Light The Way

by: Smith and Howard

November 4, 2014

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Your financial statements may be a guiding light when trying to wade through the complicated industry that is construction. Owners of small to midsize construction businesses can use the following information to hopefully help in their journey out of the red and into 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.

Therein lies a word of caution, however. 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:

1. 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.

2. 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.

3. 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. Contact Debbie Torrance, Marvin Willis, Paul Atkinson or another member of our construction team at 404-874-6244 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.

How can we help?

If you have any questions and would like to connect with a team member please call 404-874-6244 or contact an advisor below.