Construction niche audit partner, Ronnie Stamper’s article, “Light the Way: Boosting Profitability Through Your Financial Statements,” was the “Financial Feature” of the Associated Builders and Contractors, Inc.–Pelican Chapter July newsletter.
Light the Way: Boosting Profitability Through Your Financial Statements
When it comes to making sense of dollars and cents, contractors may often feel like they’re fumbling around in the dark. In many ways, it’s an understandable byproduct of a complicated industry. Construction deals often have complex payment arrangements; long sales and project lifecycles; and considerable overhead, labor costs and upfront investment costs.
But for many construction company owners — especially those heading up small to midsize businesses — the information available in their financial statements can light the way beyond just getting by into an area of greater profitability.
Reviewing the basics
Like many contractors, you probably made substantial initial investments in getting your business up and running. Of course, that was only the beginning. Now that your company is established, you’re incurring expenses for tools, vehicles, equipment, payroll and insurance, and perhaps real estate.
Because of the size of some of these expenses, you’re likely not paying them in cash. Bank loans and manufacturer financing can frequently splatter red ink over a construction business’s financial statements. When debt is subtracted from your company’s assets — that is, tangible objects that you own outright or in part — this big-picture number indicates whether your business is operating at a profit or a loss on any given day.
However, therein lies a word of caution. The integrity of your financial statements is only as good as the records you keep. As the saying goes: garbage in, garbage out. To obtain the most accurate snapshot of the profitability of your construction company, accurate and complete records are imperative — including vendor invoices, payroll records, expense receipts and current bank statements.
Respecting the ratios
The three major sections of your financial statements (income statement, balance sheet, and statement of cash flows) should give you a pretty good idea of where your construction business stands for a given period. But, alone, they don’t provide much insight into how to boost profits.
For that, you can take the data and run it through a wide variety of business performance ratios. Uncertain whether your sales cycle is taking too long? Looking to maximize performance from your workforce? Here are three critical ratios that all construction owners must know:
- Return on equity. Sometimes this is referred to as simply a company’s “profitability ratio.” Generally, the higher your return on equity (net earnings / total net worth), the better. Under some circumstances, however, a particularly high ratio may indicate that a business is undercapitalized or has too much debt.
- Working capital turnover. This ratio (revenue / average working capital) measures your liquidity. In other words, you’ll find the amount of revenue supported by each dollar of net working capital used. A higher ratio may signal a need for additional working capital to support future growth.
- Backlog. This ratio — backlog / (revenue/12) — measures efficiency. More specifically, it reflects the number of months it will take to complete all signed or committed work. A lower ratio may mean your company needs to refocus its sales and marketing efforts to ensure a strong stream of new contracts is coming in.
Following the money
As you know, it takes quite a bit of money to run a construction business. Receivables frequently run past 90 days while you still must make payroll, cover equipment, and keep up with short- and long-term debt. Oh, and in the midst of all this, you’re supposed to turn a profit!
How do you follow the money — and take more in than you’re paying out? It all begins with having the right information. Work with your financial advisor to devise a strategy for capturing all of the data you need in your financial statements to then make the best strategic profitability decisions for your company.
Ronnie Stamper is an audit partner with Hannis T. Bourgeois, LLP, Certified Public Accountants. He specializes in the construction industry and has more than 40 years of experience in public accounting. He can be reached at email@example.com or (225) 928-4770.