Quality of Earnings for Construction Company Acquisitions

Say a buyer signs an LOI on a commercial GC at $8.4M. Annual revenue of $22M. Reported EBITDA of $3.1M. The seller's broker says "the books are clean."

Then the QoE finds $1.9M of revenue booked on jobs that were 38% complete and getting hit with change order disputes. After correcting the WIP schedule, EBITDA drops to $1.7M. At the deal's own multiple, that's a purchase price closer to $4.9M — a $3.5M cut from one WIP correction.

If you're buying a construction company this year, this post covers what your accountant misses and what kills these deals.

WIP Accounting Is Where the Money Hides

Construction companies recognize revenue using percentage of completion. The formula is simple. The math is brutal.

Revenue earned equals total contract value times (costs incurred to date divided by total estimated costs).

Every variable in that formula is a judgment call. The seller controls all of them.

A QoE rebuilds the WIP schedule from source documents and asks:

Are estimated costs at completion updated monthly or only at year-end?

How many open jobs are losing margin as they progress (gross profit fade)?

What is the over/under billing position by job?

Are change orders booked when approved or when submitted?

Here's how that plays out. Picture a residential builder showing $14M in revenue and $1.8M in EBITDA, with 23 open jobs on the WIP schedule.

Rebuild the estimated costs at completion using actual subcontractor commitments, and 11 of the 23 jobs have grown well beyond their original estimate. When that happens, the percentage complete on those jobs can be overstated by 12 to 28 points.

At that magnitude, revenue would drop by roughly $1.4M. Because the costs on those jobs were already incurred, almost all of that reversal hits the bottom line — EBITDA falls by about $1.1M.

The root cause is almost always the same: the seller hasn't done a job-level cost review in months, so the buyer is making an offer based on stale estimates.

Job Costing Reveals the True Margin

A construction company can be profitable on paper and broke at the bank because job costing is wrong.

The QoE picks 8 to 12 completed jobs from the last 24 months and rebuilds them line by line:

- Direct labor allocated correctly by job and phase

- Material purchases tagged to the right job

- Subcontractor invoices matched to the right scope

- Equipment time properly allocated

- Indirect costs spread on a defensible basis

Picture a mechanical contractor reporting 22% gross profit on the trailing 12 months. Rebuild 10 completed jobs from source documents, and the real gross profit comes in at 14%.

The usual cause: labor and material overruns get parked on the balance sheet — capitalized into work-in-process instead of expensed to the jobs that incurred them. The cash already went out the door to pay crews and suppliers, but the income statement never sees the cost, so margins look stable while the bank balance quietly bleeds. That's the classic profitable-on-paper, broke-at-the-bank pattern.

That eight-point gap on $15M of revenue is about $1.2M of annual EBITDA. At the ~3x multiple a deal like this trades on, that's roughly $3.6M off the purchase price.

Where the WIP section catches revenue recognized too early, this catches cost that never hit the P&L at all. Two different levers, same result: reported earnings that don't survive contact with the source documents.

This is one of the common QoE adjustments that construction buyers miss without proper job-level review.

Retainage Is Hiding in Receivables

Most construction contracts hold back 5 to 10% of each invoice until the job is complete and accepted. That money sits in receivables until release.

A clean QoE separates retainage from regular AR and asks:

- How much retainage is current versus aged over 12 months?

- What jobs have retainage but no clear path to release?

- Are there punch list items or disputes blocking release?

- What is the historical write-off rate on retainage over 24 months old?

Picture a commercial GC with $4.2M in accounts receivable, $1.8M of it retainage. Age that retainage and $710K sits on jobs completed more than 24 months ago — several with open disputes, and a couple where the paying GC has filed for bankruptcy.

A seller's offer typically assumes 100% collection on AR. A QoE that surfaces this leads to a retainage reserve — say $450K against expected losses — plus a working capital adjustment that recovers more value to the buyer.

Sellers don't write down old retainage. They hope it collects. Without the analysis, the buyer inherits the hope and the loss.

Customer Concentration in Construction Cuts Two Ways

Construction firms develop relationships with specific GCs, developers, or owners. Those relationships generate repeat business. They also generate concentration risk.

The QoE pulls revenue by customer for 36 months and asks:

- What percentage comes from the top 3 customers?

- Are any major customers in financial trouble?

- Are the relationships personal to the seller or institutional?

- Is there a written master service agreement or just repeat work?

Picture an electrical contractor with $9.6M in trailing-year revenue, 58% of it from a single developer — a 20-year relationship tied to the retiring seller. The developer's project pipeline for the next 18 months is light. A buyer who thinks he's acquiring a stable customer base is really buying a sunset relationship.

A deal like that gets restructured: 50% cash, 25% seller note tied to retained revenue from the top customer, 25% earnout over three years. A seller in that position takes it, because losing the relationship at close would gut the value.

Equipment, Bonding, and Hidden Liabilities

Construction companies have three balance sheet items that wreck deals:

Equipment. Reported book values are rarely market values. A 7-year-old excavator on the books at $85K may be worth $45K. Equipment leases that look like rentals may actually be capital leases hiding $300K of liability.

Bonding capacity. Surety bonding is required on most public and large private jobs. A QoE confirms current bonding capacity, single-job limit, and aggregate limit. If the buyer's credit profile is weaker than the seller's, the bonding capacity drops on day one and so does the pipeline.

Warranty and rework reserves. Most construction contracts include a 1 to 2 year warranty period. If the seller is not accruing for warranty work, EBITDA is overstated. A QoE benchmarks the warranty cost as a percentage of completed work and sets the reserve.

Picture a site work contractor with $12M in revenue and $2.1M in EBITDA, no warranty reserve, and zero accrual for callback work — while historical warranty cost runs at 1.4% of revenue. That's about $168K of annual EBITDA the seller has been ignoring. At a ~3x multiple, that's roughly $500K off the offer.

Working Capital Is Brutal in Construction

Construction firms float massive amounts of working capital. Pay subs and suppliers on 30 to 45 days. Get paid by owners on 60 to 90 days. The company funds the gap.

The peg always looks too high to a seller. It usually isn't. A peg that's $300K too low forces the buyer to inject cash in week 4 to make payroll.

Picture a specialty trades contractor that closes with a working capital peg $480K below what the analysis would recommend. Six weeks after close, the buyer has to draw $600K on his SBA line just to keep subs current. The right peg would have prevented the panic.

What to Ask For Before LOI

Before you sign an LOI on a construction acquisition, request:

- 36 months of monthly P&Ls with job cost detail

- WIP schedule with cost-to-complete updated within 30 days

- AR aging separating retainage from regular receivables

- 24 months of completed job profitability reports

- Revenue by customer for 36 months

- Equipment list with serial numbers, age, and lease status

- Bonding letter showing current capacity and limits

- Open change order log with status

- Warranty and callback expense history

- Subcontractor list with payment terms and concentration

If the seller cannot produce these in three weeks, the accounting is project-by-project memory and a buyer is about to inherit the cleanup.

What to Do Next

If you are looking at a construction company acquisition:

- Get the documents above before you commit to exclusivity

- Engage a QoE provider that has rebuilt WIP schedules from source documents

- Plan for a working capital peg that funds the float

- Confirm bonding will transfer at the buyer's credit profile

- Structure the deal to protect against customer concentration risk

Read the Quality of Earnings Complete Guide for the full diligence process. For a conversation about a specific deal, reach our team.

The buyers who pay the right price for construction companies are the ones who priced the WIP, not the brochure.