Many construction companies continued to do well in 2020 despite the COVID-19 pandemic. The construction industry was a relatively good one to be in at the onset of the pandemic with large pre-existing backlog at reasonable to great margins. Plus, many parts of the central U.S. deemed construction to be an essential activity, which allowed companies to continue putting work in place.
As 2021 gets underway and financial professionals are working with external auditors on their financial statement audit or review, it is a good time to reflect on the past year. How did your company do? Are profits masking financial leakage in your company?
Benchmarking against your competition
An important gauge is the performance of the best of your competition. This is where benchmarking and key performance indicators come into play by not only reviewing past performance but in gaging current and near-term issues that can be addressed before they become problems.
Construction Financial Management Association’s (CFMA) Financial Benchmarker and similar information available through other industry associations like the Association of General Contractors (AGC) and Associated Builders and Contractors (ABC) provide great resources. The 2019 Financial Benchmarker had more than 1,400 construction industry related respondents. This means there are likely multiple firms of similar size and niche upon which to gain some insights. A typical CFMA Benchmarker general contractor in the industrial/commercial/institutional building space in the central U.S. reported annual 2019 revenue of $160 million and sales growth of nearly 11 percent with net income before taxes of about 2.2%.
As of November 2019, the Associated Builders and Contractors’ Construction Backlog Indicator was just over eight months for contractors in the middle states. A year later, it has shrunk to six months. While backlogs vary by contractor type, size and region, overall backlogs are down about one to three months from a year ago. Of course, as backlogs decrease, margins on future jobs typically decrease as well.
Given these uncertain times, here are a few items you should be evaluating weekly or monthly.
Construction Key Performance Indicators (KPIs)
Cash on hand
In normal times, contractors tend to have about 20 days of cash on hand. Cash is king and even more so today. The ratio of cash to overbillings should always exceed one, meaning that you have retained enough cash from overbillings to cover the work that has already been billed. If you have used the cash for other items, such as equipment purchases and owner distributions, you may have a cash crunch on the horizon.
Working down the liquidity chain from cash to current assets, ratios such as the current, quick and high liquidity ratios help measure your ability to meet near term financial obligations. All of these should exceed one, and it is best if the current ratio exceeds 1.25.
Timing of customer payments can significantly impact liquidity. It is more important than ever to assess the credit worthiness of both new and past customers as they may be facing cash shortages.
WIP reports are crucial to contractors’ financial reporting and business management. Are you using them to their full potential? You should be measuring profit fade and WIP by project manager, by estimator and by niche. Underbillings should be scrutinized while there is opportunity to manage and improve on the related jobs. How much backlog do you have and what level of overhead can it support? Cost cutting may become necessary to maintain profitability.