Co-authored by Ross Emerson, CPA
While the U.S. economy continues to improve, contractors must carefully watch their bottom lines. This means keeping track of how increases — or decreases — in profitability can affect your construction company. The following are ways for your company to maintain its profitability.
Review your overhead
“Overhead” or “indirect costs” — expenses that aren’t directly related to your projects — are easy to ignore. Examples of indirect costs include:
Other indirect costs include small tool, fuel and supply, and freight charges. Taxes, title transfers, permits, bonds and job insurance, and shop and marketing costs are all typically considered indirect costs, too.
If your construction company fails to properly allocate indirect job costs to projects, you’re missing out on opportunities to recoup expenses and submit accurate bids. So how can you reduce these costs? Analyze indirect costs and their relationship to your operating results. This can help you determine which costs are fixed, which are variable and which are a little of both.
Changing fixed costs can be tough. Try negotiating with your lenders, landlords, utility providers and others you regularly do business with. Look to trim variable costs by cutting out (or down on) unnecessary expenses.
Once you’ve done this, construct a budget for indirect costs to plan for the coming year. Regularly compare your budgeted amounts for indirect costs with your actual spending. If you’re going over budget, look for ways to cut back.
Manage receivables and payables
It’s easy to take for granted the management of construction receivables and payables. You do the construction work, generate an invoice and send it out. Bills come in and you pay them as appropriate.
One receivables strategy to consider is front-loading contract billings. Generally, this involves shifting some profits into earlier phases rather than applying a flat rate to all phases, as is normally done. But don’t be too aggressive; overbilling can alienate your owner or general contractor, which can cause problems down the line. But, when done properly, this strategy can help you collect some of your profits before the retainage is paid on completion.
What if you’re experiencing a cash flow shortage? If you’ve always paid vendors within 30 days, consider extending your payment cycles. Ask for a break from your creditors to help you handle the cash crunch and deal with cost overruns. Just as you’re sometimes flexible with parties that owe you money, creditors may be willing to work with you.
Control change orders
Make sure to address change orders properly. Doing so can help protect and even bolster your bottom line. This means that you need to know your contract so you can quickly identify a change and how it differs from the original agreement.
Take the time to review your change order system. Having a written, signed and authorized change order that will get you paid requires careful recordkeeping. Maintain daily reports, project correspondence, meeting minutes, schedules, cost records, photos and other documentation to help indicate an operational change.
Finally, provide written notice and an explanation of how your revised work will affect the schedule and delivery date. Include a date on the notice to prove you gave owners plenty of time to adjust to the associated costs. Following these steps will help increase the likelihood you’ll get paid for the extra work and avoid costly contract disputes that can affect both the bottom line and relationships with job owners and general contractors.
The bottom line
As with any business, having a healthy bottom line is crucial for contractors. You may already be implementing some of the concepts here, and it may be time to start others. If you are having trouble identifying your strengths and weakness in any of the above areas, try consulting with your financial advisor, or give us a call to see if there are areas for improvement.