Construction companies are often operating at a fast pace, making quick decisions to have every project completed on time and profitable. While balancing many projects, it is difficult for management to find time to reflect on their judgment calls. Miscalculations on staffing projects, ordering materials, and scheduling can have severe consequences if gone unnoticed. Bidding on a project can make or break a company. Overbidding may result in lost opportunities, but underbidding will cause financial strain and cashflow issues.
You cannot manage what you do not measure, making it essential to set measurable goals and meet with project managers and your accountant regularly to ensure you are on track to identify any roadblocks and evaluate past goals.
The best way to set measurable goals to evaluate your company is through Key Performance Indicators (KPI’s). This metric helps you understand where you stand compared to your competitors and industry benchmarks. KPI’s can give management and ownership an understanding of the relationship between cash, accounts receivable, billings/cost in excess, and many more.
Below are just a few examples of KPI’s specific to the construction industry:
1) Overbillings to Underbillings
Whether you are overbilled or underbilled is typically dictated by the phase of the project. Certain projects will likely be overbilled, while others may be underbilled. A key aspect is understanding the ratio to either an overbilling or an underbilling during certain timeframes or aspects of the project.
Are you billing enough? Are all your costs included in your WIP schedule? These are just a couple of questions that may arise if your over/underbillings are not in line with your plan. Bankers and bonding companies also analyze this KPI to ensure all parties understand the project status and expectations.
2) Underbillings to Working Capital
Working capital is the difference between current assets and current liabilities. This metric identifies your ability to meet current obligations. Still, if existing assets, including underbillings, are not converting to cash timely, this can quickly lead to the stress of making payroll and purchasing materials. It is essential to bill customers timely so that underbillings do not harm working capital.
3) Months in Backlog
The backlog of projects on the horizon is the lifeline of any construction company and the best way to gauge how profitability will be in the upcoming months/year. The formula is total contract backlog ÷ average monthly sales for the past twelve months. A less than twelve ratio may indicate that additional work needs to be picked up to maintain consistent revenues. The backlog is another metric that bankers and bonding agents scrutinize to determine its long-term growth and health.
4) Average Revenue per Hour Worked
Having an efficient and effective labor force is crucial in a highly competitive industry. However, it can be challenging to manage compensation. The key is to find the right balance between maintaining positive morale, reducing turnover, and maximizing profits. Understanding an hourly labor rate that factors all these can be used on individual projects to compare separate crews’ profitability and indicate top performers and key personnel.
5) Gain/Fade Analysis
Gain/fade analysis is one of the most often used metrics by bonding companies and banks to indicate overestimating project profitability patterns. In basic terms, this KPI is used for trend analysis by comparing the budgeted gross profit to the actual. A gain suggests that the project was more profitable than budgeted, and a fade indicates it was less profitable. If your WIP schedule frequently shows fades, it may be that the estimator was too aggressive, the project manager did not run the project effectively, or that the company took on a project that is outside their typical scope of work. Analyzing this metric can help improve your company’s overall estimating processes.
Once you have a clear understanding of the KPI’s that are meaningful to your company, the next step is to work with your advisors to develop standardized reporting. The reporting should provide historical insight into each project and highlight significant variances from the goals set. Consider setting routine meetings to review project performance. Meetings should happen more frequently during busier times of the year (or project) to prevent an issue from escalating into a substantial loss.
Author: Dave Leroux | [email protected]
Withum’s Construction Services team.
