The construction business is one of the most complicated enterprises in the world. Is the valuation based on current projects, past projects, or future projects? What is the “Sales-To-Total Assets ratio? There is so many variables in this business it is surprising that many knowledgeable contractors tend to use their “gut feelings” as a barometer for performance and are surprised to find out they had run out of cash. For the bumpy road ahead in 2023 and 2024, a savvy contractor will need to utilize their CFO and pay attention to their financial reports.
Construction projects are high-risk, highly complicated endeavors. Successful contractors are risk-takers capable of juggling multiple projects while motivating a highly dynamic workforce. Low-bid acquisition imposed by the government to combat its own corruption has disrupted the industry’s pricing process and eroded profit margins. Jack Welch, former CEO of GE, and an engineer by training, when asked about his success, replied that the application of scientific principles was the only road to success. Thirty years of research by the author of this blog has shown this to be true time and time again. The question then becomes how do you get there, from here.
Industry prognosticators are predicting a slowing of the construction market in 2023 and possibly beyond. This “slowing” may actually be a flattening and many contractors, in order to keep the cash flowing are bidding on more and more projects with less and less room for profit. Couple this with an 15% or more increase in wages and materials and what is left is a recipe for disaster. To withstand the disaster, construction professions need to “manage for profit” not “manage for growth.”
The construction business does not fit the traditional management theory taught at all the nation’s prestigious business schools. The construction business is performed through a partnership of independent specialists over which there is limited control by the contractor. When the top line growth chart slants downward, the contractor can rarely trim overhead fast enough to maintain profitability. This peculiarity within the construction business give rise to the concept of “Flexible Overhead.”
Contractors rarely have enough cash on the balance sheet to see them through down markets, particularly if banks pull back on their lines of credit which happens in market downturns. Borrowing against receivables shrinks to a trickle with less new business coming in and the common practice of front-loading payment requisitions drains cash out of ongoing work so the cash crunch can happen almost immediately upon a market downturn.
To paraphrase Rudyard Kipling…” If you can keep your head when all of those around you are losing theirs…” this has never rung more true than today in this economic downturn. Will you grab up every job available whether you have the manpower or experience? Or will you sit back and enjoy a brandy and engage in some strategic thinking?