Construction is booming in many parts of the country. Some growth is so high that back office staffing has not been able to keep up with the work; especially billing and financial statements.
A contractor’s financial statements show not only where a construction company has been, but also where it’s going. Contractors often have special needs and need to work with their financial and accounting advisors to catch problems early on to avert problems. Here are eight red flags contractors should look out for when reading their next statement
Watch for some Nasty Numbers
8 red flags to watch out for in your financial statements
- Cash is building (or not). A strong cash flow is one indication of a strong business. Flow. Important. Cash that is just sitting or is growing may mean that your backlog is decreasing and you’re running out of work, leading to a stockpile in the cash column. (Eventually, the cash stockpile will disappear.) On the other hand, if you are drawing on your line of credit when payments for a project are slow in coming or when retainage creates a problem, this could also mean trouble. A construction company should generally be overbilled on a job. If you have substantial under billing, ask your financial advisor to perform an over/under billings analysis to get a handle on this situation. It will impact your FLOW. It could be that you need extra help to get the billings out in time. Analyzing your billed/overbilled position is not as hard as it sounds, but it does require some devoted entry to each job’s cost controls. These may be done by a simple coding process. There are many times when this coding does not get done, either because of lack of time or the “boss” does not properly mark the job on the receipt or bill. There is no way to over stress the importance of the job cost system and entry.
- Decreasing equipment value. Check the depreciated values as compared to the costs. If most of your equipment has been written off (for book purposes) then you may not be planning for a growth spurt. Unfortunately, your equipment is decreasing in value, even if you are properly maintaining it and it is not getting as much wear and tear. Plus, you’re not replacing equipment at current market prices — meaning you’ll likely pay more when you finally have to upgrade.
- Changes in your debts. Substantially changing liabilities warrant a close look. If these are changing, but your Key Financial Indicators (KFI) are consistent or improving, then this may not be a concern. On the other hand, if your liabilities are increasing due to unprofitable jobs (do the cash flow analysis by job) or if you take out a loan to keep your construction business afloat, you may be losing more than you thought. Having a large amount of unsecured debt is a particularly bad sign for any company.
- More current liabilities than current assets. Seasonality may create changes in this KFI; this is important to track and plan around. Year over year and month over month financial statements are important to look at so you know what the seasonality is and what it creates in your cash flow. Also, consistently having more current liabilities than current assets is typically a sign that you’re overleveraged.
- What happened to the gross profit? Your gross profit margin is your building costs for a particular period — not including overhead, payroll, taxes and interest payments — divided by your sales revenue for the same period. This revenue should be calculated using the percentage of completion method. A smaller ratio indicates your production costs are rising faster than your prices or you are charging less than you should be. Either way, this is a trend you should be watching. Track the profit margins and also compare them from one job to another that you may be working on.
- Changes in ratios. Fixed expenses, such as rent, supplied and utilities, are less variable than direct project expenses, such as labor and materials. The ratio of these expenses to net profits will dramatically climb if your workload drops. Watch your indirect costs, such as insurance, that you should be allocating to each of your contracts. The math is that if these costs rise per contract, it usually means you have less contracts to spread them over. Again, month over month and year over year comparisons are helpful.
- Receivables growing faster than sales. If what people owe you starts to exceed your actual sales, beware. Usually this means that customers are taking longer to pay their bills and that it may be time to change your collection procedures. Remember Flag Number 1, most contractors should be overbilling and receivables should not exceed sales, unless those jobs just are not paying. This is where good analysis comes into play.
- What’s in the future? Although you may take comfort in the sight of a lengthy project backlog on your financial statements, remember that not all projects are created equal. Sometimes, a small number of profitable jobs is like the bread and butter to hold you over for the larger jobs.
For a financial statement glossary of a few key words on a financial statement, email us at firstname.lastname@example.org or call me, Jem, at 505-828-0900.