Working Harder for Less: The New Normal?

Date November 3, 2021
Authors Michael Kapics

Imagine that you are just starting your own construction company and someone tells you that you will work harder than you ever did and make less money. Plus, all of your company and personal assets will be at risk every day.

According to the Associated Builders and Contractors Confidence Index, that is the reality construction company owners face today. In its September 2021 survey, 81.5 percent of respondents said they expect sales to increase or be unchanged, yet 64.1 percent expect profit margins to decrease or be unchanged. That contrasts with, only two years ago, the September 2019 survey, where 47.1 percent of respondents expected flat or decreasing profit margins. Increasing revenues while decreasing profit is a treacherous path that can lead to catastrophic results. The outlook for profitability promises to impact the industry for well into 2022 and beyond. The time to take aggressive, proactive measures to counteract that trend is now.

Avoiding the more-work, less-profit scenario is a challenge, but it is one that can be accomplished through an active, aggressive approach to enhancing your company’s ability to reach peak financial performance, maximize company value and optimize financial returns to shareholders. You can take calculated, strategic steps to ensure your company will outperform your competition:

Assess where you stand compared to your peers. You should know where you stand in your marketplace and be able to identify your areas of strength and weakness. Identifying your strengths will help you find areas where you hold competitive advantages you can use to outperform your competition. It may be as simple as a working capital position that keeps you from having to cover the cost of borrowing against a line of credit or a leverage model that provides cost savings. Identifying weaknesses could result in productivity even greater than knowing your strengths. Taking proactive steps to improve processes and controls can be the key to improving your bottom line. For example, if your benchmarking study shows your company lags your competition in return on assets, maybe you have too much invested in assets, like equipment, and should be shedding some of that. You can identify where you can make improvements by monitoring these areas and implementing new procedures to improve these measurements. Organizations do better and generate higher margins when they focus on the areas they need to improve while they use their strengths as a competitive advantage.

Know your sweet spot. Identify the characteristics of your work that most effectively use your assets to create the most profitable returns. You might perform well on jobs that price out at over $5 million but not so well in jobs where the estimate is for less. You might do well in Ohio but you haven’t been profitable in West Virginia. One crew might prove profitable and another not. Your analysis will help you identify the type of customer, size and locations of jobs, and project managers that will produce the most profitable results. This step could be the most vital of all of the proactive procedures your company can put into place. The wrong type of work can produce deceptive results: top-line growth while the bottom line slowly erodes. Monitoring your projects regularly and using the information to identify the jobs that deliver maximum returns will help you find more of the work your company performs profitably. As well, the more focused you are on your sweet spot, the better you’ll be at pricing and estimating. Every company has a “sweet spot’ and knowing yours is vital to your success. It is particularly critical in times of increasing sales volume to ensure you are focusing on your most profitable jobs.

Train your project management team. Construction companies spend more money than companies in any other industry training their employees. They focus on skills and safety. But training doesn’t end there. The project management team controls your jobs and plays a large role in their success or failure. Investing time into this type of training will produce a project management team that not only knows how to get a job done but also knows how to do so in a manner that maximizes return. Scope creep is a common problem, where additional work and materials requested at the worksite get done but don’t get billed. Companies benefit substantially by investing in training that teaches project management how to deal with such issues as scope creep, which gives them the tools they need to drive the activities that improve return on the jobs they are responsible for managing. Your project management team, the people most responsible for the success or failure of a project, should be trained to execute their work in a way that will maximize company profits.

Analyze your overhead costs. Overhead is a large part of your costs. All successful contractors have a firm grasp on their direct costs: materials, subcontractors and labor hours. But what about insurance, equipment repairs and maintenance, deprecation and other overhead costs that can be the difference between profit and loss? One bad job can cancel out a year of hard work. If you devote time to fully understanding the costs that make up your overhead, you will be able to bid jobs more effectively, thereby increasing profits.

Know how your general and administrative costs are trending and why. What are your office expenses? Many are fixed costs and more predictable and constant, but even small upward trends in these costs over the years can erode razor-thin profits. This section of a contractor’s income statement is an area where many contractors believe spending to be out of their control. Identifying the areas of concern—Are the office wages you pay consistent with your current needs? Do you review employee benefits costs at renewal times?—is the first step in taking action to control these costs? Once these areas are identified, specific plans can be put into place that will allow a company to regain control and ensure that the expenses are necessary and helping to promote profitability. Successful contractors keep their eye on these costs and understand how small changes in those areas can affect their bottom lines.

Align your culture with your company goals. It is critical to allocate resources to ensure your company has a culture that promotes the activities that will produce successful results. The culture of an organization has a deep, lasting impact on their success. Is communication open and honest, and does it encourage good relationships between management and field personnel? Have you considered sharing financial information with employees that might encourage them to be more concerned about profitability and efficiency? Devoting time and energy to ensuring your company has the right culture in place is a necessary step to profitability and one that many times is overlooked. Companies that take the time to focus on enhancing their culture have greater success and less turnover than those that don’t.

These are challenging times. Construction companies are facing more obstacles to their success than ever. Be aggressive. Attack the status quo. Solidify the financial standing of your company. And buck the trend of working harder for less money.

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WIP: A Critical Management Tool

Date February 4, 2020

A common investment disclaimer reads, “Past performance is not a guarantee of future results.” The same applies to the world of construction. Annual and interim financial statements provide valuable information about a contractor’s past performance and current financial strength, but offer little clarity when it comes to what investors and lenders can expect going forward. That is why so many users of a contractor’s financial statements spend more time analyzing the company’s work-in-progress (WIP) schedule than they do their prior year’s income statement. There is a wealth of information buried in WIP reports that can be as beneficial to the contractor as those looking to invest in or provide financing for a project. This tool has proven itself critical to those who supply credit to a contractor (be it their surety or bank), so why do so many contractors fail to use it to run their businesses?

How WIP Works and What It Means

Under generally accepted accounting principles (U.S. GAAP), except in certain limited cases, contractors must recognize revenue on long-term contracts under the percentage-of-completion method. Under this method, revenue is recognized relative to progress toward completion of a job. For example, if a contractor has incurred 50 percent of their total costs on a project, they are able to recognize an equal percentage of the contract price on that job as revenue, regardless of how much they have billed or collected. The amount billed to date, over or under revenue recognized, is either a contract asset (underbillings) or contract liability (overbillings) and is reflected as such on the company balance sheet.

If a company has a large amount of underbillings, this can be a red flag for sureties and bankers, who may interpret them as potential future losses. It should also be a warning sign for the chief financial officer, controller and project managers before these figures are ever released to outside parties. Are these an indication of poor project management, delays in the billing process, or a need to update projected total costs on a job? Perhaps there are unapproved change orders for which work has begun or there are significant material costs that are not billable until installed. Each job can have its own unique situation that creates an underbilled scenario, so it is important to evaluate each job individually. Management should be prepared to explain underbillings and their cause while also being able to determine the proper response to correct any operational deficiencies that may have contributed to them.

Overbillings are generally viewed more favorably by creditors, as they are a way to have the customer finance the completion of the project. However, there are also some concerns to be aware of when it comes to overbillings. A WIP schedule with a combination of jobs with losses and jobs with large overbillings can indicate trouble ahead. In such a case, the billings from one project are essentially being used to cover the costs of other projects. This will create a squeeze on cash flow as the overbilled projects progress, the overbilling recedes, and cash received from one job is used to finance the completion of another. Think of it as a Ponzi scheme playing out in the financial statements. That is how creditors view it.

Overly Optimistic?

Lenders and surety bonding companies also focus on projected gross profit percentages for individual jobs. Are there any that look out of place given the contractor’s previous performance? Some contractors are eternal optimists and always project a best-case scenario when it comes to performance. If a contractor’s completed job schedule reports average profit margins of 20 percent, the lenders and sureties are certain to take a close look at jobs in progress that are projecting a gross profit of 25 percent or more. Contractors should ask themselves the same question and be able to explain why current jobs will outperform historical margins. Is there something different about this job that lends credence to the elevated gross profit percentage, or should we take a closer look at the cost to complete it? “Profit fade” is a term used to describe when gross profit from a contract is less than previously anticipated. Profit fade resulting from overly optimistic projections at an interim date will erode a creditor’s confidence in a contractor’s ability to estimate their job costs accurately. This in turn will result in reduced credit and lower bonding capacity for a contractor.

Monthly Job Reviews

A WIP schedule that is kept up on a monthly basis can be a great tool for measuring job performance. Of course, like any tool, it is only as good as the information that is put into it. If actual and estimated job costs are not correct, the report will be inaccurate and misleading, and the contractor will look incompetent in front of their surety and banker. Conversely, if monitored closely, warning signs, spotted early on, can help get a job back on track and avoid continued losses. The better a contractor becomes at monitoring their jobs in this fashion, the better they will be at preventing profit fade and demonstrating themselves as a skilled, knowledgeable and financially savvy player in the construction industry. Contact a member of HBK’s Construction Solutions Group for additional resources.

Original article published in The Dirt, Magazine.

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