At Tom Vignali CPA, Inc., we frequently have the opportunity to assist companies with their contract review analysis. This process compares the data from estimated bids to completed contract financial data. The final product is similar to a mini profit-and-loss statement for each contract.
During a recent review for a company, we uncovered a variety of issues that resulted the company losing money on many of their contracts. Although not all-inclusive, we will attempt to identify some of the major flaws in the bidding process and how they can be resolved.
Four costly flaws
The company bid on a project that required quotes for time of completion, labor costs, material costs (with an agreed-upon markup), and an agreed-upon profit margin.
1. One for the first flaws we identified is that the company used the individual employee pay rate when calculating out labor costs rather than the weighted labor rate. So, if an employee was being paid $40.00 per hour, they used that figure in their labor calculations, marked it up accordingly, and derived a labor charge per hour for that employee. Unfortunately, this did not allow for all of the expenses being incurred by the company for this employee. The actual costs would be much higher due to benefits, taxes, etc. The result was that the “markup” on labor was woefully under-calculated, resulting in significant funds being dedicated to actual expenses rather than profit margins. At Tom Vignali CPA, Inc., we have a worksheet that can assist clients with determining the weighted labor costs for each employee.
2. A second flaw that we identified involved the company’s estimate for its base labor cost. To determine this cost, individual labor rates for each employee were multiplied by the hours they were scheduled to work on the contract. However, in tracking the labor time per employee on this contract, it was revealed that employees with a much higher labor rate were used to perform services in an effort to meet time deadlines. The actual labor costs were exacerbated by a greater use of higher-paid employees than had been used in the estimates.
3. A third flaw is that the company had used excess inventory from in-stock supplies in numerous instances. Due to the fact that actual purchase invoices were used to provide for material charges, the company failed to provide invoices for these in-stock products and were unable to charge for these products. They were in fact reducing their own inventory (with no reimbursement) and the only beneficiary was the customer.
4. A fourth flaw was that in order to maintain on-time contract requirements, the company had occasionally used in-house staff to perform some of the duties related to this contract, but their time and labor costs were never tracked as direct expenses to the contract.
Under-bidding contracts comes at a price
Upon completion of the contract, the company performed what they considered to be a complete contract analysis to determine profitability. Their conclusions were that they had “made money” as had been projected in their original estimates. Unfortunately, even though they took into account the extra use of higher-paid employees, which reduced profits on the contract, they did not factor in the use of in-house staff or in-stock inventory. They claimed that their profits were not actually as high as had been projected, but that the contract was still profitable.
In fact, upon our review, this contract was far from profitable! The company had used the same flawed financial calculations in their estimates as they had used in their completed contract review. The flaw merely repeated itself resulting in a flawed analysis.
When we prepared and presented what should have been an accurate estimate, using weighted labor costs, actual hours to be worked by each employee, the labor expenses of in-house staff, and the cost of all materials used, including in-house inventory, the results were astounding. The company had vastly under-bid this contract, and a great portion of direct expenses were paid for by the company rather than the contract. Upon reviewing all of the other bids for the contract, it became evident that the company was by far one of the lowest bidders. It also became evident why the company won the bid, and why so many other bidders bid at a significantly higher rates. Most likely, their bids had much more accurate labor and material costs.
Making money starts with accurate estimates
So, when this company asked why they were losing money when their contracts were profitable, we were able to prove that the methods used to estimate bids as well as the methods used to analyze the profitability of their contracts were factually flawed. The company was losing money because they weren’t really making any money on the contracts. A comprehensive review of both processes was performed, allowing the company to develop strategic plans to significantly adjust both the estimating and contract review process.
They might not win every contract that they bid on in the future, but when they are awarded a contract, they are more certain that it will be profitable.
If you would like to further discuss this issue or any other accounting issues, don’t hesitate to contact us at: Tom Vignali CPA, Inc.
Contact Us:
Thomas W. Vignali CPA Inc.
118 Point Judith Road
Narragansett, RI 02882
T: (401) 415-0798
tom@tomvignalicpa.com
www.tomvignalicpa.com
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