Running a successful construction business requires not only expert project management skills but also a solid financial foundation. Whether you’re just starting out or looking to improve your existing business, setting up your construction company for financial success is vital for its long-term sustainability and growth. In this article, we will explore key steps you can take to strengthen your financial health and make informed decisions that will boost your profitability.
1. Establish Efficient Financial Systems:
One of the first steps towards financial success is implementing efficient financial systems within your business. This includes setting up a robust accounting software to track your project-related income and expense as well as the company’s expenses and cash flow. This means utilizing construction industry specific software (not general accounting software) that includes the ability to create AIA-type billings and a built-in WIP report. Additionally, you’ll need to ensure that both your project accounting (job costs and billings) and your company accounting records are accurate, up-to-date, and organized. Without this foundational accounting, you will not be able to report accurate financial results. This foundational step is necessary for the following steps to work. Consider collaborating with a professional accountant to set up the right system for your specific business needs.
2. Understand and Analyze Your Financial Statements:
Financial statements provide valuable insights into your construction business’s financial health. Financial statements are the reporting system that tell you ‘how you are doing’ from a financial perspective. Learn to read and interpret key statements such as the balance sheet, income statement, and work-in-process report. These documents will help you assess your company’s profitability, liquidity, and overall financial performance.
Just remember the step above – in order for your financial statements and reports to be accurate, you have to have the foundational systems, up-to-date records and proper accounting methods.
You’ll also want to understand the method of reporting your company uses. Percent complete method for commercial construction contractors is considered best practice, however due to the size of the company or the type of contractor, cash methods or completed contract methods can also be used, although they provide less visibility.
Consider enlisting the support of a financial expert who can guide you through these statements and help you identify areas for improvement.
3. Implement Sound Budgeting and Forecasting Practices:
Effective budgeting and forecasting are essential for financial success. For most contractors, there are two types of budgets: project budget and an overhead budget. Both are important to forecasting.
Let’s look at these two types of budgets separately.
To have an effective future-look at your financial performance expectations, you’ll need to have a comprehensive project budget that includes all your anticipated expenses and revenue per project. This project cost estimate/budget needs to be reviewed regularly, track your actual expenses and revenues compared to the budget, and make adjustments as needed.
The overhead budget tends to be more stagnate in that most contractors create an overhead budget annually and then follow it throughout the year. There can be changes, but most changes are based on increased revenue that required additional resources to support the company operations.
These two budgets and your financial statements (#2 above) are then used to implement forecasting to anticipate future financial outcomes based on market trends, project pipelines, and potential risks. This will allow you to make proactive decisions and minimize financial surprises.
Our clients that operate at the level of financial projections outperform their goals because they are managing what they are measuring.
4. Strengthen Cash Flow Management:
Cash flow management is crucial for construction businesses, as cash shortages can impede growth and jeopardize project timelines. To strengthen your cash flow, work on improving your invoicing and payment processes. Ensure that you bill clients promptly, follow up on outstanding payments, and negotiate favorable payment terms with suppliers. Having a buffer in your cash reserves will also provide a safety net during temporary financial setbacks.
The best time to negotiate payment terms in BEFORE you sign the contract.
5. Monitor Key Performance Indicators (KPIs):
Identifying and tracking key performance indicators (KPIs) specific to the construction industry is vital for monitoring and improving your financial performance. Some essential KPIs to consider include gross profit margin, net profit margin, project profitability, and backlog coverage. Regularly monitoring these metrics will help you pinpoint areas of strength and weakness within your operations, allowing you to make data-driven decisions that positively impact your bottom line.
We built our financial projection model, the Atlas Growth Model, to encompass many of the KPIs we used in our construction business and now in our client’s businesses.
6. Invest in Training and Professional Support:
Building your financial knowledge and expertise is a long-term investment that pays off. Consider providing training opportunities to your staff so that they can efficiently manage financial systems and make informed decisions. This is especially true of the changing technology environment. Investing in a user’s group for your accounting or management software, joining a peer group or attending your software company’s annual training are great ways to maintain systems that grow with you.
Additionally, partner with a financial expert or a virtual CFO who can act as a valuable resource, providing guidance, strategic financial planning, and forecasting expertise.
Conclusion:
Setting up your construction business for financial success requires a commitment to building efficient financial systems, understanding your financial statements, implementing budgeting and forecasting practices, and regularly monitoring your financial performance. By investing in the right tools, knowledge, and professional support, you can navigate the challenges of the construction industry with confidence, improving profitability, and securing long-term success.