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Top stories from Saltmarsh's Pensacola, Fort Walton Beach, Tampa, and Orlando offices
Contractor Dashboard: Key Indicators Track Performance
Wednesday, September 03, 2014
-This excerpt is from our Summer 2014 Dimensions newsletter-
With the recovery building momentum, many contractors are beginning to pursue growth opportunities more aggressively. As this trend continues, it is important to carefully manage both the financial and operational aspects of the business. Top performers keep a close eye on certain key financial indicators (KFIs). These function like a dashboard to give them a reading on their companies’ health and performance.
Here are some of the most closely watched KFIs, grouped into five general categories. Bear in mind these KFIs should be viewed collectively — no single metric gives you the whole picture.1) PROFITABILITY: Profits are generally derived from two sources.
Operational profit is derived directly from your company’s construction activities, while non-operational profit is derived from independent opportunities like improved cash management, savings from self-insurance programs, and income from other profit centers.There are three primary KFIs for measuring profitability:
• Gross Profit = (Revenue – Direct Cost of Work)/Revenue. Gross profit is often used to measure individual project performance.
• Net Profit = (Gross Profit – Indirect Costs)/Revenue. Net profit is best used to measure performance of an entire business unit or profit center.2) CASH FLOW: Cash is the lifeblood of your business.
• Return on Equity = Net Profit/ Owner Equity. Return on equity provides a comprehensive formula for comparing year-to-year performance. How much profit should a construction business generate? The answer depends on many factors, including your company’s size and age, your particular trade or areas of specialty,and local economic conditions.
You need sufficient cash to meet payroll, pay for materials and supplies, reimburse subcontractors, and meet general expenses, while still meeting lenders’ and sureties’ liquidity requirements. A broad cash flow dashboard reading is the cash demand period. It is driven by three balance sheet accounts: accounts receivable, accounts payable, and overbillings/underbillings:
• Cash Demand Period = Average Days Required to Fund Operations – Average Days to Pay Creditors. This is essentially the difference between the length of time it takes to receive payment for work and the time you take to pay your creditors.3) LIQUIDITY: Liquidity indicators measure your company’s ability to meet short-term obligations.
• Days in Accounts Receivable = 365/(Revenue/Accounts Receivable). Top-performing contractors reduce this by managing client relationships and collections carefully.
• Days in Accounts Payable = 365/ (Direct Cost/Accounts Payable). Prudent use of trade credit helps maintain flexibility.
• Overbillings/Underbillings = (Billings – Earned Revenue)/Earned Revenue. Aggressive billing practices can help reduce underbilling for work performed, and promote prudent overbilling.
They are particularly important to your financial partners and creditors.
• Current Ratio = Current Assets/Current Liabilities. This compares the availability of current assets to satisfy current liabilities. A minimum ratio of 1.0 is usually desirable.
• Working Capital Turnover = Revenue/(Current Assets – Current Liabilities). Working capital measures the funds available to invest in operations to generate more revenue. Working capital turnover measures how aggressively these funds are being used to generate income.
4) LEVERAGE: Financial leverage indicators directly affect your company’s risk profile.
It also shows your ability to repay debts and take advantage of new opportunities.
• Debt to Equity = Total Liabilities/Owner Equity. One of the most important financial ratios, this measures how highly leveraged your company is. A higher ratio creates additional risk. A ratio of 3.0 or lower is usually desirable.5) FORECASTING: Top performers carefully monitor work in the pipeline, and project sales and revenue at least one year out.
• Revenue to Equity = Revenue/ Owner Equity. A high ratio indicates you have less flexibility to absorb project losses.
• Backlog to Equity = Backlog/ Owner Equity. Too little backlog and your company stumbles; too much backlog and you’re overwhelmed. These KFIs should be tracked over time in order to spot trends. Monthly readings are recommended for many indicators — especially as you pursue a change in strategy — to get an early reading on whether you are gaining or losing ground.
We can help you compare your company’s KFIs to your peers and to industry benchmarks. Call us to schedule an appointment.
Qualifying for the Research and Development Tax Credit
The R&D tax credit is a Federal incentive provided by Congress to U.S. Manufacturers to offset the cost of innovating. As it is a credit as opposed to a deduction, it is a dollar for dollar offset to your tax liability. Also, since the credit is open for the 3 immediately preceding tax years, filing a claim for refund for the credit for past years can be a direct cash infusion into your company. This video explains the tax credit and how Saltmarsh can help your business claim the credits you deserve.
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