When the COVID-19 pandemic hit, nearly every industry was impacted. But the construction industry had one thing others didn’t: committed backlog. Plus, most contractors qualified for the PPP and ERC programs, so the financial pain of the pandemic was masked. Flashforward to 2022, and backlog had dwindled, replacement work was hard to find, government assistance programs had ended and the natural lag of the construction industry caught up to us. Not surprisingly, financial results for 2022 were meek, indicating that the construction industry is finally experiencing what most companies/industries felt in 2020.
As construction companies reach the end of PPP, ERC and other relief funds, financials are going to look different and new strategies are going to be needed to ensure continued growth and profitability. These strategies should include the ABCs of financial success:
You can’t fully know where to go if you don’t know where you are. Benchmarking is an important tool to measure where a business stands in comparison to its peers and in relation to industry trends. Working with so many contractors across all sectors, Grassi’s Construction team captures data across balance sheets in specific geographic regions and subsectors, to provide our clients with relevant metrics.
This data generates industry averages in accounts receivable and payable, contract assets and liabilities, lines of credit, backlog, gross profit, EBITDA and more. Considering how companies of similar size, location and revenues compare to your own is essential to remain competitive.
This benchmarking can be aided by financial ratios. Calculating ratios from your financial statement data and comparing them to industry averages and past performance can help you gauge your company’s condition in many key areas and raise red flags for where new strategies are needed.
For example, profitability ratios measure your company’s ability to generate income based on revenue, assets, operating costs and equity. The return on assets ratio is calculated by dividing net earnings by total assets, which will indicate how much profit is generated by total assets employed. The higher the ratio, the better. Debt to equity ratio, another common example, is calculated by dividing total liabilities by total net worth. Generally, a ratio of 3 or lower is acceptable.
Don’t stop benchmarking once this initial assessment is complete. Ongoing financial reporting (with KPIs) on the company-wide and project level should be the foundation of every business decision. Real-time and accurate financial reporting will help you identify issues early and remediate them contemporaneously.
Once you know where your company is underperforming or outperforming, you can begin to build the right strategies to improve or maintain results. These include:
- Purchasing & Procurement. To mitigate the impact of fluctuations in construction material pricing, consider purchasing and storing stock items in advance or secure a purchasing agreement for stock items in order to lock in prices. Review if change orders are being accepted for increased costs of construction materials or altered lead times.
- Prequalification Process. When the contractor’s prequalification program relies on year-end information, the issue becomes the reliability of outdated financial statements on which you are making award decisions. Asking for updated financial information could give the qualifying contractor greater insight into the current financial health of a subcontractor.
- Project Performance Management. It is essential to have a formal policy in place for communicating, reviewing, and documenting actual job performance in relation to the budget. Management should regularly review job costing and profitability.
- Cash Flow & Budgeting. Each project has is its own cash flow eco-system. By employing a project-centric cash flow forecast and operating budget, you can identify where projects, and the company, will experience cash surpluses/deficits and understand how this will impact the entire business. These reports should be fluid and cover a 6–24-month outlook.
- Risk Management. Regardless of your financial position in the marketplace or how well you are implementing the above strategies and tools, be sure to also build plans to proactively address areas of financial risk, such as cybersecurity, disaster planning and internal controls over fraud.
One of the most significant areas of financial risk – noncompliance – is also one of the most avoidable. With the right planning and advice, your construction company can mitigate the risk and expense of noncompliance with IRS, DOL, OSHA and other regulations.
When it comes to tax and accounting, simple compliance isn’t enough. Make sure you are taking advantage of all strategies to save dollars in a “cash is king” industry. Based on types of contracts, there are opportunities to employ an accepted accounting method as the basis of an income tax deferral strategy. For example, while a construction company’s overall method may be accrual, to the extent any projects are completed within a single tax year, that project could qualify for cash basis. With income tax rates due to sunset by the close of 2025, your current deferral methodology might shift to accelerating the recognition of income at the lower rates.
As the construction industry looks to the rest of 2023 to rebound from shaky financial results, both tried-and-true and innovative strategies will give your business a competitive edge. Working with your financial advisors, following the ABCs of success can help ensure you leave no stone unturned and no risk unaddressed.
This article originally appeared in the July-August issue of Construction Executive.