In layman’s terms, the gain/fade analysis is a comparison of the preliminary contract amount and its related cost budget to the final contract amount and total costs incurred on the job at job completion. This analysis provides the owner with valuable information related to job performance, profitability of change orders, and an estimator’s overall ability. Large variances from amounts originally estimated during the bid process should be analyzed and discussed to ensure the job cost contains accurate information and to uncover potential job management issues. Was additional work outside of the scope of the original contract performed which should be added through a change order and billed? Was there a labor overrun due to poor job management? Were costs improperly charged to an incorrect job? All of these are questions which should be asked and answered when reviewing job performance after wrap-up.
Calculation of the related asset (for underbilled contracts) and liability (for overbilled contracts) under the percentage of completion method is typically one of the most significant estimates included in a contractor’s financial statements. This is the easiest place in the financials for companies to employ earnings management tactics. In a good year, a company may be enticed to defer as much profit as possible into the next year by including an unreasonably high cost estimate. Likewise, in a poor year, they may be enticed to shift profit improperly into the current year by showing a lower cost estimate. Users of the financial statements understand the magnitude of this estimate and therefore ask questions after performing a fade analysis. Based on their retrospective review of the estimates included in the work in process calculation, bankers and bonding agents will likely form conclusions on a contractor’s ability to estimate and therefore provide them with accurate financial statements. Don’t end up in a position where they question the credibility of your financial statements.
Fade analysis is a very important tool that is used by bonding companies, bankers, and outside accountants/auditors and should be used by every contractor internally. As the old adage goes, trust is earned, not given. Therefore, it is always in the best interest of a contractor to be as diligent as possible in providing outside parties with accurate information. As part of this, we always recommend open, candid communication between accounting staff and field operations to ensure any factors and circumstances affecting job profitability are accounted for timely. This will provide management with more accurate interim financial statements, allow for better conversations with job supervisors regarding a job’s performance and will foster better conversations among operations and accounting staff.
If you have questions please contact your local Blue & Co. advisor.
