Construction Accountants CPA Hartford: William Brighenti
46 Mildrum Road,
Berlin, CT
06037
Telephone: (860)
828-3269
Email: info@cpa-connecticut.com |
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Gain/Fade Analysis: Important Tool for Contractors
by William Brighenti, Certified Public Accountant, Certified QuickBooks ProAdvisor Accountants and managers working in construction need to be aware of a very important tool used by bonding and banking analysts, one often ignored by the contractor's controller and sometimes even by the outside auditor as an analytical procedure: fade analysis (also known as "gain/fade analysis"). In the construction literature, there is reference to this procedure; however, a detailed explanation or an illustrative example of fade analysis is rarely found. In very general terms, fade analysis is a trend analysis of the estimated and/or actual gross profit of construction projects over reporting periods. Typically it reports the differences from year to year in the total estimated/actual gross profit amounts in dollar amounts as well as in percentages. This schedule allows the user to ascertain if any meaningful patterns are evident. Material differences (10% or greater) customarily warrant further examination to ascertain their cause. Also the more variability in gross profit per contract over time evident in the fade analysis, the riskier the contractor is viewed by bonding and financial agents, since predicting the future profitability of such a contractor is less likely. Decomposing fade analyses by project manager, estimator, category of construction work, etc., often accounts for the fade:
|
| Total Gross Profit
(Either
Estimated or Actual) as of December 31, |
||||||||
| Contract | 2006 |
2007 |
2008 |
2009 |
||||
| A |
$770,000 |
22.0% |
$860,000 |
22.9% |
$900,000 |
23.5% |
$775,000 |
19.1% |
| B |
1,000,000 |
20.0% |
1,050,000 |
20.5% |
1,090,000 |
20.6% |
900,000 |
16% |
| C |
500,000 |
25.0% |
530,000 |
25.9% |
375,000 |
17.1% |
--- |
--- |
| D |
210,000 |
28.0% |
215,000 |
28.1% |
135,000 |
16.8% |
--- | --- |
| E |
690,000 | 23.0% |
710,000 | 22.9% |
720,000 | 22.9% |
650,000 | 19.1% |
| To prepare a fade analysis schedule, simply compute the change from year to year in total estimated or actual gross profit on each contract: |
| Fade Analysis | ||||||||
| Contract |
2007
Gain (Fade) |
2008 Gain (Fade) | 2009 Gain (Fade) | Total
Gain (Fade) |
||||
| A |
$90,000 |
11.7% |
$40,000 |
4.7% |
($125,000) |
(13.9%) |
$5,000 |
0.7% |
| B |
50,000 |
5.0% |
40,000 | 3.8% |
(190,000) |
(17.4%) |
(100,000) |
(10.0%) |
| C |
30,000 |
6.0% |
(155,000) |
(29.3%) |
--- |
--- | (125,000) |
(25.0%) |
| D |
5,000 |
2.4% |
(80,000) |
(37.2%) |
--- |
--- | (75,000) |
(35.7%) |
| E |
20,000 |
2.9% |
10,000 |
1.4% |
(70,000) |
(9.7%) |
(40,000) |
(5.8%) |
| Total |
$195,000 |
($145,000) |
($385,000) |
($335,000) |
||||
| It is readily apparent by
examining the total fades that Contracts C and E would certainly
warrant further investigation to ascertain the cause of such large
deviations; however, when one examines the yearly changes, fades on all
of the contracts in the year of completion become evident, suggesting a
serious deficiency in the project management information system of the
construction company. Consequently, a trend analysis year by year
provides much more insight into the reliability and
accuracy of the job costing information provided by the contractor
than a simple comparison of total actual gross profit to total
estimated gross profit per contract: patterns are often revealed,
as evident in the above example, indicating a serious deficiency in the
estimating and/or accounting system of the construction company.
Without undertaking the fade analysis year by year and simply comparing
initially estimated gross profit to actual gross profit per contract,
one might have concluded that the contractor had merely miscalulated on
a couple of contracts. For instance, a carefully planned
systematic pattern of "shifting" job costs from one contract to another
between periods might go undetected simply by comparing total actual
costs to total estimated costs. At this point, further fade analysis decompositions of highly variable contracts by project manager, estimator, type of construction, or other source of variability could be undertaken to target the root cause of the fading pattern. Bear in mind that meaningful fade analyses require at least four years of operating data; and those extending over longer periods of time provide more insight into the source of the variability of the contract gross profits reported. |
| William
Brighenti has thirty years of public accounting and construction
accounting experience. His career in public accounting began in
1979; since then, he has been employed as a certified public accountant
at various public accounting firms in Connecticut. Moreover, he
has served as a controller of several construction companies, and for a
number of years directed a residential development company in New
Britain. He also served on New Britain's City Plan Commission as
well as its Board of Finance and Taxation. As a principal at
Accountants CPA Hartford, William Brighenti offers a myriad of
services to contractors, including the following: |
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| For more information on construction accounting, fade analysis, the percentage-of-completion method of accounting, the completed-contract method of accounting, construction tax methods, construction accounting software, or any other accounting and tax service, please visit our website: Accountants CPA Hartford: William Brighenti, Certified Public Accountant |