Internal Controls Can Protect Contractors from Losses

The construction industry is quite a risky business nowadays. The chance of a contractor who is business today being out of business in two years is very high. According to BizMiner, of the 850,029 construction companies in business in 2004, 649,602 were still in business in January of 2006 which is a 23.6% failure rate. Around 22% of construction companies that were in business in 2005 were out of business in 2007.

Why are these contractors doing so poorly? There are many reasons and causes as to why this is happening. The main reasons are: inadequate estimating, employee theft/dishonesty, poor site conditions, labor shortages, and materials price increases. But, there is hope for contractors who want to prevent any type of a loss.

Employee theft is a risk that affects all businesses, not only contractors. The estimated annual losses that are caused by employee theft are approximately $50 billion dollars, and that was 2002′s figures. Obviously, losses at the present time are substantially higher, due to today’s unstable economy. Due to this poor economy, an employee may feel justified in attempting to abscond with any company money or property.

How do we prevent loss? A strong system of internal controls can greatly reduce the chance of theft. Internal controls can be very useful to a contractor whose employees are scattered at various job-sites. This will greatly help the contractror since he or she may not be able to be present at each different job site at all times. With this being said, it is extremely important that the contractor carries out the following controls:

  • Designate clear lines of authority and responsibility between employers and specific departments. Accounting and operating functions should be kept as separate as possible.
  • Utilize background checks prior to hiring a potential employee to reduce the risk of hiring a potential thief.
  • Set up a division of tasks so that no one person handles financial transactions straight through from beginning to end.
  • Supervise and enforce internal controls. Management must be aware of potential signs of changing employee behavior.

Although these controls are very effective, no control system is 100% foolproof. The criminal mind can be creative and can find ways to overcome these mentioned controls. This is where a fidelity bond comes into play. If the controls are overcome and there IS a loss, a fidelity bond would be a contractor’s second line of defense. The bond would protect the contractor against any loss incurred due to dishonest acts of an employee.

There are many controls that contractors are easily able to obtain and utilize. Each contractor must recognize the risk of employee theft by enforcing a strict internal control system and also obtain a fidelity bond. Even though a contractor believes that he or she really knows their employees, it would be a very wise decision for the contractor to utilize the mentioned controls to take as many steps as possible to prevent any unnecessary losses. The statistics should speak for themselves. Theft by employees can and does happen on a very regular basis.

FHA Surety Bond Requirement Update

One of the biggest questions we receive of Mortgage Brokers is what is going on with the Federal Housing Authority (FHA) Bond?

The Federal Housing Authority (FHA) loan program is of vital importance to mortgage brokers. According to The Department of housing and Urban Development (HUD) sources, brokers originated 38.6 percent of all FHA loans for a total of $110 billion in 2003. In the past, many Mortgage Brokers have not been able to afford the costly audited financials that would qualify them to write the FHA Mortgage.

The Federal Housing Authority (FHA) bond program is currently awaiting a vote in the Senate. If accepted, this Federal Hosing Authority (FHA) program will allow a Mortgage Broker to obtain a $75,000 Surety Bond in lieu of audited financials. This will dramatically change the makeup of Mortgage Brokers that will have the ability to write mortgages for the Federal Housing Authority (FHA).

Most small businesses find the cost to produce audited financial statements to be a significant burden. The cost of hiring an accountant who meets government auditing standards and the man-hours needed to compile and report the needed data is simply impractical for a small business. As a result, many mortgage brokers decide not to originate FHA loans. By asking these businesses to purchase bonding, the Department of Housing and Urban Development (HUD) will increase competition for FHA loans. These bonds are generally cheaper than auditing financials and still providing relief to injured customers.

With the upcoming presidential election, it is speculated that the new FHA Bonding requirements will not be going through the Senate until a later time. Still, it is expected that both the Democratic and Republican Parties support these proposed bond requirements and it should fall in place. The new program will allow people from all different walks of life and financial levels to be enrolled into the FHA program. Applicants will even have opportunities if they have suffered bankruptcies. Applicants with little credit only need two lines of open credit to apply for an FHA loan. And in the event a borrower does not have sufficient credit on their credit report, the FHA will allow substitute forms.

The Mortgage Brokers will have to qualify for the new bond, which as of today it is unclear what standards the Surety Companies will set in place. The bond itself must be somewhat friendly to the Surety Company and will be analyzed by the individual companies that choose to write these bonds. We look forward to being able to write these bonds and serve a slumping industry towards a good push in the right direction.