Regularly checking on your company’s financial health is an important part of your overall business strategy. Construction company owners are extremely busy in various parts of their business, making it easy to lose sight of the overall picture and become susceptible to financial problems. Conducting regular financial statement assessments with your internal team and CPA is an easy way to spot issues before they become crises. That's why we emphasize the importance of specific financial indicators to help you identify and address potential problems. Here are the top four indicators we recommend focusing on:

1. Working Capital

Working Capital = Current Assets – Current Liabilities

Your bonding company and bank prioritize working capital, which is your current assets minus your current liabilities. Contractors have different working capital needs, and there is no "right" amount. However, a lack of or negative working capital will make things difficult. On the flip side, some contractors have too much working capital, which indicates there may be an opportunity to distribute some capital out of the business. Work closely with your bank, bonding, and accounting team to determine target working capital.

If you do not have enough working capital, there are ways to increase it. The first is to increase revenue. Your company's profitability is the most important factor determining your success. If your company is profitable and you still need more working capital, look at your billing, estimating/bidding processes, jobs fade, and overhead structure. Alternatively, you can refinance existing short-term debt or infuse capital into the business.

2. Debt to Equity Ratio

Debt to Equity Ratio = Total Debt / Total Equity

The debt-to-equity ratio tells us how much debt a company has related to its assets. The higher the ratio is, the harder it is for a business to cover its liabilities.  A one-to-one ratio is very solid. If the ratio is over three to one, you may want to assess the need for additional capital to keep up with operational needs. If your debt to equity is becoming an issue, we recommend the following fixes:

• Increase profitability
• Infuse capital into the business
• Convert short-term debt to long-term debt
• Finance equipment instead of buying outright
  

3. Return on Assets “ROA”

ROA = Net Income / Total Assets

This calculation indicates how profitable your company is relative to its total assets. Assets include cash, accounts receivable, equipment, buildings, and land. The higher your ROA, the better off you are, as it shows you effectively use your assets to increase your profitability. If your ROA is low, it indicates you have assets that are not producing, and you should look at how to utilize them more effectively. Perhaps you have idle equipment or excess capital (think excess cash balances) in the business that should be distributed.

4. Months in Backlog 

Contracts Signed but not Started / Annual Sales

Months in backlog represent the revenue you have signed contracts for that you still need to complete, divided by annual sales. A profitable backlog indicates financial stability and should cover at least one year’s worth of fixed expenses depending on your industry and length of contracts.

Solidify Your Financial Position with Lutz

Keeping an eye on these financial indicators is a great way to stay on top of your business and identify weak areas before they become real issues. Please contact us if you have any questions or would like to speak to a construction industry expert on this topic.