Contractors Mid-Year Financials: Help or Hurt?

Is it worth it to provide a mid-year financial?  Do these help?  Let’s look at this subject by first considering the overall underwriting process.

Individual Sureties are risk averse and conduct a broad analysis intended to determine if the contractor presents any likelihood of default or claim.  The account review includes the project history of the company and prior experience of the key individuals, banking and vendor relations, credit scores, plant and equipment and financial condition / performance.

The financial aspects are just one part, but they are important.  The company financial statements are a reflection of the quality of management and show the extent to which management has succeeded in attracting sufficient revenues, controlled expenses, managed debt and maintained sufficient liquidity.  A number of analyses are commonly run by bond underwriters and other grantors of credit.  All these reviews are typically focused on the fiscal year-end financials.  For many companies, this date is December 31st.

After the fiscal year-end information is reviewed, an annual determination is made for credit lines.  Individual Sureties will normally establish a dollar amount per project that they intend to support (individual contract amount) as well as an aggregate figure (collective exposure for all bonded obligations on any given day.)

As the year rolls on, the contractor may be asked to provide a mid-year financial.  In our example, this would be a June 30th complete financial statement, or at least a Balance Sheet and Profit and Loss Statement (possibly with supporting documentation.)  What does the contractor gain by not providing this?

One benefit is reduced expenses in the area of internal and outside accounting fees, plus the related management time spent in reviewing / approving figures, consulting with the accountants, etc.  It should also be noted that bonding companies only use the mid-year info to decrease a contractor’s capacity (bonding line.)  It would not be normal for them to increase the line based on favorable 6 month results because these may be inflated to impress the surety and bank, and because the profits could evaporate prior to the day taxes are calculated.  Companies with a weak first half may be hesitant to share such details.

What benefit arises from providing the information?  For one thing, the surety expects management to track financial performance during the year.  So don’t they need the info for their own purposes?  Providing the information reaffirms the quality of company management.  Secondly, the mid-year report enables underwriters to keep a finger on the pulse.  Are sales on track?  Has any net worth been bonused out to pay taxes (in a Subchapter-S corp.) or to reward management?  Have new affiliates been added, bank lines renewed and unbonded work acquired?  Are expenses proportionate based on revenues to assure the likelihood of a profitable year-end?  It is the analyst’s opinion that management needs to know the same info as the bond underwriters, so how could they function without it?

Clearly, having the information is useful for company management.  There can be early tax planning and the projected success of open projects can be evaluated.  And since the mid-year financials are not used for primary underwriting decisions, underwriters will normally accept a less formal presentation than at the fiscal year-end.  Companies that produce a year-end audit may issue a reviewed report at 6 months.  Accordingly, year-end reviews may be followed by a mid-year compilation.  Many underwriters will accept a properly prepared 6 month “internal” financial statement, such as on Quick Books.  This saves expense dollars and shows that the company is tracking their status internally (continuously) even without the assistance of the outside accountant – a confidence builder for the underwriter.

Conclusion: Mid-year financials are beneficial for companies that require the support of their creditors throughout the year.  They enable company management and outside analysts the opportunity to monitor year-to-date progress and make adjustments in a timely manner.  Stockholders see this as a prudent management practice and favorable results are a confidence booster for all who read the report.  Considering the time needed to issue fiscal year-end statements (often not available for + / - 90 days after year-end), the 6 month statement helps bridge the gap until updated info is available.

Bottom line, mid-year financials are an expense but are necessary.  Well managed companies produce a credible document in a timely manner.