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Accounting - Benchmarks provide contractors valuable path to improvement

image Ryan Rummel, CPA, Manager, RSM US LLP, San Antonio, TX

SAN ANTONIO - In today’s highly competitive construction market, it’s not enough for any contracting business to be just good enough. To stay ahead of competitors, a contractor has to work continuously to get better. One of the most effective ways to do this is by means of benchmarks that track how well the contractor is doing compared to others in the industry.

 

 

   While benchmarking has been used to some degree in the construction industry for many years, interest has surged in recent years because of the availability of national performance data. This information allows companies to more easily measure their performance and set targets.
    Today, construction companies can find a great deal of useful benchmarking information from organizations such as the Construction Financial Management Association (cfma.org), Associated General Contractors of America (agc.org) and Construction Industry Institute (construction-institute.org). These organizations conduct annual financial surveys, and most break the information down by region, specialty, company size, etc.
    One of the easiest ways to find benchmarking information is to go to www.financialbenchmarker.com. The site is a treasure trove of industry benchmarks.
    For contractors who are not actively using benchmarks, a great way to learn the process is by talking to colleagues experienced in the process. Assistance is also available from financial partners and sureties, who are particularly interested in benchmarking data because they are providing loans and bonding.
    The basics of successful analysis are fairly simple: Contractors choose important functions and practices that can be tracked over time, then use the data to measure their progress against that of competitors, including best-in-class companies.
    Setting up benchmarking documentation, including charts and graphics, is much easier than in past years. On the market today are several software packages that allow contractors to easily establish, update and analyze benchmarking data. Most can be found by means of a simple internet search.
    When beginning the benchmarking process, contractors should first prepare a financial analysis of the company. For best results, and to make certain accounting and tax issues are taken into account, contractors should seek assistance from their certified public accountant.
    When developed properly, benchmarks can give contractors a revealing new perspective on long-time practices. In doing this, they offer a valuable guide to weaknesses and opportunities. If, for example, a contracting company learns its debt-to-equity ratio is rising, this tool can alert the company early on so it can bring debt back in line.
    So that benchmarking works to optimal benefit, the best construction companies review their data at least monthly. Trends that show up in the data are addressed quickly, either to improve newly discovered weaknesses or to accelerate strategies that are showing the most success. 
    When it comes to choosing ratios, there are scores contractors can use. However, there are a few that are most popular, including:

    •    Working Capital Turnover: This ratio is a product of total revenues divided by working capital (the net of current assets minus liabilities) and indicates the amount of revenue being generated by the available working capital. A ratio exceeding 30 may indicate a need for additional working capital to support future revenues.

    •    Current Ratio: This measurement indicates the extent to which current assets are available to satisfy current liabilities. They usually are stated in terms of absolute values (i.e., 2 to 1 or simply 2.1). Generally a minimum current ratio is 1, which indicates that current assets at least equal current liabilities.

    •    Debt to Equity: This ratio equals total liabilities divided by total equity. The higher the ratio is, the greater the risk the creditors are assuming. Generally a ratio of 3 or lower is considered acceptable.

    •    Profitability Ratio: This measurement demonstrates the profit generated by the total assets employed. A higher ratio reflects a more effective employment of company assets. This ratio is generally stated in terms of percentages, such as 10 percent of return on assets.

    •    Days in Receivables: This indicates the number of days to collect accounts receivable. A lower ratio indicates a faster collection of accounts receivables, therefore more liquidity. In general, a ratio of 60 days or less is desirable.

    •    Days in Payables: This ratio indicates the number of days it takes to liquidate trade payables. Usually a ratio of 45 days or less is considered adequate.

    •    Months in Backlog: This measurement tells managers the number of months it will take to complete all side or committed work. A ratio of less than 12 indicates a need to secure new contracts in the next year to maintain a constant level of annual revenue.

    •    Under-billings to Equity: This indicates a level of contract volume being financed by the stockholders. Usually stated as a percentage, a ratio of 30 percent or less is considered acceptable.

    •    Backlog to Equity: This ratio indicates the relationship of signed or committee work to total stockholders’ equity. In general, a ratio of 20 or less is considered acceptable.

    Whether a contractor uses general or highly technical benchmarks, information derived from the process provides a valuable map for improvement. And it makes decision-making dramatically easier in an industry ruled by tough decisions.
    But for any of it to work, the contractor must be willing to change and adapt based on the findings derived from the process.

Ryan Rummel, CPA, is a manager at RSM US LLP in San Antonio. He can be reached at 210-828-6281 or Ryan.Rummel@rsmus.com.


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