How construction companies can right-size to improve financial performance Featured

9:01pm EDT April 30, 2011
How construction companies can right-size to improve financial performance

When the housing bubble burst, many construction business owners were amazed at the speed and magnitude of decline within their industry. With the slow improvement of the economy this year, and even slower recovery of the housing and construction segments, contractors will continue to feel pressured to find new ways to improve the bottom line.

“Managing your business through these uncharted waters can prove difficult,” says Marc McKerley, partner at Crowe Horwath LLP. “Most all construction businesses have been impacted as almost all market sectors of construction are experiencing a slump.”

Smart Business spoke to McKerley about strategies for construction companies to improve financial viability.

What are the typical problem areas for the contracting industry?

Given the potential for continued difficulties within the industry, it’s valuable to take a look at the significant challenges that contractors have struggled with in the past. An industry consulting study that took place before the recession hit showed that more than 89 percent of the time, declines in shareholder value were primarily attributable to either strategic issues (58 percent) or operational issues (31 percent), including:

  • Lack of a comprehensive business plan
  • Significant changes in ownership and/or
  • personnel
  • Over-expansion
  • Changes in scope or line of business
  • Loss of loyal customers
  • Poor project management
  • Poor estimating and job cost reporting
  • Communication problems

A study conducted by Crowe Horwath LLP and Arch Insurance Group of CFMA (Construction Financial Management Association) contractor members garnered similar results. The survey covered corporate values, strategic vision, mission statement, strategic goals and initiatives, selected industry best practices and key performance indicators. Companies ranging in size and type all found their businesses to be ineffective in the management of people, sales and customer satisfaction, project delivery and risk.

How does this apply to the problems faced by the construction industry today?

Generally, these problem areas can be masked during peak economic times, but will often come to the surface in painful and financially troubling ways during periods of economic decline.

Leaders should re-examine the following areas of their business to identify internal issues that can be repositioned for future success:

Development and execution of business strategy: Defining the company’s mission and strategic direction, understanding customers’ needs, understanding the competition’s strengths and weaknesses, executing strategic initiatives.

Organizational effectiveness: Identifying and developing leaders, establishing a formal succession plan, communicating the company’s strategic direction internally, using effective channels of communication to manage day-to-day operations, having clear lines of authority and accountability.

Human resources management: Appropriately incentivizing employee performance, using technology to measure employee performance through a formal appraisal system, guiding employee development with clearly defined career paths.

Business development and customer satisfaction: Establishing a sales process that builds a sustainable pipeline of new business, using technology to effectively manage sales and customer relationships, measuring customer satisfaction through a survey process.

Operations and risk management: Following defined criteria for selecting which projects to bid, following established procedures for estimating and bidding, pre-qualifying and managing subcontractors, managing and measuring work quality and field productivity, selecting and managing suppliers and other service providers, managing the billing and collections process, managing contractual risk and insurance programs, preventing and detecting fraud, consistently delivering projects on time.

Performance measurement and management reporting: Defining key indicators that drive financial results, using technology to track and report progress (i.e. scorecards, dashboards), reporting accurate financial and project information in a timely manner, utilizing the full capabilities of the technologies deployed by the company.

What should construction businesses consider when attempting to ‘right-size’ their companies?

Even the best managed companies have been forced to ‘right-size’ their business to manage profitability. Construction companies must make a realistic assessment of their financial condition. Look at areas such as underbillings, overbillings, receivables, estimated costs to complete, loans to shareholders and tangible working capital. Also, take a hard look at your business plan and strategies for getting work. Ask yourself: What market sectors do we have sufficient experience in to successfully pursue and complete work? Many contractor failures in recent years have been due to attempts to diversify into niches where they lacked experience.

Right-size your cost structure to match your company’s projected revenue and desired level of income. This should include contingency plans that consider different projected revenue levels; the plans should contain ‘trigger points’ that prompt management into action. Here, positive cash flow is the overall objective.

Keep a close eye on the risk areas that worsen during tough economic times, including owner prequalification and funding verification risk, subcontractor and vendor default risk and contractual risk.

Finally, stay close to both your bank and surety. Now is not the time for surprises. Make sure they understand and agree with your plan and strategies.

Marc McKerley is a partner at Crowe Horwath LLP. Reach him at marc.mckerley@crowehorwath.com or (214) 574-1009.