details in
writing of the full loan conditions and charges. Take time to read and understand them fully
before you commit your company. Your position is at its strongest while the bank wants you
to take a loan, but you have not yet signed up for it. That is the time to ask the searching
questions, not when you are struggling to pay charges that you failed to note in the small print
of the contract.

On the other hand, the company may struggle, the industry could have one of its cyclical
downturns, or the economy could go into recession. In this situation, it is not unknown for the
bank to feel it necessary to reduce its exposure. Either alone, or with other companies, you
could find that your loan facility has been reviewed. The loan limit may be reduced, charges
could increase and interest rates may climb. For any company, such a change of climate will
demand a serious re-examination of financial budgets and plans. If the company has not been
prudent or lucky, the unscheduled change of resources could be very damaging or even fatal.
Finally, the spectre of immediate repayment is ever present. For any directors with personal
guarantees and associated second mortgages, the pressure could be intense.

6.3.6 The last resort

If you cannot get out of trouble by our own efforts and doom is staring you in the face, you
need independent specialist help. Your usual accountant and lawyer are nice competent chaps
who have served you well to date, but what experience do they have in dealing with this type
of crisis? Probably very little!

If your regular lawyer and accountant have no experience in this area you should obtain
specialist advice. Most professionals will be aware where they have reached the limit of their
competence and will be happy to recommend a fellow professional with the correct expertise.

Many accountants and lawyers specialise in this area. You will probably need one of each: an
accountant to help you work out a commercial solution and a lawyer to advise you so that you
do not inadvertently break the law as you struggle to keep the company afloat. Get the best
advisors that you can get. They will be expensive, but at this stage, you dont really have a
choice. If they are successful, the company will have a big bill that it can afford to pay. But
if they fail, it is much more difficult to criticise actions taken after taking the best advice.

6.3.7 The investigating accountant

If you owe a substantial amount to the bank, by this stage they may be pressing you to appoint
an investigating accountant to look at your company. Although the investigating accountant
will be trying to save your company, his main client is the bank. He will be paid out of your
bank account, but he will have been appointed at the banks direction, and will act primarily
for the bank. In any event, you represent a one-off fee opportunity for the investigating
accountant, whereas the bank is a continuing source of work.

The professional ethics of the investigating accountant should stop them recommending an
inappropriate receivership, liquidation or other insolvency process.

There was much concern that some investigating accountants had recommended a
receivership, which was not justified by the facts. However, in reality this happens very
rarely. To deal with this perceived problem, some banks have changed their internal rules so
that they do not appoint investigating accountants to act as receivers in a subsequent
insolvency.

6.3.8 Stop trading when there is no hope

The law is quite clear - trading whilst insolvent is a criminal offence. Fraudulent trading is an
even more serious offence.

When you get to the point where there is no possibility of saving the company it is time to
take a difficult and unpalatable decision. It is time to appoint an insolvency practitioner to
deal with the company. The appropriate form of insolvency will depend on the exact
circumstances of the company and if there is any possibility of either rescuing the company or
the business surviving as a going concern under new ownership. Your professional advisors
or the insolvency practitioner will be able to advise on the appropriate form of process.

6.3.9 Responsibilities of directors

The law is again quite clear - the responsibility of the directors is to take every step to avoid a
loss to the creditors

In addition, directors are required to assist the appointed insolvency practitioner to carry out
his duties during the insolvency.

6.3.10 Inactive directors

There are no exemptions to the rules for inactive directors.

It is not uncommon for family members or others, typically long serving employees, to be
appointed as directors for reasons of prestige, but for them to take little or no part in the
management of the company.

When the legislation was first introduced, the initial view of the prosecuting authorities was to
be lenient with wholly inactive directors. The authorities had limited resources and were far
more concerned to obtain successful prosecutions against some high-profile directors who
they believed were guilty of very serious offences over many years. And who had not been
successfully prosecuted under the previous legislation.

Recently more resources have been available, the most persistent offenders have been
prosecuted, and attitudes have hardened. As a result, more prosecutions have made of
inactive directors. The courts whilst expressing some sympathy to the inactive directors have
taken the view that as directors they have duties to the company shareholders, creditors and
others which they cannot avoid. They have assumed the responsibilities of directors and
should have taken an active interest in their statutory and financial duties and by their failure
to do so have demonstrated that they were unfit to be directors.

As an aside, the position of any inactive directors in your company should be considered. The
options may depend on the level of management skill and financial expertise of the
individual.

! Some could become more involved in the management of the company, e.g. by
reading the management accounts and other board papers, and attending board
meetings.

! For others without the necessary interest or skills, the alternative could be to resign.
If they resign when the company is in reasonable financial health, there is little risk
of any problems at a later stage.

It is probably appropriate to obtain appropriate legal advice on this issue if you have any
doubts as to the best course of action.

6.3.11 Penalties for trading whilst insolvent

A director found guilty of trading whilst insolvent will be found to be unfit to be a director.
This finding can be made in respect of other failings as director including failing to assist an
insolvency practitioner. However, corporate failure is the most common reason for the
prosecution to be bought, and the other matters are included to add weight to the prosecution.
The penalty is a minimum disqualification period of two years and a maximum period of 15
years.

The penalty regime for fraudulent trading is even more severe. There is a possibility of a
prison sentence in the most severe cases.

6.4 Analysing Company Performance

The most common and in many respect the easiest way to analyse the performance of a
company is to calculate performance ratios for the balance sheet and profit and loss account.

Some care should be taken when interpreting the results as companies in different industries
and sometimes sectors within industries will have different profiles. In addition one ratio on
its own will not be as useful as looking at all of the ratios to form a view of the company
overall. There are relationships between different ratios and a very large good might not be
entirely consistent with good performance. Where possible some of the difficulties are
pointed out in the relevant section.

Contrasting management aims are likely to give different profiles to equally well run
businesses in the same sector. For example, a widely held public company might be run to
maximise distributable profits whereas a similarly sized private company might be run to
maximise the value of the future business by investing in plant and machinery.

When using ratio analysis, it is prudent to use several comparator companies to evaluate the
performance of your own or an unknown business. To minimise errors, you should create a
comparative matrix of results from known high and low achievers.

6.5 Analysing the Profit and Loss Account

Ratio analysis is also applicable to the profit and loss account

6.5.1 Basic performance ratios

The most used performance ratios are described below.

6.5.1.1 Gross profit percentage

The gross profit percentage is the gross profit divided by the turnover expressed as a
percentage. The higher the number the better.

The gross profit percentage in constructional steelwork will vary according to how overheads
are allocated.

6.5.1.2 Net profit %

The net profit % is the net profit divided by the turnover expressed as a percentage. The
higher the number the better.

In tightly held or family-managed businesses, the directors can take profits as bonuses or
dividends. The effect of directors remuneration on performance ratios should be considered
for this type of company.

6.5.1.3 Turnover per employee

The turnover per employee is the turnover divided by the number of employees.

This is a measure of the value of output per employee and the efficiency of the company. A
large investment in machinery will tend to increase the turnover per employee.

The best performing companies, with large capital investments, will achieve turnover per
employee in excess of 100,000 per year.

6.5.1.4 Return on capital

Return on capital is the profit before interest and tax divided by the total shareholders funds
employed in the business, expressed as a percentage.

This can be compared to the return that could be earned if the money had been invested in a
bank or building society. There should be a greater return to compensate for the greater risks
inherent in constructional steelwork.

6.6 Analysing the Balance Sheet

Ratio analysis is also applicable to the balance sheet.

6.6.1 Basic balance sheet ratios

The most used balance sheet ratios are described below.

6.6.1.1 Turnover per of fixed asset

This is the turnover divided by the amount of fixed assets employed.

It shows how intensively the fixed assets are used. However, interpretation of this number on
its own is not easy. A low number could mean very low levels of efficiency or over-
investment in plant, machinery and buildings. A high number could mean high levels of
efficiency, or under-investment in new plant.

6.6.1.2 Debtor turnover

Debtor turnover is the amount of the debtors divided by the turnover, multiplied by 365. This
gives the average number of days that debtors take to be collected.

A lower number is generally better.

Care should be taken in interpreting this number for constructional steelwork companies. The
point at which WIP is transferred to debtors will vary between companies. Some companies
will make the transfer as soon as possible; others will make the transfer as late as possible.

Timing is another issues to consider. A large contract completed and transferred to debtors a
few days before the year end, and paid 30 days later, will increase the debtor days
substantially and give an incorrect impression of the company.

6.6.1.3 Creditor turnover

Creditor turnover is the amount of the creditors divided by the turnover, multiplied by 365.
This gives the average number of days after which creditors are paid.

The theory is that a company should take as much credit as possible without disrupting its
ability to obtain supplies.

Most supplies are made based on payment within 30 days or within 30 days of statement
issued at the end of the month during which the supply was made. This suggests that a
company paying at the end of the normal credit period will average 35 to 45 creditor days,
depending on the exact mix of terms. However a well-managed company with excellent
supplier relationships might be able to extend credit to 60 days or more.

Nevertheless, a substantially greater number of creditor days might suggest that the company
could be in financial difficulties and unable to pay its debts as they fall due.

Conversely a company with very low creditor days might be using its financial power to pay
promptly and to get discounts, or it might be having difficulty obtaining credit.

6.6.1.4 Stock/WIP turnover

This is the amount of stock/work in progress divided by the turnover and multiplied by 365.
This gives the average number of days that WIP takes to be collected.

This is the converse of debtors turnover and the two items should be looked at in conjunction.
The point of transfer will vary between companies. Companies, which transfer contracts from
WIP to debtors as soon as possible, will have low WIP and high debtors. Conversely,
companies which transfer from WIP to debtors as late as possible will have low WIP and high
debtors.

Timing is another issues to consider. In the debtors example above, a large contract
completed and transferred from work in progress to debtors a few days before the year end
will reduce the WIP days substantially and might give an incorrect impression of the
company.

7. INDEX [Awaited from the author]

Apart from any fair dealing for the purposes of research or private study or criticism or
review, as permitted under the Copyright Design and Patents Act 1988, this publication may
not be reproduced, stored or transmitted in any form by any means without the prior
permission of the publishers or in the case of reprographic reproduction only in accordance
with the terms of the licences issued by the UK Copyright Licensing Agency, or in
accordance with the terms of licences issued by the appropriate Reproduction Rights
Organisation outside the UK.

Enquiries concerning reproduction outside the terms stated here should be sent to the
publishers, The British Constructional Steelwork Association Ltd. at the address given below.

Although care has been taken to ensure, to the best of our knowledge, that all data and
information contained herein are accurate to the extent that they relate to either matters of fact
or accepted practice or matters of opinion at the time of publication. The British
Constructional Steelwork Association Limited, the authors and the reviewers assume no
responsibility for any errors in or misinterpretations of such data and/or information of any
loss or damage arising from or related to their use.

Publications supplied to members of the BCSA at a discount are not for resale by them.

The British Constructional Steelwork Association Ltd.,
4, Whitehall Court, Westminster, London SW1A 2ES
Telephone: +44 (0)20 7839 8566 Fax: +44 (0)20 7979 1634
E-mail: postroom@steelconstruction.org
Website: WWW.steelconstruction.org

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