Building Success: Essential Key Performance Indicators (KPIs) for Contractors

When it comes to Key Performance Indicators (KPIs) in construction, contractors must focus on metrics that assess financial stability and performance and the efficiency and effectiveness of their projects. KPIs provide insights into various aspects of financial performance, aiding in decision-making, planning, and monitoring. Sureties use KPIs in their company evaluations and as indicators of the contractor’s ability to fulfill its obligations. Banks use KPIs to award lines of credit or other larger loans and ensure a company can repay loaned funds. As such, it is imperative for construction companies to review their KPIs regularly, at least monthly, to find indications of problems or weaknesses before the surety or bank comes calling.

Consider the following essential KPIs:

• Financial Ratios: Most companies are familiar with key financial ratios such as:
  • Liquidity ratios
  • Current ratio: Compares current assets to current liabilities, indicating the company’s ability to meet its short-term financial obligations. A ratio above “1” suggests good liquidity.
  • Quick ratio: Also compares current assets to current liabilities, but excludes inventory from current assets for a more stringent measure of liquidity.
    
• Leverage ratio
  • Debt-to-equity ratio, comparing the company’s total debt to shareholder equity, indicating the proportion of debt and equity financing used to fund operations.
    
• Profitability ratios
  • Return on equity: Evaluates the profitability of shareholders’ equity investment in the company, indicating how effectively the company uses equity to generate profits.
  • Gross profit margin: Indicates the percentage of revenue that exceeds the cost of construction, reflecting the company’s ability to generate profit from its construction contracts.

Financial ratios provide insight into the contractor’s financial health and ability to meet obligations. Depending on the trade, those ratios alone might be sufficient in terms of KPIs. However, most contractors should consider tracking additional KPIs that sureties and banks are increasingly reviewing. Like financial ratios, these should be reviewed at least monthly, and frequently, more often.

• Work-in-Progress (WIP) Schedule Accuracy: Sureties evaluate the accuracy of a contractor’s WIP schedule to determine the reliability of estimated project cost and gross profit. Significant discrepancies can indicate poor project management or financial mismanagement. By performing a fade analysis on the WIP schedule, a contractor can uncover gross profit fade, which is a reduction, gradual or significant, in the gross profit of a project. If widespread gross profit fade is uncovered, the surety will not have faith in the contractor to perform on projects and the related bonding will be negatively affected and/or the contractor may have issues continuing in business.

Gross profit fade can also indicate to the contractor that project managers and superintendents are not performing as expected if the estimates on the job are on par. Or it could mean that estimators are not providing good estimates, leaving the project manager and superintendent set up to fail. (For more on the WIP schedule, see WIP: A Critical Management Tool by Brandon Dougherty, CPA, MSAT, CCIFP, MBA, of HBK Constructions Solutions.

• Backlog to Revenue Ratio: This KPI compares the contractor’s backlog of contracted work to its annual revenue. A high backlog to revenue ratio indicates a steady flow of future work, while a low ratio could suggest potential financial instability or overreliance on a few large projects. Many contractors mentally review this ratio, but never put it on paper and track it over time.

• Accounts Receivable greater than Accounts Payable: A KPI often overlooked by contractors but ensures the company can pay their payables with incoming cash from receivables. A KPI of above one is ideal. However, when payables exceed receivables, a review is necessary to determine why there is a KPI of below one.

• Return on Investment (ROI): Generally, ROI is a key and commonly used KPI. However, measuring the ROI on the purchase of equipment will reveal the return a contractor is earning on their investment in equipment and will help explain when a contractor is over-buying equipment. Although a contractor may see an increase in assets with new equipment, sureties and banks are not interested in excessive equipment and may discount or even remove the value of the equipment from bonding or loan maximum calculations.

How can a contractor review KPIs in a more efficient manner?

1. A contractor could create their own tool to track KPIs. Excel and other programs help track KPIs over time.
   
2. A Benchmarking Report is a more comprehensive way to review KPIs. A benchmarking report involves many different types of KPIs in comparing the performance, processes, and outcomes of a construction company against industry standards or competitors. It is a strategic management tool that helps contractors identify areas for improvement, set performance targets, and stay competitive. Benchmarking tools include more than just financial benchmarking and can include comparing line-of-credit to annual revenue and overbillings to annual revenue, as well as months in backlog, revenue per employee, and many more indicators.

Some contractors dismiss KPIs, considering cash in the bank as the bottom-line indicator of their strength. Cash in the bank is an indicator, but not the only indicator. By developing, monitoring, and tracking KPIs over time, a contractor is taking a proactive approach to mitigating potential losses and ensuring financial stability.

We can help you determine and create the KPIs that are most essential to your business. Contact HBK Construction Solutions in your local area to schedule a time to meet and discuss how HBK Constructions Solutions can help your company.