Article
Brochure
Executive Resource
Insight Hub
Ext. Publication
VideoFinancial Diligence Considerations for Percentage of Completion Companies in M&A Transactions
Transaction Advisory Services
Transaction Advisory Services
Never miss a thing.
Sign up to receive our insights newsletter.
Evaluating a project-based business that uses percentage of completion (PoC) accounting requires more than reviewing reported revenue and EBITDA. Buyers must understand whether the financial statements accurately reflect the economics of ongoing work.
Structuring Financial Diligence for PoC Companies
Financial diligence for PoC businesses requires a more focused approach than traditional revenue models. Reported results are influenced by estimates, timing and project-level variability, meaning standard analyses may not fully capture risk.
Diligence must assess how results are generated and whether they are sustainable. This typically involves assessing normalized performance, revenue recognition practices, working capital and post-closing operational considerations.
The lookback analysis in practice
The standard tool used by quality of earnings (QoE) providers to address PoC timing issues is the lookback or hindsight analysis. This procedure replaces estimated costs with actual final costs and recalculates margins across the life of each project, smoothing out timing differences created by estimates.
What the lookback reveals: The lookback removes noise created by estimate-driven timing differences, produces a cleaner view of historical performance and reduces the volatility introduced by the cost estimation process.
What the lookback misses: The limitation is that it removes more than noise. It also removes information about how the business performs. Variability in project margins driven by estimate revisions, cost overruns and execution issues are part of the operating reality. A company that consistently overestimates early-stage job profitability is not equivalent to one that estimates conservatively and performs to plan, even if the lookback produces similar adjusted EBITDA.
Why buyers need more than a lookback: The lookback normalizes EBITDA by removing estimate-driven timing noise. In doing so, it discards the execution signal buyers need. Recovering that signal requires a separate analysis. Sophisticated diligence teams analyze management’s historical accuracy, including actual versus budget performance across completed projects, the frequency and magnitude of estimate revisions and the lag between when problems develop operationally and when they are reflected in the financials.
Lookback limitations on open projects: The lookback only applies to completed jobs because it relies on final actual costs. Therefore, it provides limited insight into open contracts, which often drive current earnings. This creates an additional risk, as reported EBITDA is based on current estimates for those open jobs. Assessing those projects require a separate estimate-to-complete review focused on reasonableness of remaining costs, percent complete and over or under-billing positions. Lookback conclusions should not be extended to the open portfolio without this additional analysis.
GAAP compliance and revenue recognition
A typical QoE analysis does not include a full GAAP compliance assessment of PoC methodology. Such evaluation is generally performed in an audit or a dedicated revenue recognition analysis rather than a QoE engagement. While GAAP provides a framework for revenue recognition, its application involves significant judgment, and more than one approach may be acceptable depending on the facts and circumstances.
The cost-to-cost method and data reliability: Under ASC 606, companies must identify performance obligations, select an appropriate measure of progress and recognize revenue as control transfers to the customer. For many middle-market project-based businesses, the cost-to-cost method is a commonly used and generally acceptable measure of progress.
Diligence usually focuses less on methodology and more on the quality and consistency of underlying cost data.
Stored materials and timing risk: The purchase of significant stored or uninstalled materials can create revenue recognition complexities under ASC 606.
In some cases, these costs are excluded from progress while revenue equal to cost is recognized, resulting in no margin. If not properly accounted for within a cost-to-cost framework, this can result in revenue being recognized before corresponding performance has occurred.
This directly affects revenue, gross profit, PoC calculations and net working capital. Accordingly, diligence procedures commonly evaluate whether adjustments are necessary to better reflect the economics of project performance.
Other revenue recognition considerations: Alternative methods of measuring progress may be available, and in certain circumstances, may better reflect performance. However, they are often more complex, require additional data and may not materially improve the financial reporting outcome relative to the costs of implementation.
Warranty obligations also require attention. Whether these represent separate performance obligations or embedded contract costs affects both the timing of revenue recognition and the adequacy of accruals.
Similarly, government contracts may include unallowable costs that require separate treatment and could affect reported margins if not properly isolated.
Net working capital: Complexity below the surface
PoC accounting creates net working capital (NWC) dynamics that are difficult to analyze and explain to sellers. These issues can materially affect purchase price discussions.
Billings more than costs: Billings in excess of costs represent cash collected for work not yet performed. From a buyer’s perspective, this cash will be consumed by future project costs and should not be available for distribution at closing.
Whether it is treated as debt-like depends on if the cash was collected and will remain on the balance sheet at closing. This is often contested in purchase price negotiations because sellers may not view advance cash as tied to future obligations rather than freely available at closing.
Retainage and receivables quality: Retainage, the portion of contract billings withheld by customers until project completion, creates additional issues. If commingled with receivables, days sales outstanding calculations will be distorted, and cash flow may be overstated. Buyers should segregate retainage and model collection timing separately.
Project timing and inventory impacts: Large material purchases tied to specific jobs can add more complexity. Inventory swings may distort historical NWC and affect both peg negotiations and cash flow modeling.
Post-closing integration risks
The financial complexity of PoC businesses does not resolve at closing. These issues often become more visible as accounting is standardized, and new stakeholders evaluate the business through a different lens.
Lender understanding and covenant setting: Lenders accustomed to conventional manufacturing or services businesses may struggle to understand why the balance sheet and income statement look different after closing as accounting is normalized. Setting appropriate covenants requires proactive education on PoC dynamics and expected financial performance post-closing.
Audit readiness and GAAP alignment: Audit readiness is a related concern, particularly in platform acquisitions where the company may face its first audit or integration into a public-company reporting structure. An audit team may take a different view of revenue recognition than the QoE analysis, creating gaps between audited and QoE-adjusted results. Bridging this gap for lenders, investors and management requires careful planning.
Finance function and systems: Integration planning should address the finance function. Many middle-market PoC businesses rely on understaffed teams and manual processes. Investment in systems, whether upgrading enterprise resource planning (ERP) or implementing job costing tools, is typically necessary to meet reporting expectations. Personnel changes may also be required to support the complexity.
Closing perspective: The lookback explains what happened. Management’s estimate history indicates whether future issues will be identified proactively or only after they emerge.
Deal Implications: Where PoC Risk Shows Up in the Process
Financial complexity in PoC businesses can impact deal execution. Understanding where these risks surface allows deal teams to anticipate and manage them.
EBITDA disagreements and retrading
A common consequence of PoC complexity is a disconnect between buyer and seller EBITDA expectations. Sellers frequently anchor to reported financials, while buyers relying on QoE analysis see a different picture. If this gap is discovered late, it often results in a retrade, typically a purchase price reduction. Retrading damages trust, extends timelines and increases the probability of failed deal.
Deal teams mitigate this risk by engaging QoE advisors early. Investment bankers often recommend sell-side diligence prior to going to market. Sellers who understand PoC normalization before negotiations are better positioned to defend value and avoid surprises.
Purchase agreement protections
PoC risks require careful drafting of the purchase agreement. Earn-out provisions tied to backlog conversion or project margins can bridge valuation gaps tied to uncertainty around in-flight work.
However, earn-outs also introduce risk: poorly defined metrics, measurement periods or accounting conventions can lead to post-closing disputes. How backlog conversion and project margin are measured and which accounting policies govern those calculations should be defined precisely.
Escrow arrangements and representations and warranties (R&W) insurance provide mechanisms for post-closing claims related to project losses or estimate errors. Claim procedures and escrow duration should align with the risk profile of open projects.
Net working capital protections: The NWC peg is a critical element in PoC transactions. Whether the peg is based GAAP basis or historical practice affects the seller’s ability to reperform calculations and dispute post-closing adjustments.
If the methodology does not align with how the company maintains its books, the seller may be unable to reproduce the calculation and is disadvantaged. This is critical because sellers lose leverage once the deal closes, and calculations are limited to the methodology defined in the purchase agreement.
Buyers and sellers should ensure that the NWC calculation methodology is clearly defined in the agreement, including treatment of advanced billings, retainage and inventory.
Closing perspective: The purchase agreement is the final line of defense. Vague definitions and under-engineered terms create exposure long after closing.
What Buyers Should Take Away from PoC Diligence
PoC accounting affects more than financial reporting. Revenue recognition, working capital, deal structuring and post-closing integration can all influence transaction outcomes. When these risks are identified early, deal teams are better positioned to align expectations, reduce transaction friction and protect value.
Weaver’s transaction advisory professionals evaluate the accounting, operational and contractual factors that drive performance, providing buyers and investors with greater visibility into earnings quality, working capital and transaction risk.
Whether supporting a buy-side diligence engagement, assisting with sell-side readiness or evaluating post-closing integration considerations, we help clients identify issues early and work through complex transactions with greater confidence. Contact us to learn how we can support your next transaction.
©2026
