In the construction industry, the finance and accounting functions of middle market companies often operate in a way that results in recurring issues. There is a lack of forward visibility with respect to these companies’ financial performance, which is essential to optimizing profitability and cash flow. Key projects continually go over budget, profit margins slide as the year progresses, and cash flow becomes challenging—often with little warning.
Profit fade is a chronic issue among middle market construction companies. Throughout a project, labor and material costs increase and these issues are not addressed in a timely manner, so the teams do not take corrective action. Over time, the project’s gross margins drop, and by the time a job closes, the company is left with minimal profits—or worse, they have lost money on the job. The same process occurs with annual budgets with each over-budget job cutting deeper and deeper into profits.
Fortunately, middle market construction companies can break the cycle by adopting best practices that are embraced by the most successful construction companies, including:
By implementing these three practices, construction companies can dramatically improve financial performance, unlock millions of dollars in cash, and provide the financial leadership necessary for the organization to make the timely and informed decisions that lead to success.
One of the most important changes a middle market construction company can make is to adopt a forward-looking approach to financials. Most construction companies review project financials after a job is closed, at which point, the team looks back and expresses frustration over mistakes made and profits lost. The same process is often repeated at year-end.
Rather than looking back at how things performed, leadership needs to alter their mindset and look forward. This requires a shift in the role finance plays in the organization and the way in which they interact with project managers.
To view data and project performance through a forward-looking lens, companies need to improve how they develop and track data. Yearly budgets should be set and reviewed monthly and individual jobs should be reviewed weekly to understand how they are tracing relative to budget, and to enable timely corrective action if needed. This is crucial to hitting performance targets and maximizing profitability.
By reviewing the financial performance of projects on a weekly and monthly basis in connection with the timely closing of monthly financial statements, companies can identify issues early and course-correct before it is too late. Regular financial reviews will also help leaders spot trends and understand where they can increase project margins or improve internal operations.
It is rare for a middle market construction company to have company-wide visibility into cash flow in a way that enables them to actively manage cash. In most cases, middle market construction firms find themselves saddled with unfavorable contract terms and unpaid invoices, and the delayed receipt of cash becomes a burden on the company’s finances. They may also run short of funds which can create unfavorable relationships with the company’s lender, and in some cases, require owners to inject additional cash. Fortunately, there is a relatively easy solution for these issues.
In the most profitable construction companies, project managers and the finance department are closely aligned and establish contracts that allow for better cash flow. They submit timely and accurate pay applications and invoices based on milestones established in the contract, which facilitate billings earlier in the contract. This results in the faster receipt of payments from customers per the agreed terms. This acceleration of invoicing and the collection of amounts due can unlock millions of dollars in cash that will reduce the balances on bank lines.
It is a requirement of the business for middle market construction companies to work with third-party constituents, including banks and bonding companies. When meeting with these firms, members of the finance team need to possess the high-caliber financial acumen to obtain better terms on loan agreements and higher levels of bonding capacity.
They need to understand how to advocate for the company and communicate performance indicators effectively, including future financial projections. Most importantly, they need to provide financial leadership to the management team and/or the ownership group to allow the company to deliver on projected earnings. This is essential to maintaining the strong relationships, confidence, and financial support necessary for the companies’ long-term success.
Not only will these three changes help middle market construction companies unlock millions in cash and optimize profitability, but they better position the business to acquire other companies. Professionalizing the organization and maximizing profits helps companies build the type of platform that can be used to make smart acquisitions as the industry consolidates, including middle market family-owned construction companies that do not have succession plans in place–which is quite common today.
If your finance team does not possess these capabilities, it might be time to speak with a firm that has helped numerous construction companies develop these important financial practices. FortéOne consultants have more than 20 years’ experience building and leading construction companies and helping our clients install the internal processes that maximize profitability.
Contributor: Robert Wasielewski