Many industries will experience ripple effects from the COVID-19 pandemic for years to come.
While the overall construction industry fared well during 2020, many uncertainties remain, such as fluctuations in material prices, supply chain issues, labor shortages, additional outbreaks of COVID-19 and outlooks for construction spending. As a result, we may be only beginning to see the long-term impact of the pandemic on the construction sector.
According to projections for 2021, residential construction spending is expected to decline 7%, and nonresidential construction is expected to decline 8%.
The extent to which your construction company has been, or will be, affected by these uncertainties is unknown. In light of this, it’s vital that contractors:
- Understand their current financial position;
- Are ready to take quick action to maintain continued financial stability should a negative event occur; and
- Are confident in reacting decisively to positive opportunities that may arise as a result of the pandemic.
Below, we’ve outlined methods to help contractors understand and maintain control of their finances during uncertain times.
Historical Financial Reporting
Accurate financial reporting is the bedrock of planning during times of uncertainty.
I oftentimes hear business owners disregard or minimize the importance of historical financial reporting as being unimportant because it only reports history rather than informing the future. However, there is much truth to the old adage: “You can’t know where you are going unless you know where you’ve been.”
Having timely and accurate financial statements is a key component to leveraging uncertainty. Financial statements provide information regarding the overall financial health of the company, as well as its level of operational excellence.
Accurate financial reporting can provide definitive answers to common questions such as:
- How much liquidity does the company have?
- How much borrowing or bonding capacity do we have?
- How accurate are we at estimating?
- What is our breakeven revenue?
- What is our overhead rate?
Knowing the answers to these questions allows a contractor to react quickly and confidently to changes in their business, or the economy, because they are armed with timely and accurate financial data about their business.
Once a contractor is confident in its financial position and historical results of operations, it can move quickly into building forecasts for the future of the business.
During times of uncertainty, it’s essential to keep a close eye on your business development efforts, backlog, operating profit, overhead, and cash flow. A well-informed contractor will have detailed forecasts for each of those areas.
Your forecasting efforts should rely on data you gather based on your historical financial results, current backlog and future financial goals. They should also consider scenarios that may result from economic variables that are presently unknown.
To that end, forecasts can easily be designed to allow for changes in assumptions or inputs so that management can quickly see how those changes affect profitability and financial health. Forecasts should be data-driven and always be approached as methodically as possible.
Cash Flow Management
Cash flow is vitally important to any business, but even more so to contractors in uncertain times.
A good cash flow model considers not only the profit shown on the P&L, but also takes into account items which affect cash flow, such as:
- The timing of billings;
- Purchase orders;
- Vendor payments;
- Retainage releases;
- Debt service;
- Equipment purchases;
- Tax payments;
- And more.
With so many components at play in a business simultaneously, it’s important to understand the timing and sufficiency of the business’s cash flow so that management has confidence in knowing that the business will always have the available cash it needs.
Understanding cash flow allows management to see potential issues before they happen, as well as identifying ways to improve cash flow on an ongoing basis.
Perhaps you have breakdowns in communication between field and office personnel which result in delays with retainage being released or in project billings being made timely and fully to project owners. Creating and maintaining a cash flow model will uncover these areas for improvement.
Communication with Supply Chain
While you may have a great handle on the financial position of your business, that doesn’t necessarily mean your customers, suppliers, and subcontractors do as well.
There are countless horror stories from the last recession involving customers who were unable to pay and subcontractors who were unable to complete projects. A good way to help prevent this from happening to your business is to stay in constant communication with all parties with whom your business partners.
Not only can this proactive communication reveal potential issues, but it can also create strong relationships with vendors and subcontractors which may pay dividends when materials or labor are hard to find.
Fostering close relationships is not only beneficial for business development. It can also give you an edge in procurement and project delivery.
Proactive Planning for Cost Reductions
In times of uncertainty, many contractors immediately focus on reducing costs. While understandable, there are many other components to having a well-constructed plan.
As discussed above, establishing a sound forecast will inform management regarding the wholistic outlook of the business under various scenarios. Additionally, it will better inform management regarding areas where costs could potentially be reduced without sacrificing the long-term success of the business.
If cost reductions are necessary, having a proactive plan allows for management to focus on strategic cost reductions rather than haphazardly making across-the-board reductions. Reducing costs in a strategic manner may involve applying lean working processes to reduce waste, digitizing certain processes to improve efficiency, outsourcing labor, and proper asset management.
Learn More about Proactive Planning
In times of uncertainty, it’s important to focus on what your company can control. While you can’t control economic factors that influence the construction industry, you can do everything in your power to forecast, budget, and manage expenses and cash flow.
Consider our suggestions to help you keep your finances stable despite the uncertainty that may loom ahead, and don’t hesitate to contact the trusted advisors at Warren Averett for additional guidance.