Nasty numbers on Financial Statements
Financial statements show not only where a construction company stands financially, but also where it may be headed. Contractors who work with their financial advisors to analyze their statements can often catch problems early on before they turn into bigger issues. Here are eight red flags to look out for when reading your next statement:
- An accumulation (or lack) of cash. A strong cash flow is one of the hallmarks of success. But the key word here is flow. A static reserve of cash can be a sign that your backlog is dwindling and you’re running out of work, leading to a stockpile in the cash column.If you find yourself drawing on a line of credit when payments for a given project are slow in coming, you could also be headed for trouble. A construction company should always be in an overbilling position on a job. If underbilling is occurring, ask your financial advisor to perform an over/under billings analysis to get a handle on this dilemma.
- Declining equipment value. Slow periods in your business can lead to an unnoticed decrease in your equipment’s value and force greater spending down the line. You may be tempted to think that, because your assets aren’t getting as much wear and tear, they’re maintaining their value.Annual depreciation continues to steadily do its work on your assets. and you’re not buying replacement equipment at current market prices.
- Significant liability changes. Substantially changing liabilities warrant a close look. If your profits are dwindling, for example, certain liabilities may shrink as well, such as payments to profit-sharing plans or deferred tax liabilities. On the other hand, liabilities can balloon if you take out a loan to keep your construction business afloat.
- More current liabilities than current assets. Because many contractors have seasonal swings in their businesses, you may have more bills to pay than cash on hand at one time of the year or another. This is something worth tracking and planning around.
- Shrinking gross profit margin. Your gross profit margin is equal to your building costs for a particular period, not including overhead, payroll, taxes and interest payments, divided by your sales revenue for the same period. If this ratio is dwindling, it means your production costs are rising more quickly than your prices, or you’re charging less for your construction services (perhaps in an attempt to gain market share).
- Increasing ratio of general and administrative expenses to profits. General and administrative expenses, such as rent and utilities, are less “elastic” than project expenses, such as labor and materials. Thus, the ratio of these expenses to profits will skyrocket if your workload sags. Keep an eye on indirect costs, such as insurance; if the amount of these rises significantly, it’s often because you have fewer contracts to allocate these expenses to.
- Receivables growing faster than sales. If your receivables start to dwarf your actual sales, beware. It may be a sign that customers are taking longer to pay their bills or not paying at all and that it may be time to rework your collection procedures.
- Far-off or unprofitable future projects. Although you may take comfort in the sight of a lengthy project backlog on your financial statements, remember that not all projects are created equal.
Ciuni & Panichi, Inc. has a dedicated team of construction experts. Please contact John Troyer at 216.831.7171 or jtroyer@cp-advisors.com for additional information and with any questions you may have regarding your financial statements.
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