Your reports and schedules, when understood and responded to, are precious to keeping your profit. They represent the financial control of your business. You need to use your balance sheet, income statement, working capital schedule and your schedule of estimated cost to complete jobs in progress as a sanity check against your field review, office feedback, job cost reports, project notes and other weekly and monthly schedules.

By understanding how to effectively manage from our financial and job cost information, we permanently increased our gross profits by 20 points and increased our sales by another 20%.

David Newton, President, XYLEM Builders, Weymouth, MA

The problem for many smaller and mid-market companies in the construction industry is that they are often misunderstood or ignored because their reports and schedules are not trusted to be accurate. They are often not accurate because the reports are used primarily as a tool for the accountant to prepare a tax return or to fulfill a bank-reporting obligation, so they do not contain complete enough information for you to control your business.

Let’s go backwards. Let me explain the purpose and value of a “Balance Sheet” and an “Income Statement”.

A Balance Sheet

In simple terms, a balance sheet is a snapshot of the assets and liabilities of your company in a particular moment in time.  It shows where you stand with what you own, and what you owe on a particular date.  Your assets are stated “at cost” minus any depreciation or amortization taken over the ownership period of the asset.  Nothing is shown at “fair market value”. Your balance sheet needs to state the amount of money the stockholders will receive before capital gains taxes on liquidation, plus or minus the fair market value of the assets versus the value stated on the balance sheet, or the “short fall” if there is a negative equity.

For the income statement to be correct, the balance sheet must be correct at the start and end date of the period covered by the income statement. For example, the income statement for the year ending 12-31-06 would need an accurate balance sheet dated 12-31-05 and 12-31-06.

The purpose of the balance sheet is to control the accuracy of the income statement.  If your balance sheet is substantially inaccurate on the opening or ending date of the income statement period, then the income statement will be substantially wrong!

I met with a new client recently whose accountant not only “lost his records” for the past three years, but “could not locate his records” for the current year.  Knowing that accountants do not “lose” that many records ever, and knowing that accountants normally back up their computer records; I knew we had a big problem.  My client thought he had generated about $6 million in revenue from the past 12 months as a result of the revenue generated from his high-end NYC co-op remodeling projects. He had pretty good job cost and billing data, but needed bank financing. He had a horrible bid to award ratio and he needed guidance with his plan of revenue and profit for his company. He needed to know what his margins should be in order to win bids and how to identify who his customers should be. He needed to know if his bid margins allowed for profit after general conditions and overhead, plus he was unsure as to whether he was making money or losing it. In addition, he was unsure about what happened to his business over the last 3 years.

My client and I were in a situation where we could not wait for his new accountant to slowly reconstruct his last three years of records, so I sat down with my client and created a balance sheet.  That involved me interviewing him to determine what he owned and owed, locating his records which included his bank statements, accounts receivables, retainages receivables, an inventory of his trucks and computers, his vendor and subcontractor payables, the amount of debt on his trucks, cars, and equipment, the jobs he had in progress and, finally, the estimated costs of those jobs to complete. With that information I was able to create a balance sheet that covered the beginning of his fiscal year and the eleventh month of his fiscal year.

Finally, satisfied that we had two “good” balance sheets, we simply computed the change in his equity section from one date to the other, added back in the dividends which were checks other than payroll or expense reimbursement to himself during that period.  Then we looked at the payroll records to compute what he was able to earn in salary during that same eleven month period.  Our final step was to combine what the client earned in salary and profit for the eleven months reviewed.  The combined information noted above allowed us the basis to know, within a quick couple of hours, the amount the client had earned. So, when you are unsure of your financial situation, use this short cut to make sure your balance sheet is correct, otherwise look no further at your financials because they will not be accurate and will likely be useless.

Next, let’s explore your estimated cost to complete/completed contracts. It is my experience that, with other than the residential developer/builders who use the “completed contracts” method of accounting for revenue and cost, nearly all contractors use the “percentage of completion” method of recognizing revenue and cost.  “Completed contracts,” means just that: when the job is completely done, you “book” or record the total income and the total expense of construction on the income statement. No income, job expense, profit or loss related to the specific job is to be recorded on the income statement until the home settles.  Prior to that, the job costs appear as an item on the balance sheet named “work in progress”. Revenue appears as a liability called “customer deposits”, “deferred revenue”, or an item of “debt”.

Keep in mind that “percentage of completion” means that revenue is recognized as income at the rate the job is completed.”Job costs” are recognized at the rate they are incurred in ratio to both revenue recognized and total job costs expended to date, plus what is estimated to be incurred to complete the job.  Your balance sheet will have an asset entitled something like “costs in excess of billings” – meaning that you have costs that you have not or can not bill right now to the customer on jobs in progress. A liability account, or “billings in excess of costs” means that the contractor has billed the customer for work not yet done which is where all contractors would prefer to be…placing the contractor ahead of the customer on a cash flow basis.

If the costs in excess of billings are greater than the billing in excess of costs, you will likely have a cash flow problem.  This means that either you are spending faster than you are billing, or your project managers are behind in getting their bills out, or you have costs on your balance sheet that are really losses such as job overruns or change orders that aren’t approved or won’t be approved.  All jobs with costs in excess of billings will be lumped together under a liability account on the current asset side of the balance sheet.  Always review it to ensure that it does not hold surprises of losses not yet recorded.  You, as an owner, may not know about the losses. A project manager might simply fall behind in billing, which costs you interest expense, poor vendor relationships, cash heartache, and sleepless nights.  If your “billings in excess of cost” are always substantially higher than your “costs in excess of billings”, it is good for current cash flow as long as that difference is rising. I will warn you that it will give you a false sense of cash security as once the job comes to an end because the cash flow becomes more negative.  The excess billings over costs are not profit, they are simply a positive cash flow timing difference that will change from time to time.

The “schedule” of closed jobs and the open jobs “estimated costs to complete” should be prepared more often than once at year end when the accountants request it.  That is a way to maintain a current review of all jobs status.  That method also allows for problems to be addressed while the job is ongoing and you know you will have problems to face during the course of the project. Do not wait to address them until the job close out meeting occurs when everyone hopes they’ll do better next time rather than confronting problem situations earlier in the project.  Reviewing the schedules and reports allows estimating, on superior jobs, an opportunity to bid higher or correct a problem in the bid process.  It is critical to remodeling companies, as most of their problems occur during the preconstruction process, specifically in estimating errors or “buy out” of material errors.

Our firm instituted a weekly job review and estimated cost to complete process for one of our remodeling company clients, Xylem Builders, Inc..  Margins on their jobs increased by twenty points as a result of their being able to identify problems immediately and making corrections in preconstruction in the future.  Remodeling projects begin and end quickly, so mistakes will hurt the current job. Those mistakes do not have to be repeated if you institute weekly reviews and estimates.  It can be difficult and time consuming to correctly prepare an estimated “cost to complete schedule” for larger jobs in their early stages, yet it is worthwhile.  You may continue to assume that your estimate is correct.  However, the estimator, project manager, job superintendent and controller must review a job early on to determine what is needed to complete and uncover looming problems. That step will create better value engineering, change orders will be billed in a timely manner and job profit will increase.  Each of these steps were taken by our client, margins increased over 20 points on average within 2 months, and sales have continued to increase by over 20%.  They made less mistakes, sold more jobs, and controlled the margins that were sold consistently by adding on this process routinely with the sales person, estimator, and field superintendent.

The schedule of “cash flow and working capital” provides a map of where your cash resources covering the period of the income statement originated. It consists of profit, new loans or repayment (principle due more than twelve months in the future), purchases or sales of capital assets and depreciation. All of these have the affect of increasing or decreasing cash. An accurate reading of the schedule results in better billing practices, better collection practices and prevents slower paying of vendors and subs. It shows where and how money was used to absorb losses, the debt principle repayments and may contribute to faster paying of bills. It prevents poor billing practices, slow receivables and reflects retainage receivables, purchase of equipment or other assets.  If the opening and closing period balance sheets are correct, then this schedule will be correct.  I repeat, “If the balance sheets are not correct, do not waste your time looking at this schedule…  or any other financial statement…because they will be wrong!”

Working capital is defined as the total of your “current assets” which is comprised of your cash, receivables, retainages, costs in excess of billings, work in progress, inventories and prepaid expenses minus your “current liabilities”. Your current liabilities are comprised of your lines of credit, principle payments of debt due within twelve months, accounts payable, accrued expenses, payroll, and taxes, billings in excess of costs, customer deposits and deferred income.  A greater than 1:1 ratio is important. Your bank may require a defined working capital ratio, so check your loan documents.  If the ratio is too high, you’re likely wasting the use of your cash and resources by making them too idle. A good business analyst will determine the amount of your excess working capital/cash that is funding the income statement profit versus your normal operations.  I have seen many a multi-generational businesses with excessive working capital and upon a quick analysis of a profitable income statement, saw a story portraying a generous financial income but it was derived from discounts from vendor early pay, interest income and low interest expense. In fact, it was a poor business operation masked by the working capital wealth of the company.

Your income statement should be a validation of what you believe is going on with your jobs in the field, assuming that your opening and closing balance sheets are correct. Your income statement should be in the same category as your job cost comparison to your estimates; and it should be in a format that allows you to, at a glance, see the critical components of your business and whether they are operating according to plan or poorly.  In order for your income statement to be used as the effective management tool and “sanity check” that it was meant to be, the following components must exist for a construction company:

It must be an accrual, not cash basis statement.  Accrual means you have recorded all your receivables and debt inclusive of payables on the balance sheet.

• It must include not only numbers next to the expense categories, but percentages of revenue next to the number.
• The only revenue in your top line should be job revenue.  No interest income, rebates, sales of equipment should be included.
• The costs of construction must be detailed to identify construction labor and payroll added costs, subcontractors, materials, equipment rentals, revenue driven liability insurance, superintendents’ costs or other direct costs of construction as detailed in the estimate and tracked in your job cost reports.  Some or all of these are your “Direct Job Costs”.  Labor, materials, subs, and equipment rental, permits, direct insurance, etc. are at a minimum, included here, on your job cost reports regardless of software, and in the estimate.
• Indirect construction costs such as mobilization, trucks, pagers, cell phones, supers, trailers, etc. may be what you call “general conditions”.  Define what you mean by “general conditions” and categorize these costs separately on your income statement.  This will allow you to see if the general conditions you are utilizing in your estimates are making you money or losing you money.
• Categorize your pre-construction costs of estimators and bidding / selling expenses separately on the income statement.  Divide the number of bids or estimates produced into this total and see what it is costing you to bid.  Add that to your bid to award ratio and you may find not only that you’re wasting money in bids you’ll never get but how much you are wasting.
• Keep the office and support staff under an administrative expense category.  Be sure to allocate the workmen’s compensation insurance, vehicle and equipment insurance, depreciation, payroll taxes, benefits, safety, and training to the indirect or general conditions as appropriate.
• Show purchase discounts and interest income as “Other Income” after computing profit or loss from the construction operations.  These are financial incomes which are earned due to ownership, equity, and working capital, not from operations.
• Compare the percentage of gross profit from jobs completed, jobs in progress, to your income statement.  This should be done before general conditions are deducted when you compare the percentage of gross profit.  Be aware of additional profit that you may earn in gross profit from the labor rate that you use in estimating, versus your labor rate posted to job cost sheets or categorized on your income statement. If you use your own equipment in construction in lieu of renting it, separately analyze these costs to see if you are making or losing money in this regard.  If you are earning a profit from this, that’s great, but it will likely distort the gross profit from construction if your estimate utilized a fair market rental rate.

Meet with your outside accountants if they are construction knowledgeable, or your construction business advisor, and/or your controller on a monthly basis to review your balance sheet, income statement, working capital and source and use of funds statement, and completed jobs/estimated costs to complete schedules, and do it regularly.  It establishes control in your business. It also helps create the “sanity” of profit, helps avoid the “insanity” of making the same mistakes over and over again, and avoids your losing profit or your construction business itself.

Each of our last three clients had issues that could be traced back to their previous family members’ ownership. All too often the preceding owner is a strong person, respected in the community, respected within the business, and they are the “CONTROL”. The problem is that since a “person” is the control, he or she determines what “good” is for the organization. Thus, problems can be covered over by them saying, “I’m already successful and I must be doing it right”, and the successor family member begins to learn a dangerous method of management.

Each of our clients were historically “successful”. Each experienced frustration with the successor family member. Either “they just weren’t up to it” or “they aren’t doing what we did”, therefore leaving hundreds of thousands or millions of dollars “on the table”. Upon review, the structures and individual employee accountability to “minimum acceptable standards” of action, results, and reporting were never established. Information was generally wrong or incomplete or unfocused in form to the real problems and controls of the company. Without correct information, the successor was “flying blind”, and more importantly and disastrously, was attempting to rapidly expand the business. The concept was not wrong. However, without accountable structures in place, the company simply lost more profit while revenues increased. The attitude of, “We’re making money, so it must be good” and “It is just a matter of more revenue to be great”, is just a rehash of the old style of management which the successor believed did not work.

Prior to turning over your business via buy-out or gift, get a formal analysis of the operations and personnel including the current ownership and the planned successor by a qualified outside resource. Understand your strengths and weaknesses. Once defined and agreed upon, implement the corrections prior to the business transfer. The investment in yourself and the future will almost always yield multiples of the cost shown by new profit every successive year. Formulate a plan for the next generation to be well-prepared to move the company to even greater heights.

The Burruano Group has just become a Bronze Sponsor to NAHB Women’s Council. We are continually trying to extend our contacts and influence in the building industry through our numerous articles in construction trade publications, membership in the National Association of Home Builders, memberships in regional NAHB committees in commercial construction and remodeling.

As you probably already know we continue to perform and participate in a number of national speaking engagements, and noted business advisory and implementation services for the construction industry. We believe by joining the National Women’s Council of the NAHB and becoming a bronze sponsor of the council, this will continue our goal of becoming the premiere construction business consulting firm in the nation and addresses and often overlooked segment of the construction market: women.
Nearly 25% of our current consulting engagements are with women owned companies. Although the business issues may often be the same regardless of the make-up of privately held companies’ ownership, there are unique challenges to the women who operate in the construction industry. This affords our firm a unique and important insight and knowledge building to add to the services and advice we offer to our clients nationally.

We recently participated in the ICAN Event Auction. We offered a $10,000 voucher for our business consulting services as a means to raise money for the Island Coast AIDS Network, a charity that raises money and assists those afflicted and affected by AIDS, at its annual charity ball auction in Naples, Florida.

The Philip Douglas Salons (2 For The Road, Inc.) was the big winner and commenced work with us to expand their revenues, increase their profits, and attract and retain the very best hair stylists and color experts in the region.  Philip Lindquist and Paula Warnock, owners of the renowned chain of salons in Naples, Florida, enjoy the reputation of “Salon to the Stars on the Gold Coast of Florida“.  Philip, personally, is noted for the generous philanthropic giving of his services and money to those suffering from cancer.

Ed Sundberg and Tony Burruano, Joint Managing Directors of the Burruano Group, Inc., will be delivering 2 workshops at the Southeast Building Conference (SEBC), in Orlando, Florida tomorrow, July 14 2007. Sundberg will be presenting a workshop from 8am-10am on successful succession planning (Succession Planning: What, When, Why, & How) for privately held and family owned businesses.

Burruano will be presenting a workshop entitled “7 Deadly Mistakes Construction Businesses Make… How to Recognize, Quantify, and Avoid Them” from 10am-12pm also tomorrow, July 14^th.

This is the second straight year Burruano and Sundberg have offered workshops at this Eastern Regional construction business event. Marcia Albert, EVP – Marketing for Burruano Group will be on hand for both presentations to answer questions of the attendees regarding BG or regarding marketing/branding issues of their companies.

www.sebcshow.com

We are proud to announce the Burruano Group has joined NAHB. The NAHB is an association that offers timely information and support to the home building, home remodeling, and commercial construction industry. Burruano Group contributes to the NAHB by volunteering their time to several construction committees of their local chapter, Collier County Builders Association, and by offering their business consulting services to members of the NAHB at a discount. By the active involvement of its executive staff of Ed Sundberg, Marcia Albert, and Tony Burruano in NAHB, Burruano Group intends not only to broaden the firm’s knowledge of construction issues, but hopes to assist the association and its membership with improving their respective companies in terms of increased revenue and profits.

For more information please visit the NAHB’s website: http://www.nahb.org

We cannot be all things to all people! Not only do we need to focus on the applications of our products or services, but as our first step, we must clearly define, exactly, who our top tier customer is, where he is, and how to get there. The top tier customer is that person who is willing to pay for the value added service we provide (i.e. give us the margins we want) and will normally repeat that sale if that is important to us. Once we know who we want, we need to fine tune our message to them in order to set standards for ourselves around how many steps it will take to secure each sale. Our message confirms the “customer promise” (what the customer expects) and defines the value proposition that our business must deliver (we set up centers of excellence behind the value proposition). The standards define the resources we need to get the results we must have.

Hooking a potential customer takes much deliberate work. The first step is to find out where he lives and how to access him. It may often take a third party introduction or finding the proper conduit for reaching the prospect. The second step is to arrange that first meeting. That may sound odd, but the less you come across “selling”, the less the chance you will be lied to in return. Just think about all the times people have tried to sell you things you didn’t want to buy. You would tell them anything to get them out of your way. That applies to even the best sales person when talking to someone who doesn’t know they need your product or service. So the approach here is not to sell, but set up the prospect to buy! This is called “hooking”. If the hook is buried deep, you can close. Premature closing can result in that fish pulling away and the “sale” lost.

So how do you hook? First, you must appreciate the research that says that people “buy” emotionally and not intellectually. Second, you need to get your prospect into your system of selling and get them out of their system of buying. During your discourse with them, qualify their emotions to determine it they fit a “real” customer profile. If you undertake your discourse correctly, you will lead your prospect into a funnel of emotional pain. That emotional pain is not an “OUCH!”, it is an emotional need to change and buy your product or service in order to solve their serious issues or needs that you can address better than your competitors. Once you have captured the emotional issues surrounding your prospect’s ability to do a better job for themselves by using your product or service, you have placed the hook. Setting the hook deeper requires a constant reinforcement in the “selling” process. Their relief from pain comes from working with your company using your solutions that he is very willing to pay for at this point. Now how do we get to “close”?

The next article in this series will describe how to “close” the customer.