Contractors encouraged to form an “ideal” financial dashboard
As the country grapples with the coronavirus pandemic, many construction projects are continuing as scheduled, albeit with extra precaution, but other projects have been put on hold. Recently, the Associated General Contractors of America shared the results of a survey indicating the pandemic has halted or delayed projects for 39% of respondents.
With the economic landscape quickly changing for the industry, companies will need to take stock of their financial health. During the 2020 AGC Convention in March, experts shared the most important financial metrics to create an "ideal" contractor dashboard. While these insights came before the pandemic escalated, one could argue the lessons learned here are more important now than they were a few weeks ago.
Typically, when people think of a financial dashboard, they assume it only applies to capital and cash management. Those factors are important, said Dennis Engelbrecht, a consultant with Family Business Institute, but contractors also need to evaluate other factors of profit performance, including:
- Gross profit: Booked vs. goal for current and following year
- Year-to-date overhead vs. your target goal
- Annual return on assets for the month and year-to-date vs. target
- Annual return on equity for the month and year-to-date vs. target
- Return on sales revenue for the month and year-to-date vs. target
A lot of companies like to use top-line, 12-month financial statements to gauge how they’re doing, but because different types of project managers put them together, they lack consistency and are essentially fiction, according to Engelbrecht.
“You have various people that are sandbaggers and then have some that at various times might report more aggressively, so you have this whole mix of what's going on,” Engelbrecht said. “Until that job finishes, you never really know what the profit is. If you look at your profit along the way, it's never exactly the same as it is at the end.”
Fran McCann, president and CEO of Polk Mechanical, said his company used to rely on corporate-level income statements to determine financial performance. However, in 2018, when the company believed it had set a new record for financial performance, an analysis of divisional statements revealed the top-line statement was a smokescreen for two divisions that were losing money.
Another key component of an ideal financial dashboard is operational performance. One of the most important factors of operational performance, according to Engelbrecht, is a company’s gain-to-fade ratio – a trend analysis of the estimated and/or actual gross profit of construction projects over reporting periods. He offered one example of a client that reached a roughly 40:60 ratio (40% gains to 60% fade) after reaching $150 million in revenue. It sounds like a lot of money, but the ratio was headed in the wrong direction. By not keeping their management ahead of their growth room, they lost out on $3.5 million in opportunities, Engelbrecht said. McCann added that over/under billings can also be a useful metric. Polk Mechanical has a color-coded system for jobs that are less than 25% billed and jobs that are less than 45% billed.
“Those are early warning signs because if at that stage in the job I'm not able to get billed ahead, it's generally an early warning sign for some kind of a financial problem on the job,” McCann said.
It’s also important for contractors to track change orders outstanding and the contingency that people have in those jobs at the end of any month, Engelbrecht adds. McCann notes that contractors need to emphasize the number of a days a change order is outstanding and not just how many change orders a company has.
On the preconstruction side, the dashboard can include backlogs, new “lifetime customer” prospects booked and percentage of book work negotiated. However, context is important. McCann noted that in 2009, Polk Mechanical’s hit ratio went from 25% to 10%, but the company mistakenly didn’t see it as a reflection of the market.
“We were living on high backlog, pounding our chest about how good we were, but the reality was the market had taken a dive,” McCann said. “So generally speaking, prior to [the market] going down, you're going to feel pretty good because you're going to be flushed with work.”
Engelbrecht also noted that not all of the data and information contractors need comes out their direct financial systems. Things such as headcount, turnover rate, community involvement and employee morale may not seem directly relevant to a company’s financial health, but a recent study of Family Business Institute’s most successful clients revealed a positive correlation between philanthropy and financial performance.
For McCann, the bottom-line benefit of creating a financial dashboard is evident by the number of days Polk Mechanical has been in the line of credit. Prior to conducting a financial analysis, the company was in the line of credit for 23 days for the month of January. But the company later realized that if it had managed its days sales outstanding to where it was at the end of the fiscal year, it would’ve only spent one day in the line of credit.
“It's one thing to have metrics dashboards. It's another thing to actually listen to what they're telling you,” he says.