For two long years, COVID-19 wreaked havoc on every part of our lives. Now, with the more visible impacts of the global pandemic largely in the rearview mirror, it’s time to take a deep breath and consider what happened, what was learned and how to be better prepared. Just don’t take too long reflecting on the past, because now is when the real work needs to be done. For construction business owners and executive management teams, the pandemic changed how to conduct business and how to strategize financial success for the company, clients and employees.
Owners and executive management teams should take some comfort in making it this far. They have shown resilience and learned new skills to be more agile, adapt quickly, improve communication and master the ability to juggle day-to-day operations. These skills were pivotal to finding success the last two years. Unfortunately, in many ways, 2022 is shaping up to be just as stressful. Stimulus funding has largely dried up, borrowing is becoming harder and more expensive and managing daily schedules can seem more out of control than ever.
It’s time to combine the talents learned since 2020 with time-tested financial lessons that too many companies abandoned during the height of the pandemic. Proper financial planning tools include a rolling cash flow analysis, real-time feedback to ensure proper bidding, a continued focus on cost controls and, yes, even more communication.
Don’t Overlook This Critical Financial Tool
It goes without saying that the most important financial tool to a contractor is a work-in-progress (WIP) schedule. Knowing the status of projects, whether projects are over or underbilled and trends in gross profit gain or fade is crucial to understanding the financial state of a company.
But while having a WIP may seem obvious to top-tier companies, what is often overlooked, is arguably the second most important financial tool: a cash flow model that predicts the timing of both the sources, and uses, of cash on a weekly or monthly basis.
While traditional financial statements can provide validation to owners and outside financial partners on historical results, they provide very little detail on how the company will perform in the future. By its nature, a cash flow model looks to match future operations of the company with the cash used to achieve these results and the return on the company’s efforts. When updated regularly, the model identifies operational pain points, escalating material costs, importance of timely billing and the impact that late collection of contract receivables can have.
Cash flow models allow business owners and executive teams to better align the financial and operational resources of the company that can reduce stressful pinch points and put owners in a better planning position. For example, a contractor that managed a successful 2021 will likely find themselves in a decent cash and equity position today. But while they may feel great about their current financial status, 2022 is shaping up to be very active and unpredictable. By using a proper cash flow model, the contractor can identify that the current cash balance and availability on the line of credit does not provide sufficient cushion for rising material pricing and the high volume of projected production. They can take proactive action instead of being met with an unfortunate surprise.
In addition, most companies have not invested in property, plants or equipment at the same pace as pre-pandemic. The cash flow model overlays the necessary production schedule with the ability of the company to provide employees with more efficient equipment to get the job done. Let’s imagine that an owner is asking a bank for an increased line of credit for working capital and a new term note to finance the necessary equipment. Traditional financial statements can easily show a solid financial foundation and reason for the request. But having a repayment strategy from a reliable cash flow model will put the borrower in a far more favorable position to have the request approved.
Bidding for Future Success
Another area of increasing importance is how construction companies approach bidding for new work. Contractors have long been able to justify an overly competitive bid by stating that they needed a stockpile of projects to give employees the ability to provide for their families and have a reliable, consistent work schedule.
But today, the industry is exceptionally busy and it’s hard to find a contractor who isn’t facing a massive backlog. There are many causes including delays in permitting, COVID-19 job site restrictions, delays on negotiating material price escalations and supply chain disruption. The result of these factors and the overall pent-up demand in the industry means that no contractor needs to offer overly competitive bids or “buy work” in 2022.
In fact, owners and executive management teams need to establish a gross margin that will be an acceptable minimum threshold for new projects. In the past, companies would build out a cost estimate and add a profit margin at the end. Now, they should determine the required profit margin first, and then apply each cost line item. This practice gives the contractor a price the moment the estimate is finished and eliminates the ability to justify a lower contract price to win a job.
Many factors can influence the final contract price, including new client relationships, size of the job, minimizing competition in a geographic location, and expanding into a new industry. The new method of pricing will, at a minimum, highlight the financial discount accepted from the pre-determined standard needed to meet financial goals.
Controlling What You Can
The ability to secure a proper return is important, but as the pandemic subsides, executive management teams cannot cast aside the cost controls that were so critical in recent years. Many companies experience more financial difficulties during a time of economic growth than during a recession. A major reason is the assumption that a growing top line will overcome any increase in the cost to perform. While this is true in theory, increased costs need to be heavily scrutinized to be sure that hard earned revenue is not squandered. This is especially true when one considers how little control contractors have over material pricing and labor, which are being dictated by outside market forces. One way to combat the material cost problem is by opening lines of communication with primary vendors and trying to negotiate a long-term agreement that helps secure reasonable pricing of material or, at a minimum, consistent availability.
But one area where business owners do have more control is with general and administrative costs. Owners have minimized investment in the business over the last two years, and 2022 may not be the time to break that cycle. Things may seem better than 2020, but the marketplace is still unpredictable and returns on capital investments need to be clearly defined.
As the industry emerges from the pandemic, optimism is returning. Significant backlogs, new technology to combat the labor shortage and a political focus on infrastructure are all positive signs that the battle was worth the fight. By using the tools noted above and leaning on the battle-hardened resiliency developed throughout the pandemic, business owners and executive management teams can insure prosperity in 2022 and beyond.