If you are manufacturing widgets, your production environment is pretty much a controlled one. Temperatures in the plant are consistent year-round, as is the speed of your production line. Other factors are well within accepted levels also.
But think of the construction company. There are unforeseen conditions, the size and scope can be staggering and the quality of workers can vary.
“A construction company does not have that luxury of consistency. Therefore, every job is unique and presents its own challenges,” says Kent Beachy, CPA, CIT, CCIFP, principal and director of construction services at Rea & Associates.
To build a more profitable construction company, taking into account these challenges takes a four-part approach.
“You first estimate, then you do the work, then you account for it and then you analyze it,” Beachy says. “You bring all those pieces together, then you tweak it, and see that you can make money in the business, and then you go for it.”
Smart Business spoke with Beachy to learn the keys of building a more profitable construction business.
What’s a good rule of thumb to follow as your first step toward profitability?
You have to be able to estimate for profit. Construction companies are generally bidding against the competition. You have to know your company’s backlog, what work flow you have in place, how busy the company is at present and how busy it will be when construction actually begins.
What other considerations are there?
Is the job within a niche of yours where your labor is skilled and has done work before and can do it efficiently and effectively? Or is it something new that you’re going to have to get up to speed on? That is a risk factor you have to be concerned about.
If you are a general contractor, you have to consider the subcontractor, what is his or her schedule and if you can use him or her.
If you are a subcontractor, you have to consider if you have the labor in place and will be able to get the job done effectively and efficiently.
You also have to know your overhead — the fixed prices, utilities, rent, the telephone — to be able to estimate for profit.
What about benchmarks and key performance indicators?
Another process within a more profitable construction company is being able to measure the financial aspect of your company. That includes breaking it down by job using a construction accounting software that allows you to job-cost.
That way, you’ll know whether or not you’ll have potential change orders, work that is added to or deleted from the original scope of the job. You have to be able to manage a change order and still be profitable.
After you tally up the figures for these jobs, then you can do your analysis. For instance, if a company wants to measure profitability on a job, you would measure gross profit margin. If you want to measure profitability within the company, you would measure return on assets or return on equity. Liquidity ratios, such as the current ratio, is an important measurement and one the surety is interested in as it measures to what extent your current assets are available to satisfy your current liabilities. An efficiency ratio one may want to consider is backlog to working capital. While backlog represents jobs waiting to start, the relationship between committed work and working capital may determine if you need more working capital to be able to finish the work.
How can ratios help you analyze your company’s performance?
You could do comparisons to industry — in fact, that is how you benchmark. You can get ratios for the industry through the Construction Financial Management Association, which conducts surveys. You can benchmark against the industry and determine which ratios are key to the company’s performance and measure those.
You can put everything in a nice package and show the company executives where they’re at. But you want to be able to determine what ratios are important to the company, to its profitability. Just a few ratios will make sense to the owner, the controller or other executive so they can measure on a regular basis to spot signs that will let them know if something is wrong.
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