As life seems to be shifting back to a normalized pace, businesses are still feeling the effects left behind by COVID-19.
Many industries have learned to cope with life post pandemic and in some cases have thrived. That holds true for many construction companies across the U.S., but it has come with challenges.
Sadly, it appears these challenges are not expected to be relieved anytime soon—with continuous supply chain disruptions, shortages in labor, COVID-19 spikes in recent weeks and now the hot button topic of inflation.
Can the construction companies that succeeded during the pandemic survive today’s economy? Below, we discuss what the impacts could mean for your construction business and some ways to manage an inflationary economy.
The State of Today’s Economy
I think we can all grasp the concept of inflation, but what are its causes? Basically, it comes down to supply and demand.
Increases in demand can cause prices to increase. Decreases in supply can cause prices to increase. Unfortunately, we’re currently seeing both factors in the market. In May 2022, U.S inflation hit a high not seen since the 1980’s, as we saw general prices in the economy skyrocket north of 8%.
Economic Issues Impacting Construction Companies
So how does this impact those in the construction industry?
Incremental Rate of Borrowing
One of the most impactful items that will be and is affecting many industries is an increase in the incremental rate of borrowing.
The Federal Reserve is responsible for controlling inflation, and one way they combat it is by increasing interest rates to make it less appealing for borrowers. The Fed raised rates in May, and it is anticipated to raise more throughout the year to slow consumption and help reduce inflation. As people spend less, demand is reduced, and typically prices come down.
Cash Flow Management
For many companies, cash flow management can be the most difficult hurdle to overcome, especially if they’re experiencing expansion. If the business grows too quickly, cash flow can’t handle the rapid surge due to the delay in revenue stream with upfront costs of mobilization and materials purchases.
A popular alternative for many businesses is to take a debt approach to help with cash flow obstacles. Many construction companies require financing to complete projects along with leveraging assets for investment purposes in the future.
Also, there is some reliance on leasing of special equipment to perform certain jobs. Be aware; as these interest rates climb, there could be the requirement for additional capital to see projects to fulfillment, along with the potential for increased scrutiny from surety underwriters.
This will require tighter budgeting and having the ability to cut excess costs that diminish efficiency.
Supply Chain Constraints
Another element that will affect prices going forward is a continuation in supply chain constraints.
Until supply can align with demand, there will continue to be heightened material costs. At this point, it’s imperative for accurate historical financial data and a firm understanding when it comes to estimating job costs to help mitigate these inflated costs.
Once you come to grips with the historical data, we can begin factoring in the current numbers. As this data is compiled and analyzed, you can begin to see trends within the business and can create baselines.
Forecasting in the future is extremely difficult, but having accurate financial data could help ease the task. Ask yourself questions such as:
- Are we charging enough for the work?
- Are we being truly efficient?
- In what areas are we experiencing success?
When setting contracts, factor in these higher costs and negotiate some flexibility to help mitigate these risks.
Some construction companies are bidding on jobs, in some cases, years in advance. Again, it’s difficult to know what lumber and material cost will be in the future. However, by adding these stipulations within budgeting, we can at least be in front of risk and have a plan in place to manage the business.
Also, benchmark yourself against others in the industry. Look at items such as top-line revenue, gross profit margin and operational margin. These indicators will help build that solid forecast to set you up for nimble decision-making.
Increased Labor Costs
Be aware of an increase in labor costs. Adjusting estimates to factor in these items will be key. Employees will require additional incentives and/or an increase in wage for their families to cope with the economic environment.
Learn More About Growth for Your Construction Company
In times of rising prices and economic uncertainty, construction companies have an opportunity to review their processes and financial goals to propel them into the future as a high performing company.
Now that the economy is forcing you to take a hard look at your construction company and how it is operating, it’s a perfect time to get an outside perspective of ways to improve any inefficiencies, processes and help generate greater profitability.
Contact your Warren Averett construction CPA and advisor directly to learn more, or ask a member of our team to reach out to you.