Your Profit & Loss Statement doesn’t have the full story.
Here’s how you can tell if you’re running a healthy construction business.
But first, what does a “healthy business” mean anyway?
A Healthy Business
If I ask you what it means to be a healthy person, you wouldn’t point to the fact that you are alive and will likely be so tomorrow, bar any sudden accidents, G-d forbid.
You’ll talk about how you feel:
I feel good, energized, fit, strong, sharp, and happy. I don’t have any sicknesses or diseases, no cavities or root canals, no problem with my vision, hearing or other senses, thank G-d.
In other words, we think of being healthy as being in peak condition for a flourishing life.
For a business, it is very much the same.
A healthy business isn’t just alive. Making it day-by-day. Not going bankrupt tomorrow.
It is thriving.
It has a strong financial showing. Operations are smooth. The culture is alive. Employees are engaged, and customers are happy.
For now, I’ll stay in my lane and focus on the ‘strong financial showing.’
Good Numbers
As with people, there’s no ‘one-size-fits-all’ picture of health.
In construction, specifically in the small to mid-sized range of the industry, there are a few conditions to look out for.
1. Project Margins
2. Labor Productivity
3. Cash Flow
All three are closely connected.
All three are necessary for the other.
Project Margins
The first sign of a weak business is thin or inconsistent margins.
Construction companies should aim for 35% profit margin on jobs and 15-20% net margins after considering the overhead costs.
Don’t feel satisfied with low margins.
While 5% might make you feel good and think you’re bringing home money, you’re not. Low margins mean you’re barely breaking even, because your business needs cash to sustain itself and grow.
Even 10% margins are not really cutting it.
That’s like saying my company is alive, it is not bankrupt.
But that is not life, that is survival.
If you have low margins, here’s where you should investigate:
Are you underbidding, over staffing, not documenting change orders, leaving invoices uncollected?
Labor Productivity
This is one of the most overlooked aspects of running a construction company. Which is surprising considering labor costs are your number one expense (also taxes, but that’s for a different day)!
Too many construction businesses are leaving bags of money on the table because their workforce is not nearly as efficient as it could be.
A proven metric to help you stay on top of this is the Labor Efficiency Ratio (LER).
This metric counts how much money your company earns in top line revenue for every dollar it spends on workers. There are multiple ways to calculate this ratio. The one I usually recommend to our clients is like this:
(Revenue – Materials) / (Wages + Subcontractor Labor)
Here’s what that means:
Your total revenue, after the cost of materials, divided by all the money you pay in wages, including your subcontractor costs.
What you get is a ratio 2:1, for example, which would mean that every dollar you spend on wages gets you two dollars back in revenue. That is pretty good!
If this number is low, you won’t have much cash left after considering all other expenses and your margins would be razor-thin.
While businesses vary, we consider a 2:1 LER a healthy goal across the board.
If you’re not getting that kind of productivity, it can mean one of three things.
a) You’re systems and processes are not efficient.
b) You’re overpaying your staff.
c) You’re underbidding on jobs.
Cash Flow
Here is where it all comes down to.
Life is in the blood.
In business, cash is blood.
And cash flow is blood flow.
You might have good margins and productive workers, but if you’re constantly low on cash your business will not last. On the other hand, a business with no profits, but flush with cash, can thrive.
The essence of cash flow management is getting cash in faster, and cash out slower.
This means paying bills on time, collecting invoices early, and documenting and accounting for all change orders promptly.
But business is never so simple.
Cash cycles, off seasons, Capex, and bad debt are all factors to consider. Even a profitable business can end up in a cash crisis if they are not looking ahead. It’s critical to gain foresight with powerful forecasting tools and financial analysis.
Getting on top of cash flow means you have room to ride the bumps and even build up a reserve.
Don’t Survive; Thrive
If you’re winning bids, working hard, and covering payroll, and you’re not about to go bankrupt tomorrow, then Mazal Tov, you are alive!
To live healthy and flourish, look for consistent profit, cash reserves, and a smooth system setting itself up for growth.
You can start today.
Look closely at your last few projects and see where you can tighten up your margins or bid more accurately. Get clarity on your labor efficiency, and start looking ahead so you can make smart decisions about your cash.
Each step makes your business a little healthier.
