The CPI, or Consumer Price Index, measures the change in prices of consumer goods and services. The index is released monthly by the Bureau of Labor Statistics for the United States, although data specific to certain geographic areas is also available.

In August 2022, the CPI increased 0.1% due largely to heightened food and energy prices. Offsetting most of these increases was a decrease in automobile fuel costs of 10.6%. While this seems to be generally welcomed news, the CPI has increased 6.5% when annualized, more than three times higher than the Federal Reserve’s target inflation of 2%. Rising costs are still affecting consumers and businesses considerably.

Although some manufacturers may not sell directly to consumers, the CPI can provide several insights useful for manufacturers. Considerations include the following:

• Despite a drop in automobile fuel costs of 10.6% last month, fuel prices remain 25.6% higher than costs in August 2021. Manufacturers may notice this via freight bills for hauling goods to or from their facilities. Optimizing shipments, researching and pursuing alternative freight methods, seeking suppliers in close geographic proximity, and negotiating prices with both suppliers and customers are tactics manufacturers may consider in managing this cost.
• Despite relief in the monthly CPI report, inflation is continuing, with costs of consumer goods and services continuing to rise. Specifically, the CPI reports increases to the costs of goods including food, household goods, apparel, medical supplies, and recreational goods. These rising costs can affect consumer demand for manufactured goods as discretionary income is affected. As a result, manufactures should evaluate how this may affect demand.
• In addition to the rising costs of goods, it is expected that interest rates will also continue to increase. To control inflation, it is expected that the Fed will increase interest rates by 75 basis points in September. As interest rates rise, manufacturers and end users alike may face increasing costs and lower levels of discretionary income. Again, manufacturers should evaluate how this may affect demand.
• Further, with the increase of interest rates, manufacturers may consider their debt structure and capital budget. Notes with variable interest rates will likely see another round of increases in interest costs. Further, planned capital expenditures requiring financing may be reconsidered based on the projected actions of the Fed. Manufacturers must monitor their debt structure and capital budget spending closely to ensure they maintain proper liquidity and solvency.
• The CPI also indicates that supply chain disruptions are easing. Manufacturers continuing to experience significant disruptions may consider working with their suppliers to identify root causes and solutions for continued issues or alternative products that may prevent continued disruptions, especially those that are affecting the company’s ability to effectively service customers.

For questions about the CPI or the affect of the economy on your manufacturing business, contact a member of HBK Manufacturing Solutions at manufacturing@hbkcpa.com or 330-758-8613.

Manufacturers continue to face economic challenges, especially related to increasing commodity prices, labor availability, and ongoing effects from pandemic shutdowns. Watch HBK Manufacturing Solutions and special guests Joe Woodall and Tim Quinlan from Wells Fargo to provide a commercial banking perspective of the economy and its impacts on manufacturers.

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The recently enacted Covid-19 relief package titled “Consolidated Appropriations Act, 2021” has extended the Federal Energy Tax Credit (Section 45L) through December 31, 2021, and made the Energy Efficient Commercial Building Deduction (Section 179D) permanent. While both tax incentives offer significant value and the qualification process is simple, they are often overlooked by developers and homebuilders. Section 45L Section 45L is a tax credit of up to $2,000 for each new or rehabilitated energy-efficient dwelling unit that is first leased or sold by the end of 2021. If you qualified for the credit but did not take advantage of it in previous years, your tax returns can be amended for up to three past years—2017, 2018 and 2019—to get you the credits you are entitled to. Qualifying dwellings include newly constructed or rehabbed single-family homes, low-rise apartments, and other complexes of three stories or less, including condominiums, townhouses, senior living facilities, and student housing. The projected annual heating and cooling cost of the dwelling or residential unit must be at least 50% below the annual energy consumption level based on 2006 standards. Most new developments today exceed these standards simply through energy-efficient features, such as high-R value insulation and roofing, windows, doors, and/or HVAC systems. To capitalize on the 45L credits, you must engage a licensed professional to certify energy improvement standards have been met. The cost of certification is typically much less than the financial rewards gained from the tax credit. For example, consider a three-story apartment complex with 60 qualifying units that were fully leased or sold in 2020:

• Tax credit = $2,000/unit x 60 units = $120,000
• Project Certification Fees (estimated) = $400/unit x 60 units = $24,000
• Net benefit of the 45L credits = $96,000

Section 179D The 179D Energy Efficient Commercial Building Deduction of a maximum of $1.80 per sq. ft. per qualifying property is available to those who have built or renovated properties they own with energy-efficient commercial building property (EECBP). EECBP includes interior lighting, materials used on the building structure, and mechanical systems. The 179D deduction is also available to those who have designed or built government-owned buildings, such as engineers, architects, and contractors. In certain situations more than one of the companies designing and building a property will qualify for the credit, so it is important to address the issue up front in the building contracts. Both the Section 45L and 179D tax incentives have been available for years, but few developers and builders who qualify take advantage of them. If you think you might qualify for either one, call your tax advisor. It could mean a significant financial benefit to you and your company.

Projecting the performance of the U.S. economy has always been a difficult task, even given a relatively constant and agreed-upon set of variables. This year the exercise is even more challenging considering the unprecedented nature of the economic environment. The specter of a new presidential administration, the shifting balance of power in Congress, and how leaders in different states across the country will react to spikes in cases of COVID-19 add to the uncertainty that most businesses have felt since we became aware of the pandemic.

Will additional relief spending be authorized in Washington? Will inflation be used as a means of reducing the $27 trillion national debt thereby driving up business costs? Will freezes on evictions be extended and what will happen to the residential and commercial real estate markets when they are lifted? While we can’t yet answer many of these questions, businesses can use the information we do have to prepare for the year ahead.

Through the end of November, the construction industry recovered 80 percent of the jobs lost during the first two months of the pandemic. However, many challenges remain. The Associated General Contractors of America (AGC) conducted several surveys of construction companies throughout the last year to gauge the impact of COVID-19 on contractor operations and they provide the information we can use to analyze where we have been and plan for where we could be headed.

Due to lockdowns, many contractors had to cut back on their planned spending and find ways to ensure positive cash flow. One of the first cuts was to unnecessary improvement projects, resulting in the cancelation of planned jobs. The number of AGC survey respondents reporting they had canceled scheduled jobs grew from 32 percent in the AGC’s June survey to 60 percent in August and 75 percent in October. Meanwhile, only 23 percent of the October respondents reported winning additional project bids compared to 21 percent in June. The trend is sure to result in diminished backlogs for contractors.

Historically, smaller contract backlogs have led to increased competition on new bids, driving down contract prices. Over prolonged periods of time, this economic trend puts a strain on contractor cash flows. To guard against diminishing cash flows, contractors should ensure they have reviewed their overhead costs and included changes in those costs in their estimating and bidding strategy. Additionally, forecasting cash flows over the next 12 to 18 months is essential to planning for any lean months throughout the coming year.

The shortage of new jobs and increased cancelations has not been the only problem facing the construction industry. Many firms are finding it difficult to find the resources they need to complete jobs. Shortages in both materials and equipment were up from 25 percent in June to 42 percent in October. Meanwhile, 35 percent of contractors experienced disruptions due to the scarcity of skilled workers and/or subcontractors. These trends are troubling because not only are material costs likely to increase, but project delays create issues with scheduling, which could impact multiple jobs as well as increase the likelihood of cost overruns and liquidated damages. Project management will be more important than ever to make certain that work is completed as efficiently as possible. Contractors should invest the time to ensure their project managers understand how individual jobs impact the company’s bottom line and how they can help strengthen the company through superior performance on their projects. Additionally, a review of a contractor’s past completed projects could uncover strengths and weaknesses in their project management team that will help with staffing decisions on future jobs.

One bright spot in the industry over the last year has been residential construction. Both new home construction and renovations have seen positive gains with bid prices up over 10 percent since the start of the pandemic. Alternatively, on the commercial front, there has been less demand for retail, office, and higher education construction, a trend that could be long lasting as many operators in these spaces are transforming the way they conduct their businesses.

What was a slow trend of declining demand for a brick-and-mortar presence in retail was accelerated by COVID-19 lockdowns and social distancing guidelines. As well, many businesses have found ways to reduce the need for office space by conducting both internal and external meetings online, and numerous universities have moved to a distance-learning model to minimize physical contact between faculty, staff, and students. Even after vaccines are available en masse, a rebound in brick-and-mortar projects is likely to be sluggish if present at all.

Contract backlogs have historically delayed the impact of economic downturns on construction companies by 12 to 18 months. As contractors work through their projects under contract at the start of a recession, they may appear to be insulated from the downturn. However, as that backlog shrinks and is replaced by jobs bid in the depressed economy, they are likely to experience diminished margins. Planning ahead in these scenarios is the key to a soft landing.

Many of these trends are geographically focused, as states with the strictest lockdown measures have seen the most severe impact on local businesses. Shifting populations could soften the effect of negative trends in the states that are seeing population increases such as Arizona, Florida, Idaho, Nevada, and Texas while exacerbating the negative impact in states like Illinois and New York which saw their populations decrease by half a percent between 2018 and 2019.

Nearly all businesses have been forced to adapt on the fly to an economy in the throes of the COVID-19 pandemic. Those that continue to be nimble and innovative will put themselves in the best position to weather any storms that come their way in 2021 and beyond.

Michael Kapics, CPA, CCIFP, and Construction Industry Group Leader for HBK CPAs & Consultants, would like to share the following article written by Brandon Dougherty, CPA, which highlights several important recommendations to assist contractors in maneuvering through turbulent economic times.

In times of economic prosperity, contractors tend to be less concerned about surviving and more prone to taking unnecessary risks. But it is in times of relative security that business owners are in the best position to prepare their companies for the inevitable less prosperous times.

Set Realistic Expectations for Growth
In bull markets, many business owners take advantage of improved margins and increased cash on hand to grow their businesses. While their overall growth strategy might be sound, the implementation of an effective strategy is imperative to ensure that the expansion does not negatively impact the company’s liquidity. Rapid expansion into new, unfamiliar geographic areas or service lines can be disastrous if not carefully planned. Entering new markets can lead to losses in the new initiatives and put additional stress on established operations.

Further, significant increases in the size of individual projects, whether in a new geographic area or a new service line, can appear attractive on the surface because revenues are likely to increase. But higher revenues do not necessarily translate to higher profits. Especially if a company is unfamiliar with the licensing requirements and regulatory environment in a new state or municipality, what sounded like a great idea around the boardroom table, could ultimately destroy what the owners have built through years of dedication and hard work in their field.

When planning for expansion it is essential that the business take a deliberate, measured approach to ensure that the new enterprise does not negatively affect the existing operations. Realistic growth plans typically extend 12 to 36 months and allow the businesses to evaluate and react as things unfold during that time.

Invest in Your Human Capital
Another leading cause of contractor failures relates to performance and personnel issues. A lack of skilled labor has impacted many of the nation’s contractors. While this can make a successful expansion nearly impossible, it is also a struggle for many businesses just trying to maintain their existing levels of operation. Inadequate training or experience, as well as an insufficient quantity of personnel, can halt a growth plan in its tracks. A strong business invests in its workforce through formal, on-the-job training at all levels, and develops a culture of loyalty, ownership, urgency and accountability.

Prudence in Prosperity
Maximizing distributions to owners, deferring the reduction of debt, and other policies that erode a strong financial foundation can squander a company’s opportunity to truly improve its financial footing. Contractors should avoid big-ticket items like planes, boats and equipment unnecessary to the business, as the cost and upkeep of such items can be burdensome when cash flows are tight and margins are compressed by an economic downturn. Resale values are also typically substantially depressed during down markets. Instead of splurging on non-vital items, business owners should invest a portion of their profits in short-term, liquid investments as a way to ensure future cash flow.

Create a Long-Term Succession Plan
Succession planning plays a huge part in the long-term viability of a company. Retirements, unexpected deaths, or other changes in leadership can result in a shift in focus that can lead to abandoning ways of doing business that led to the company’s success. With no plan to ensure continuity in the event that a death or disability could cause a change in the culture, key staff members could become disgruntled, and some of them might ultimately leave a business at a time when they are needed most.

The topic of succession can be an unpleasant conversation, but it is critical for owners of small and medium-size businesses to have a plan in place for what happens when they move on, by choice or otherwise. Having a trusted advisor knowledgeable about succession planning can ensure a thorough and objective analysis of all factors.

Economic downturns, national or local, external or internal, are inevitable. Informed, thoughtful planning is the best way to ensure your business will survive the next one. For questions, please contact Brandon Dougherty of HBK’s Construction Industry group at BDougherty@hbkcpa.com