The instrument rated construction company financial management that we have been discussing these past few weeks is not simply a metaphor. Most of the contractors that failed mid-project when my company was completing construction projects for sureties were surprised that they had suddenly run out of cash and could no longer continue operations. In one instance, I witnessed a contractor punch his accounting manager in the nose when he learned he was broke. His company didn’t have the cash to make payroll or pay subcontractors, and he had no idea he was about to go out of business.
I Couldn’t Believe It
I was the consultant that sureties sent in to investigate failing businesses and complete the interrupted projects. I couldn’t believe what I was experiencing. Competent contractors who had been in business for many years, some for decades, did not know what their company’s cash position was with any degree of accuracy. This simple lack of accurate information was dangerous enough to put thousands of contractors out of business. That shocked me.
It’s the Nature of the Business
One of the causes of this dramatic financial oversight is that we (contractors, sureties, bankers) do not have enough respect for the daunting complexity of the construction business. Since most of us started our business with very little money and made good, often beyond our wildest dreams, we don’t see the contracting business as requiring anything beyond some construction experience and a good dose of common sense.
BUT – What a Complex Business!
A construction project is an algebraically complex business transaction.
- Even the simplest project requires the coordinated efforts of a team of skilled professionals and trade people.
- The working drawings are turned over to estimators who attempt to set a profitable future selling price before their company has even built the product. The jury is out on the final cost of a project often for a year or more until the project is completed and accepted. (It would be nice to know the cost of the product you’re building before you set the selling price. In construction, it’s the other way around. You estimate the cost, set the selling price, then learn the true costs after the project is complete.)
- Every new project is like going into a new business. New geography-new plans-new team of subcontractors-new inflationary cost environment – new local regulations – and on and on.
- Since the final selling price is preset by contract, it’s tough to tell if a project is functioning profitably as it is being built. Contractors can only estimate how much revenue has been earned each month and attempt to calculate the costs that apply to that portion of revenue.
- Every project assembles a new team of highly skilled trades. The land clearing team turns the site over to surveyors, heavy equipment operators, crane operators, iron workers, masons, cement finishers, scaffolding erectors, and carpenters. Even more trades on building projects such as: plumbers, welders, electricians, painters, HVAC technicians, and on and on. Coordinating the activities of all these highly skilled and independent trades is a daunting task that is never a sure thing. If only one of these trades fails to stay on schedule it throws off the entire project.
- Finally, all these contractors are required to finance the project all along the way. This puts the builders into the role of bankers, and an entirely different set of financial skills is required to operate a bank.
Instrument Rated
I have been using the analogy of “instrument rated” piloting these past few weeks to impress on readers how vital it is to see their complex business as requiring a team of highly skilled business specialists to bring the company in for a soft landing. To avoid ending up like the contractor whose last official act was to punch his accounting manager, contractors must take the following steps:
- Hire a competent CFO and elevate that position to the senior level in your company.
- Have the CFO familiarize you with the proper management use of the traditional financial statements: P&L, Balance Sheet, Statement of Changes.
- Be certain your CFO uses the Direct Method of compiling the Cash Flow Statement (Statement of Changes.)
- Have estimators learn from your CFO to ensure that they follow accounting principles when preparing estimates. Accuracy is critical at this stage.
- Watch cash flow weekly. Have your CFO prepare a weekly cash report using the direct method and review it with them every week or whenever necessary.
Next Week
Next week we’ll discuss the proper use of the three traditional financial statements and how to make decisions in advance to avoid risk. Don’t let this accounting class tire you because you are in the industry with the second highest failure rate in the nation. This information is critical to your continued financial success.
For more information on the construction business failures, read more at: FAILURES
For a broader view of the role of the CFO, read more at: CFO
To receive the free weekly Construction Messages, ask questions, or make comments contact me at research@simplarfoundation.org.
Please circulate this widely. It will benefit your constituents. This research is continuous and includes new information weekly as it becomes available. Thank you.
