Know who your “Top Tier” customer is. There is no magic to this definition. Simply define the qualities of your best type of customer; determine the current sales and potential sales of this group; the cost of acquisition of this customer…or even more importantly, the cost of loss of this existing customer type; and finally determine how this definition will affect your profit plan. Profit center or division can identify a customer. The company lead generation process can be branded to attract them, and the sales process and pricing process can be developed to encourage them to buy from your company.

Sell effectively to them. Don’t leave business on the table because you don’t know your market and your pricing position, which is sometimes known as “price point”. Just as important is the “selling” of someone who is not a buyer. Benchmark your process, and price to sell to real buyers or “price shoppers”. Unless what you are selling is a commodity, and you want to sell a commodity, then you are wasting your time and money trying to distinguish yourself from the competition. The value of your product or service is that you’ve compared it on an “apples to apples” basis, inclusive of the core components and design required by the customer. Additional value added, or “between the walls” value, should be explained to your customer, which assists them in understanding the value they may desire. The absence of this process will either price you out of the market or dramatically reduce your margins below the market. Do not let your brand be known as, “they’re good and reliable, but very expensive”, even when your margins are below market. This happens more to fixed price custom builders or to “T&M to a maximum price” residential builders and remodeling companies than the commercial market, which tends to be more defined, and it is incredibly costly to them. In the commercial market, the problem and opportunity is that engineering and design on paper is rarely what can be done totally in the field, and change orders ensue. The commercial process is “selling” the change order in an environment where it often must be started without formal approvals in place by either contract language or practicality. In this case, the “sales” process is one of up-front discussion, definition of process, then constant follow through and documentation of communications and action requests. More commercial companies go out of business or lose money due to unapproved change orders than from “bad bids”.

Define your “Customer Promise”, and keep it. A “Customer Promise” is both your up-front documented and agreed upon statement of what the customer expects of the builder and the results, plus what the builder expects of the customer. This “up-front” process is added to at each stage of interaction with the responsible party of the company at each stage of customer hand off, thus the initial “Customer Promise” must state that this will occur and will be a positive expectation of the customer. The process is a branding and control process that allows the marketplace to know who you are and what is expected of you. It allows you to measure by post job questionnaires and/or reference letters/testimonials from the customer that you in fact keep your Customer Promise. It is one thing to say we are this or that…it’s another, and most effective, to agree up front as to who you are and how you are going to conduct yourself, then get a “report card” at the end that is publicized. Post your testimonial letters and cumulative scores on your website. If you are a high end remodeling company or builder in specific geographic areas, encourage your customers to rate you on the “Franklin Report”, in other markets on “Angie’s List”, and in addition to your own rating system and process that supports your brand or “Customer Promise”. You will generally fail if you:

• Fail to review with the prospective customer prior to beginning any presentation your contractual process within your defining of the “Customer Promise”
• Fail to identify the prospective customer’s emotion surrounding the project or “pain”
• Fail to clarify the issue of Money
• Fail to get the prospective customer’s agreement as to how a decision will be made and when

“Hook”, don’t “sell”. Generally, people and businesses don’t want to be sold. They want to be fulfilled, and most often they want to buy from someone who can create emotion for them, take away “pain” from previous interactions with contractors, and fulfills their expectations. You can be assured that when you are asking questions of the potential customer, “you are in control”. Conversely, when you are answering questions, “you are out of control”. This doesn’t mean that you shouldn’t answer questions, but it’s important to ask why they are asking the question. First of all, it establishes interest, assuming your delivery is not snide; it establishes control; and finally it touches the emotion or pain of the customer, which is the fundamental basis for decision-making. Intellectualizing will get you little in the way of business, unless there is emotion that is not overwhelmed by the intellectualization. At all costs, do not start “selling” the prospect. If you need to talk about your company, do it in an up front statement that tells the prospective customer how you work with customers, what they can expect of you, what the problems of construction might be, and what you do or don’t address. There are multiple methods of non-selling that work. One that is popular in the construction industry, is the Sandler Method, which is described in the book “You Can’t Teach A Kid To Ride A Bike At A Seminar”, by David Sandler. There are also various tapes and franchised/non-franchised trainers which teach the method based on asking questions, eliciting emotion, and identifying “pain” up front. The method is excellent to follow if you are serious about choosing an effective and different way of closing business. In the Sandler method, a general series of questions called a “Pain Funnel”, is asked:

a. Is that a problem, or was that experience a problem in the past?
b. Can you be more specific?
c. Tell me more about that?
d. How did this affect you in the past on a day to day basis?
e. How did you try to correct this or mitigate its impact? Did it work? Did you give up trying?
f. For how long did you have to deal with this problem? That long?
g. Ball park figure, what do you think the problem cost you (is costing you) in dollars, time and emotional inconvenience? That much? Are you sure?
h. How does that make you feel?

One of the best Sandler trainers I’ve seen is Pat Cahill (how2sell@aol.com). He has enjoyed exceptional success in the construction industry and is worth contacting should you be interested in learning the Sandler technique. Burruano Group has used a version of the Sandler method with all our clients since our inception. We do not have a client who has not read the book, and there is not a client of our firm that isn’t using some lessons learned from the Sandler Methodology. It is a “good read” and with your commitment, a process that can successfully differentiate yourselves from your competition. Remember, “Don’t sell, let the customer buy”.

Use recruiting and retention methods that work regardless of the kind of person you can afford. There are just as many mistakes made by hiring an expensive person who can’t perform, as hiring someone without the experience or qualifications because recruiting them is too expensive. It is easier and less costly to develop internal management and key personnel then to go outside your company. In order to do that successfully, you must develop an effective process that is defined, tested, routine, and communicated to the targeted employees. Beyond defining training processes to the candidates, you must also define your expectations of them, what they should expect for themselves and what’s in it for them. That will allow you to develop the personnel who might otherwise choose to leave for a better opportunity with another company. However, do not promote someone who is great at a current job to a position for which they are not fully prepared because they will fail, and you will lose money and your valued employee. Typically, a truly performing employee should not have to be promoted to receive more pay. As described under “pay for performance”, a great producing employee could make more money than the manager who manages them. Remember, a manager is there to support those they manage and to nudge them back when their actions take them “out of bounds” of the company policies, job or business plan. If you have control processes in place, use your employees to “sell” the company; promote these policies on your website under employment opportunities inclusive of testimonials of current and past employees who benefited from these policies. Develop a rational business culture of communications that confront and coach coupled with a working pay for performance plan, and you’ll become a leader in recruitment and retention of valued employees.

Use Pay for Performance plans that work and sell others on your company. If your company is under control as defined by the previous 5 noted steps, you should introduce a pay for performance plan. I do not mean the plans that are Christmas bonuses, or subjective bonuses that become entitlements. You do not want your employee questioning what they got, why they received it, if it was enough, or if it is what they deserve. A true PFP plan establishes measurable standards attributable to the job the person performs with at least one of the measurements dealing with the link between what the person does and profit. If what they do is not measurable directly to profit, such as the accounting department, the timeliness and accuracy of what they do weekly and monthly is, as are evaluations monthly or quarterly by their internal customers in other departments. Ultimately the combination of values that comprise the bonus score is taken as a % of the pool created by the % of the company profit as defined as to what profit means, the pool available to the department or profit center, and the pool available to the individual by job classification. The PFP plan is a scorecard that shows the employee how they are doing periodically in measurable terms and money. Each company plan should be unique. Each company plan should incorporate standards that support the company goals of revenue, profit, customer branding, and internal culture. Each plan should be implemented when the company has successfully implemented the first 5 steps above. Do not begin unless the 5 controls are in place or the plan will fail and harm the company.

Include middle managers in senior management meetings. A development process for performing key staff is important. Regardless of the process, it is always useful to include non-management staff in appropriate business meetings to introduce them to the real process of managing the company. It gives them a sense of inclusion, an opportunity to learn, contribute and makes them feel valued. Of course, it is critical to hold a meeting that begins on time, has an agenda, involves participation by attendees and is followed up.

Listen to and respond to suggestions from the field and staff. Employees sometimes will state a concern or idea but there is no structured response to them. There is no response such as “great idea, good insight, won’t work and why”. The opportunity to coach the employee as to how the business needs to make decisions is lost. I recognize the issue of response is often about money…can’t afford it, not in the budget…or the like. However, the opportunity is to put the response into a “coaching/learning” moment, by explaining the need for a return on investment that is accountable to someone to do anything in business. In effect, if someone has an idea that can be measured as to ROI to an amount and timeline, and if the business is willing to take the risk, and the person managing the process or key to it (typically the one making the suggestion) is willing to “take the hit” within their pay for performance plan if it doesn’t work, then the company has the basis for making a decision to go forward with the idea. Conversely, if an employee suggests something that is beneficial to the company and has a measurable effect on the profit of the company or sales of the company, then the employee should be rewarded within the PFP plan or in addition to it based on the measurable gain to the company. In the end, it is ok to say “No” when the “No” is explained. It is important to let someone know that you listened by following up with the employee. It is the essence of good management, and it keeps the employee from “going to the well too many times and finding it dry” and “losing the emotional investment of trying anymore”. This of course is measured in lost productivity and profit/revenue loss.

Complete job reviews monthly and include the estimated cost to complete. Whether you are a remodeling company, residential builder, or commercial builder, and if the job takes two weeks or two years, a job review process inclusive of an estimated cost to complete process assists you in rapidly identifying job issues. It creates a feedback required for estimating and managing field issues, and ensures better accuracy of your monthly financial statements. Working for a profit is all about management, knowing potential issues, mitigating them, and building knowledge. Those four elements control profit along with your time investment and the quality of the buildings you build.

Compare sales results and billing results to planned results. All too often, companies “take what they get” as a sales result. Just as you manage a job, estimating processes and quote processes, the lead generation process must be set with standards that are linked to your revenue and profit plan. Those standards must be measured and responded to. One of the primary duties of the manager is to respond to the results of the measurement of standards. It is expensive when you do not target your estimating process. It is equally costly to have poor lead generation and follow up of leads. Determine the results of sales, billing and lead generation every month and compare those results to the cost of inaction versus the benefit of action. You will find poor results that can be improved.

Respond to and mitigate problems urgently. It doesn’t do anyone any good if you have access to information or knowledge and there is no urgent response to it because you didn’t understand it or address it. A manager must be able to clearly understand the accuracy and meaning information in front of him and respond to it immediately. The manager must determine when and how the problem will be solved. All too often in business, the issue is not that problems occur, but that they are not recognized, resolved, or mitigated quickly. There is no perfect business. The most successful companies are the ones that respond to problems and opportunities, maximize opportunities, mitigate current problems, and stop making the same mistakes over and over again. They look…they understand…they respond…they learn…they change.

Control a sale/job from pricing to completion. Whether you are a contractor with a pre-construction process, a service manger with a dispatch process, or you are planning profitability via a service contract sales process, integrate all the involved parties up-front before commencing the sale output. Know the costs on the job, hours on the job, material requirements, buy-out gain, parts requirements, and know that the labor scheduling needs are relative to your actual cost versus the revenue you will realize. Simply put, measure what the true profit on this job or service is supposed to be, so the job or service can be measured against what it should be. Get everyone on the same page. Start with a clear understanding of what the profit is after direct costs of the job or service. If you use overhead or general conditions in your estimating/pricing process, have your accounting department measure your profit or loss based on the “absorption” rate of those costs. Measure the effectiveness of estimating. Determine what your true cost of time and expenses is on sold jobs, which will determine an effective sales strategy. If you attribute a labor overhead rate to the hourly cost of labor, measure those costs inclusive of overtime against hours estimated (not used) on jobs. You may find this to either be a profit center, and therefore also a tool to price tighter, or you may find that this is a loss that can be better controlled, or simply that you are “leaving money on the table” with your rates that you can increase without jeopardizing sales.

Learn to maximize profit. Review the categories of sales or “profit centers” routinely. Almost every company does something really well. Identify the job or service you can use to be more predatory in your sales process to increase your bottom line by maximizing your less risky type of work. Correct or avoid the jobs or services that are hit and miss and never seem to work as envisioned. If you have job controls, accurate and timely reporting, a strong pre-sales or pre-construction process, and an engineering/design process linked to the budgeted estimate of costs that supports the actual ability to build within the budget, you can target your sales efforts and increase revenue and bottom line. This will also allow you to take a “tight” job that you want for branding, overhead absorption, or competitive reasons, and drop whatever you make after direct costs to the bottom line.

Make sure the cost of sales on your financials mimics your management reports. All too often information is “lumped together” on the financial statements. Often the categories of direct costs, overhead, or general conditions are not depicted on the financial statements in the same manner that they are used in the estimate or in pricing. For example, for a residential developer, the base home revenue and cost should be segregated from the post sale “selections” revenues and cost, and the home should be segregated from the land revenue and cost. The commercial contractor should segregate direct costs within the estimate from general conditions costs within the estimate on the Income Statement. If there is a separate pricing process for change orders, segregate the revenue, and if possible within your current systems, segregate the cost of the change orders billed or not billed. The service company should segregate revenue and costs of service contracts from time and material work, and segregate the materials/parts that are billable from supplies. Labor and labor overhead should be listed as defined in the pricing, often inclusive of payroll added costs, uniforms, licenses, vehicles costs, radios, pagers, or cell phones. This basic process avoids surprises when viewing financials versus internal job cost or management reports, allows for a “sanity check” as to accuracy, and avails itself to analysis that is meaningful. In the end, construction is a business of risk management. The better the information and its use, the better the “intelligence”, and the better the intelligence used, the better the profit results.

Know what gross profit should be. In keeping with the previous section on “mirroring the estimate on your financials”, the next step is utilizing percentages. Know your gross profit percentage on revenue after direct costs of labor, materials, subcontractors, equipment rentals, permits, etc. If you own a service company, your gross profit is based on your real profit on labor after payroll added costs and costs of non-productive time planned, and your gross profit on parts and materials based on your mark-up is the combination of the relationship between labor and materials planned gross profit percentage compared to your actual gross profit percentage. Variances for all industries are non-billed labor hours from overruns and excessive non-productive time or overtime, missed change orders, missed parts/material billing and estimating mistakes are mitigated by material buy-out gains.

A business decision made by any person working in your company must be an informed decision based on the experience and savvy of the person, and the decision needs to include the following four points before acting upon. The absence of any of these four points will undermine the probability of a positive result and ultimately create “anarchy” in the business decision making process, because each person will incorporate their own standards of what “good” is to them. The four points are:

Support the company’s stated goals of profit and sales growth. Whether at the level of the job estimate, service contract, engineering budget, design budget or service call, all employees who make decisions must consider whether or not this intended action will move the company closer to achieving their stated revenue and profit goals as understood at the level of the person making the decision. The absence of this step creates a separate little business within your company, run by each person who doesn’t follow this step. You do not want your financial life created by the uninformed decisions of others!

Be consistent with the “customer promise” of the business. At each level of “customer touch” within your company, each person must know the specific commitments made to the customer. The promise should be written and presented to the customer so that “pictures” or “expectations” are commonly agreed upon and communicated throughout the organization that interacts with the customer. Time/schedule, change orders, follow-up, written communications processes, payment terms, warranty, and intended results should be known and reinforced at each level, with the practical input of each level of employee customer interaction. The promise is simply the agreed upon standard you set with the customer. If the customer perceives it to be different, depending with whom they interact, you can be assured of a problem impacting your revenue, profit, and reputation.
Be consistent with concepts of teamwork and inter-departmental “customer”. Be sure that the decisions you intend to make include the resulting impact upon the other departments affected by the decision. Get their input. The decision may be good for one area and not for another. The ‘bottom line” on this one is, don’t “kill” someone critical to your business by not letting them know what you are about to do.

Ensure that the decision or action meet “compliance” or regulatory requirements of your industry, federal tax code, and state and local standards. This may seem like common sense, however, the issue is to prevent not knowing a potential problem with some regulatory body. Simply get a sanity check where appropriate, within the company. Whether it has to do with taxes, or the hiring of a fake-documented (for workman’s compensation insurance) subcontractor, or illegal aliens, or local/state regulations, simply ask the question to someone who should know the answer. Do not accept “I don’t know” for an answer.

Knowing your cash needs beyond today is another way of saying “Cash is King”. If you have a basic plan of how you make money with accountability links, then cash planning will become your guide to success. For every client we engage, we establish a business plan that represents the “translation” of the revenue and profit plan into cash flow planning to make it “real”. The plan answers many questions such as: When are large expenditures due? Does the bank line have to be cleared for 30 days each year? Is principle reduction on debt larger than depreciation, or visa versa? What are the expected and manageable terms of our revenue billings? What can be done to increase cash now and each week? Many of our new clients are “profitable” but cash poor. Beyond the clear changes they need to make to increase their profit, cash must be addressed up front for each, or it is all just paper money.

Knowing how to manage to the needed cash flow is essential. Just as each of you manage a job, service contract, or service call to ensure labor and material control and accuracy in billing, so too must cash be managed. You must resolve disputes rapidly, contact companies owing you money a week before it’s due to address any needs and confirm the payment date, let them know you care, are on top of your billing/collection process, and that you DO manage cash at your company. Be the “squeaky wheel”, or you will not be paid first. GET IN LINE NOW AND STAY THERE. Watch how quickly your “days in receivables” drops, simply by having a proactive process which involves a clerical position and a team that works for and services the customer.

Don’t hide inefficiencies in your equity strength. Many “old line” companies have large equities and strong cash flow. That position was often described as “idle cash”. Most companies like that are profitable each year, but when analyzing the components of profit, they are often dramatically under performing. When you add up interest, dividend income, purchase discounts from early pay, cash discounts on quantity purchases (because the company has “the cash” to negotiate), and negligible interest expense (because the company doesn’t have to borrow), you reduce the actual profit by that total. Add to that total an “S” company that pays dividends to the active stockholders even though their salaries are below market, the total artificially increases profit. I’m not suggesting changing the strategy of Dividends versus Salary, but don’t be fooled by the Profit and Loss results.

Know what accountability means. In very basic terms, accountability means that every critical employee knows specifically, the minimum that is expected of them each day; that their job performance is relative to the profit and sales of the company, is measurable and therefore objective to results; that the measurement is communicated to them regularly; and that their ability to exceed the company standards will impact how much they earn each year or, if performance is a standard, that they may lose their job. Standards and measurements can be developed when revenue is planned and controlled, when a plan of sales, gross profit, labor productivity, schedule, material controls, general conditions, overhead and profit is linked to what employees actually do every day, week, month and year.

Know what accountability means to sales and profit. The process of lead generation, selling, estimating, pre-construction, buy-out of materials, labor scheduling, labor productivity, project management, dispatching, parts, tools, vehicle, materials usage, job costing, punch list, post job completion reviews and marketing is linked to the selling and profit making process. It does not matter whether the standard of performance is specific to a sold job directly or to an office support function. If employees are clear about their job expectations and the measurement of their performance, and they accept that they can do the job defined for them at the standard of performance required, then accountability can and will exist when routinely managed.

Learn to manage accountability to attain it. Managers are accountable to the results of their managed processes and to those who report to them. Managers must communicate with their employees, support their achievement of planned results and get out of their way of doing their jobs. Also, the employee standards linked to the profit and sales plan of the company must be clear to the reporting employee. Managers become a resource to their employer and to the people they manage, as long as they have critical measurements available in a timely and accurate process with proactive communications of great work, problems, or potential problems provided to the company. Standards and results make the company work. Attaining “accountability” does not mean there are no problems. In construction, there are potential problems every day. Accountability mitigates problems and their effect on profit and sales. Accountability creates an open process of preventing the same mistake being made over and over again. Accountability saves the cost of those problems due to someone not knowing, not being sure sure, or not wanting to say that the problem was a problem.

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.