Case Study 34-2 — Argosy Builders on the WIP Schedule: Four Quarters of Reported Profit and the Arithmetic of Insolvency
Argosy Builders, its people, and its numbers are a Tier-3 composite drawn from a pattern this industry repeats every cycle. The names are invented. The mechanism is not.
Chapter 2 told you what happened to Argosy Builders: a well-run $80,000,000 general contractor tripled to $240,000,000 in three years and died doing it. This case study does something different. It shows you where it was legible, in which document, and in which quarter — because every step of §34.8's cascade was on a page that somebody at Argosy printed, initialed, and filed.
Setup
The company. Argosy Builders, founded by Hollis Prine, run in Year 3 by Hollis and Terrell Vance, his vice president of operations. Controller: Denise Okada, fourteen years in the chair. Surety producer: Marisol Kranz. Argosy's financial statements were prepared at the review level — analytical procedures and inquiry, limited assurance — by an engagement partner named Yusuf Adebayo. They had been at review level when the company was $80,000,000, and nobody upgraded on the way up.
Hold that detail. §34.7 says sureties want an audit for a program of consequence, because an audit is the procedure that tests the WIP schedule. Argosy carried a $200,000,000 aggregate bonding program on review-level statements. The place the problem was hiding was never removed.
The three-year picture, as reported at the time:
| Year 0 | Year 1 | Year 2 | Year 3 | |
|---|---|---|---|---|
| Revenue | $80,000,000 | $128,000,000 | $186,000,000 | $240,000,000 | ||
| Reported net income | $2,480,000 | $3,584,000 | $3,534,000 | $2,640,000 | ||
| Working capital | $7,200,000 | $8,100,000 | $8,600,000 | $9,100,000 | ||
| Net worth | $11,400,000 | $12,900,000 | $14,100,000 | $14,900,000 | ||
| Surety aggregate | $60,000,000 | $95,000,000 | $150,000,000 | $200,000,000 | ||
| Revenue ÷ working capital | 11.1× | 15.8× | 21.6× | 26.4× |
The two jobs, both started in the first quarter of Year 3, both bid at a 4.50 percent gross margin, both staffed off the same thin bench:
| Contract | Original est. cost | Original est. GP | |
|---|---|---|---|
| Meridian Point Hotel — first hotel Argosy ever built | $34,000,000 | $32,470,000 | $1,530,000 | |
| Corbin Yards mixed-use — largest job in company history | $41,000,000 | $39,155,000 | $1,845,000 |
What happens
The income statement, which looked fine all year
| Q1 | Q2 | Q3 | Q4 (as forecast in Month 10) | Year 3 | |
|---|---|---|---|---|---|
| Contract revenue earned | $54,000,000 | $60,000,000 | $64,000,000 | $62,000,000 | $240,000,000 | ||
| Cost of revenue earned | $50,868,000 | $56,700,000 | $60,736,000 | $58,776,000 | $227,080,000 | ||
| Gross profit | $3,132,000 | $3,300,000 | $3,264,000 | $3,224,000 | $12,920,000 |
| Gross margin | 5.80% | 5.50% | 5.10% | 5.20% | 5.38% |
| General and administrative | $2,160,000 | $2,340,000 | $2,460,000 | $2,450,000 | $9,410,000 | ||
| Interest and other, net | $(162,000) | $(198,000) | $(246,000) | $(264,000) | $(870,000) | ||
| Net income | $810,000 | $762,000 | $558,000 | $510,000 | $2,640,000 |
Four quarters. Four profits. A declining but respectable gross margin. Nothing on this statement asks a question.
The balance sheet, which did not
| Dec 31, Yr 2 | Mar 31, Yr 3 | Jun 30, Yr 3 | Sep 30, Yr 3 | Dec 31, Yr 3 | |
|---|---|---|---|---|---|
| Cash | $4,200,000 | $3,400,000 | $2,600,000 | $1,900,000 | $1,150,000 | ||
| Contract receivables, net | $26,400,000 | $30,100,000 | $33,700,000 | $36,900,000 | $39,200,000 | ||
| Retention receivable | $6,900,000 | $7,800,000 | $8,700,000 | $9,600,000 | $10,400,000 | ||
| Costs in excess of billings | $1,300,000 | $1,900,000 | $2,600,000 | $3,400,000 | $4,100,000 | ||
| Prepaid and other | $900,000 | $950,000 | $1,000,000 | $1,050,000 | $1,100,000 | ||
| Total current assets | $39,700,000 | $44,150,000 | $48,600,000 | $52,850,000 | $55,950,000 |
| Accounts payable — trade and subs | $17,900,000 | $19,100,000 | $20,100,000 | $21,200,000 | $22,000,000 | ||
| Accrued expenses and payroll | $1,600,000 | $1,750,000 | $1,900,000 | $2,000,000 | $2,100,000 | ||
| Retention payable | $4,300,000 | $4,850,000 | $5,400,000 | $5,900,000 | $6,400,000 | ||
| Billings in excess of costs | $5,900,000 | $7,600,000 | $8,700,000 | $9,300,000 | $8,000,000 | ||
| Current maturities of long-term debt | $700,000 | $700,000 | $700,000 | $700,000 | $700,000 | ||
| Revolving line of credit *(limit $8,000,000)* | $700,000 | $1,400,000 | $2,900,000 | $4,800,000 | $7,650,000 | ||
| Total current liabilities | $31,100,000 | $35,400,000 | $39,700,000 | $43,900,000 | $46,850,000 |
| Working capital | $8,600,000 | $8,750,000 | $8,900,000 | $8,950,000 | $9,100,000 |
| Current ratio | 1.28 | 1.25 | 1.22 | 1.20 | 1.19 |
| Quick ratio | 1.21 | 1.17 | 1.13 | 1.10 | 1.08 |
| Cash as a share of current assets | 10.6% | 7.7% | 5.3% | 3.6% | 2.1% |
| Revolver availability remaining | $7,300,000 | $6,600,000 | $5,100,000 | $3,200,000 | $350,000 |
Working capital went up. That is the trap. The headline liquidity number Hollis looked at every quarter improved by $500,000 across the year, and every ratio underneath it got worse. What changed was not the size of the current assets but their quality: cash fell from 10.6 percent of current assets to 2.1 percent, while retention receivable and costs in excess of billings — the two slowest assets a contractor owns — grew from $8,200,000 to $14,500,000.
And here is the sentence to carry:
Argosy reported $2,640,000 of profit in Year 3 and consumed exactly $10,000,000 of liquidity doing it — cash down $3,050,000 and the revolver up $6,950,000. That is §34.8 Step 1, on one line.
The two jobs, quarter by quarter
Meridian Point Hotel — $34,000,000 contract, $32,470,000 estimated cost, $1,530,000 estimated gross profit (4.50%):
| Period | % compl. | Cost to date | Revenue earned | GP earned | % billed | Billed | Over-billed |
|---|---|---|---|---|---|---|---|
| Q1 | 14% | $4,545,800 | $4,760,000 | $214,200 | 20% | $6,800,000 | $2,040,000 | |||
| Q2 | 35% | $11,364,500 | $11,900,000 | $535,500 | 44% | $14,960,000 | $3,060,000 | |||
| Q3 | 55% | $17,858,500 | $18,700,000 | $841,500 | 65% | $22,100,000 | $3,400,000 | |||
| Month 11 | 71% | $23,053,700 | $24,140,000 | $1,086,300 | 79% | $26,860,000 | $2,720,000 |
Corbin Yards — $41,000,000 contract, $39,155,000 estimated cost, $1,845,000 estimated gross profit (4.50%):
| Period | % compl. | Cost to date | Revenue earned | GP earned | % billed | Billed | Over-billed |
|---|---|---|---|---|---|---|---|
| Q1 | 11% | $4,307,050 | $4,510,000 | $202,950 | 17% | $6,970,000 | $2,460,000 | |||
| Q2 | 27% | $10,571,850 | $11,070,000 | $498,150 | 37% | $15,170,000 | $4,100,000 | |||
| Q3 | 44% | $17,228,200 | $18,040,000 | $811,800 | 55% | $22,550,000 | $4,510,000 | |||
| Month 11 | 58% | $22,709,900 | $23,780,000 | $1,070,100 | 67% | $27,470,000 | $3,690,000 |
Combined over-billing on the two jobs: $4,500,000` at Q1, `$7,160,000 at Q2, $7,910,000` at Q3, `$6,410,000 at Month 11.
Read the last two numbers. Over-billing on these two jobs peaked in Q3 and fell $1,500,000 in the following two months. Nobody at Argosy noticed, because a falling liability looks like nothing. It was §34.8 Step 5 beginning — the jobs consuming their remaining cost against a shrinking billing balance — and it arrived four months before the company ran out of money.
Note also that neither job's estimated gross profit changed in any of those four columns. Not once, in eleven months, on a first-of-its-type hotel and the largest job in company history, both run by new superintendents. §34.4 has a name for a forecast that never moves on a job like that, and it is not "stable."
Month 11: Denise runs the number
Yusuf Adebayo would not proceed with the year-end review without an honest cost-to-complete on both jobs. Denise Okada spent nine days on it with the two superintendents and the estimating department.
| Meridian Point | Corbin Yards | Combined | |
|---|---|---|---|
| Original estimated cost | $32,470,000 | $39,155,000 | $71,625,000 | |
| Honest estimated cost at completion | $37,270,000 | $45,355,000 | $82,625,000 |
| Original estimated gross profit | $1,530,000 | $1,845,000 | $3,375,000 | |
| Honest estimated gross profit | $(3,270,000) | $(4,355,000) | $(7,625,000) |
| Fade | $(4,800,000) | $(6,200,000) | $(11,000,000) |
| Percent complete, as reported | 71.00% | 58.00% | — |
| Percent complete, corrected | 61.86% | 50.07% | — |
Corbin Yards was reported at 58 percent and was actually at 50 percent. The eight points did not come from a physical measurement; they came from a denominator that was $6,200,000 too small.
Now the charge to income, which is not the same number as the fade. An anticipated loss on a contract is not spread across the remaining work — the full estimated loss is recognized in the period it becomes known, and the profit already taken reverses.
| Meridian Point | Corbin Yards | Combined | |
|---|---|---|---|
| Gross profit recognized to date, as reported | $1,086,300 | $1,070,100 | $2,156,400 | |
| Required: the full estimated loss, now | $(3,270,000) | $(4,355,000) | $(7,625,000) | |
| Charge to income | $(4,356,300) | $(5,425,100) | $(9,781,400) |
The fade was $11,000,000; the charge was $9,781,400. The $1,218,600 difference is profit that had never been recognized on the old forecast — it does not hit the income statement, because it was never on it. Learn that distinction. It is the one people get wrong in the room.
Add $1,020,000 of fade across the rest of the portfolio, which surfaced the moment anyone was allowed to ask, and the Q4 charge is $10,801,400.
The quarter that ended it
| Q4 as forecast in Month 10 | Q4 as finally recorded | |
|---|---|---|
| Net income before contract loss provisions | $510,000 | $510,000 | |
| Provision for contract losses and reversal of recognized profit | — | $(10,801,400) |
| Net income (loss) | $510,000 | $(10,291,400) |
| Year 3 net income (loss) | $2,640,000 | $(8,161,400) |
And the balance sheet, restated:
| As reported | Restated | |
|---|---|---|
| Total current assets | $55,950,000 | $55,950,000 | |
| Total current liabilities | $46,850,000 | $57,651,400 | |
| Working capital | $9,100,000 | $(1,701,400) |
| Current ratio | 1.19 | 0.97 |
| Total liabilities | $47,750,000 | $58,551,400 | |
| Net worth | $14,900,000 | $4,098,400 |
| Debt to net worth | 3.20 | 14.3 |
The three things that happened next, in eleven days
One — the surety. Marisol Kranz brought the underwriter in during Month 12. The program went from $200,000,000 aggregate / $70,000,000 single project to $85,000,000 / $30,000,000. Argosy's uncompleted bonded work was $79,400,000, so the existing bonds stood — with $5,600,000 of room. The $61,000,000 of work awarded or in final negotiation could not be bonded and evaporated in an afternoon. Backlog fell from $187,000,000 ÷ $20,000,000 = 9.4 months` to `$126,000,000 ÷ $20,000,000 = 6.3 months, with nothing able to replace it.
Two — the arithmetic of finishing. Somebody finally asked what it would cost to complete the two jobs, using the honest forecast.
| Meridian Point | Corbin Yards | Combined | |
|---|---|---|---|
| Contract amount | $34,000,000 | $41,000,000 | ||
| Billed to date | $26,860,000 | $27,470,000 | ||
| Remaining to bill | $7,140,000 | $13,530,000 | $20,670,000 |
| Honest estimated cost at completion | $37,270,000 | $45,355,000 | ||
| Cost to date | $23,053,700 | $22,709,900 | ||
| Remaining cost to complete | $14,216,300 | $22,645,100 | $36,861,400 |
| Net cash consumption to finish | $(7,076,300) | $(9,115,100) | $(16,191,400) |
Against that $16,191,400: cash of $1,150,000 and $350,000 of undrawn revolver. $1,500,000 of liquidity against a $16,191,400 hole, on two jobs, before anything else in the company was considered. That is not a turnaround problem. That is arithmetic.
Three — the covenant. Argosy's credit agreement required minimum working capital of $6,000,000 and minimum net worth of $10,000,000, tested quarterly. As reported, both passed comfortably. Restated, working capital was negative $1,701,400 and net worth was $4,098,400. Two of three covenants tripped, the line was frozen with $7,650,000 outstanding, and the company that had reported a profit in every quarter of Year 3 could not fund the next month's subcontractor payments.
The rest — thirty-one unpaid subcontractors, the liens, the payment-bond claims, the general indemnity agreement Hollis and his wife had signed in Year 0, the wind-down in Month 14 of Year 4 — is in Chapter 2's case study. None of it is in this one, because none of it is a finance lesson. It is the consequence of the finance lesson.
Analysis
The cascade, mapped to the page it was on
| Step (§34.8) | What happened at Argosy | Where it was visible, and when |
|---|---|---|
| 1 — Growth outruns working capital | $2,640,000 of reported profit against $10,000,000 of liquidity consumed | Balance sheet, every quarter of Year 3: cash down, revolver up, working capital flat |
| 2 — Staff dilution degrades forecasting | Average superintendent experience 19 years → 7 years; revenue per superintendent $13.3M → $17.1M | Not on any financial statement. Visible only as Step 3 arriving late |
| 3 — Fade appears and is absorbed | Both jobs' estimated gross profit never moved for eleven months | The WIP, Q2: two new-type jobs, new superintendents, and a forecast frozen at bid margin |
| 4 — Over-billing covers the gap | Combined over-billing $4,500,000 → $7,910,000 by Q3 | The WIP, Q1 through Q3 |
| 5 — Over-billing reverses | $7,910,000 → $6,410,000 in two months, with $20,670,000 left to bill against $36,861,400 of cost | The WIP, Month 11 — and computable at Q3 by anyone who ran the remaining-cash line |
| 6 — Surety reduces the program | $200M/$70M → $85M/$30M; $61,000,000 of work gone | Not in the WIP. Caused by the WIP |
| 7 — Working capital negative, covenant trips | $9,100,000 → $(1,701,400) | The restated balance sheet, one quarter later |
Steps 1, 3, 4 and 5 were all on documents Argosy produced itself, in the first three quarters of the year, and circulated to its bank and its surety.
The three mechanisms worth naming
A forecast that never moves is not a stable forecast; it is an absent one. Both jobs held their bid margin to two decimal places for eleven months, through a first-of-its-type building and the largest job in company history. §34.4's table calls the "steady small increments across the whole job" pattern a bad forecasting culture. Argosy did not even have that. It had no fade at all until it had $11,000,000 of it, which is the worst pattern on the table: fade appears in the last 20 percent of a job, in a lump — either nobody knew, or nobody said.
Over-billing is a liability whose repayment currency is work, and Argosy scheduled its own bankruptcy with it. $6,410,000 of over-billing on two jobs meant those jobs had already collected the money they needed to finish themselves. The reversal was not a risk. It was a certainty with a date on it, computable from four columns on a page, in Q3, by anyone who subtracted twice.
Assurance level is a control, not an expense line. A $240,000,000 contractor on review-level statements is carrying a $200,000,000 bonding program on numbers nobody independently challenged. The single procedure that would have caught this — an auditor testing the total estimated cost on every significant contract — was not being performed, and had not been performed on the way up from $80,000,000. The surety accepted review-level statements because the relationship was good and the market was hot, which is exactly when that decision gets made and exactly when it is worst.
What the numbers cannot show you
Denise Okada asked twice for a real cost-to-complete on both jobs and was told twice that they would recover in the buyout of the remaining trades. She was right, she said so, and the outcome did not change — because she was a capable controller who had never been given the authority a $240,000,000 company's finance function requires. The reporting problem at Argosy was not that nobody knew. It was that the person who knew did not own the decision.
Discussion Questions
-
Argosy's reported working capital improved every quarter of Year 3 while its liquidity collapsed. Design a one-page monthly report for Hollis Prine that would have made the deterioration visible on the front page. Name the four or five lines it contains and say why each is on it. You may not use net income.
-
The fade was $11,000,000 and the charge to income was $9,781,400. Explain the difference in your own words, then explain why a project manager who does not understand it will misjudge how much trouble a fading job is actually in.
-
Both jobs reported the bid margin, unchanged, for eleven months. Write the specific question you would have asked at the Q2 review, and describe how you would tell the difference between a genuinely stable forecast and one that has simply not been re-run. What evidence would satisfy you?
-
Argosy's surety accepted review-level statements throughout the growth. Was that the surety's mistake, Argosy's, or the producer's? Argue it from each of the three seats, then say what you would have required if you had been the underwriter in Year 1 when the aggregate went from $60,000,000 to $95,000,000.
-
Compare Argosy to Kestrel in Case Study 34-1. Kestrel's Rivermont Elementary #12 faded steadily and visibly; Argosy's two jobs did not fade at all until the end. Which pattern is worse, and why? Then answer the harder question: which one is easier for a company to fix, and what does that tell you about which one to be more afraid of?
Your Turn
You are Denise Okada, and it is the Q3 close of Year 3 — two months before Yusuf Adebayo forces the issue, with only the Q1, Q2, and Q3 columns above in front of you. Terrell Vance outranks you. Hollis Prine signs your paycheck and does not like conflict.
Produce three things, on two pages:
-
The remaining-cash analysis for both jobs at Q3, using the reported forecasts — remaining to bill against remaining cost to complete, per job and combined. Do it before you read further. Then state what that number alone entitles you to demand, without accusing anyone of anything.
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A three-question memo to Terrell Vance that does not require him to admit the jobs are bad. Each question must be answerable with a document rather than an opinion, and each must be one that a project team with a healthy forecast can answer in a day. Design them so that the inability to answer is itself the finding.
-
The escalation you would use if the memo produces nothing. Name who you would go to, what you would put in writing, what you would keep a copy of, and what you would do if the answer is still no. Be specific about what you are risking and be honest about it — this is the part of the job that no textbook can make comfortable, and pretending otherwise would not help you.