From the baseball field to the boardroom, metrics and statistical analysis have changed businesses nationwide. And the construction industry is no exception. With proper preparation and guidance, contractors can have at their fingertips a wealth of stats-based insight into how their companies are performing — far beyond the bottom line on an income statement.
The metrics in question are commonly referred to as key performance indicators (KPIs). These formula-based measurements reveal the trends underlying a construction company’s operations. As such, they can encourage you to continue on the right path or give you fair warning when you’re headed in the wrong direction.
Where to Start
A good place to start with KPIs is with some of the metrics that apply to most businesses. For example, take current ratio (current assets / current liabilities). It can help you determine your capacity to meet your short-term liabilities with cash and other relatively liquid assets. You generally want this ratio to be at least 1.0 — though 2.0 is an objective well worth pursuing.
Another to regularly calculate is working capital turnover ratio (revenue / average working capital). Most construction companies deal with temperamental cash flows that wax and wane based on project phases and owners’ ability to remit payments. This ratio shows the amount of revenue supported by each dollar of net working capital used. Again, look to exceed 1.0.
Debt is also an issue for many contractors. You can monitor your debt-to-equity (total debt / net worth) ratio to measure your degree of leverage. The higher the ratio, the greater the risk that creditors are assuming and the tougher it may be to obtain financing or bonding. A ratio of 3.0 or lower is generally considered acceptable for many construction companies.
Of course, there are many KPIs specific to construction projects. For instance, a KPI called the bid-hit ratio assesses your rate of winning project bids. Say you bid on 12 jobs and won four of them. That’s a bid-hit ratio of 12:4 (or 3:1). A typical ratio is hard to pinpoint because of differing frequencies and approaches to bidding. But the lower the ratio, the better.
Once work begins, there’s a lot of information you could track. One simplified example: cost variance (budgeted cost of work – actual cost of work). Specifics here will obviously depend on the budgeted and actual expenses of a given job. But a negative cost variance means that a project is over budget, while a positive variance means it’s under budget.
As your project pipeline grows, there’s a backlog KPI — backlog/(revenue/12) — that can help you measure efficiency. More specifically, it reflects the number of months it will take to complete all signed or committed work. A lower ratio may mean your company needs to refocus its sales and marketing efforts to ensure a strong stream of new contracts is coming in.
As a construction business owner, you’ve made an investment in your company. Thus, there are KPIs that can help you keep an eye on whether that investment is rising or falling in value.
For example, look at return on assets (net income before taxes / average total assets). A common objective here is 15% or more. So let’s say you earn a net income of $900,000 and have average total assets valued at $6 million, for a return on assets of that coveted 15%. Meanwhile, your biggest competitor across town is also earning $900,000, but has average total assets valued at $8 million, for 11.25%. Under this pleasant scenario, you’re doing a better job of converting assets into profit.
An additional important KPI for business owners is return on equity (net income / shareholders’ equity). It lets you know how efficiently your construction business is managing its assets and generating returns for shareholders. Generally, you want to aim for 15% to 20%. So, going back to our example, if you’ve earned $900,000 in net income with a shareholders’ equity of $5 million, you’d have a return on equity of 18%. This isn’t a terrible return but probably indicates need for improvement.
As mentioned, there are many other KPIs we could discuss. The exact ones you should look at depend on the size of your construction company and the nature of its work. But every contractor needs to pick their mission-critical KPIs and set up a “dashboard” for monitoring them daily. Once you do, you’ll likely be able to view your operation’s finances with much greater clarity.
Digitize your KPI Dashboard
So you’ve done it. In consultation with your financial advisor and top managers, you’ve picked your construction company’s most important key performance indicators (KPIs). Now what? You know you’re supposed to keep an eye on these metrics every day but . . . where?
Technology has you covered. There’s a specific type of software — commonly referred to as “KPI dashboards” — that allows business owners and executives to create customized views of all of their chosen KPIs. And these applications don’t just lay out the numbers like a spreadsheet. They can include pie charts, bar graphs and other graphic elements to really illustrate the data.
Like any tech purchase, however, you’ll need to go about this one carefully. Set a budget and compare prices and functionality carefully. As a contractor, you’ll likely want a mobile option that allows you to check your dashboard on your phone or tablet at job sites.
We welcome the opportunity to put our construction industry expertise to work for you. To learn more about how our firm can help advance your success, please contact Dave Wolfenden at (302) 254-8240.