The Flash Report
Last week I highlighted the critical day-to-day usefulness of liquidity ratios in alerting a CEO that he might be flirting with financial difficulty. Today I would like to back up and take a look at the bigger picture – the CFO’s critical role in helping manage a construction enterprise.
The CFO is to produce timely, accurate, and useful financial information and statements. He or she is a critically important member of the top management team. Way more than just a bookkeeper, which some treat them as. They don’t need to have expertise in engineering, design, or marketing and certainly don’t have to maintain a single digit golf handicap. They do need to produce timely financial information and statements that you can rely on and utilize in day-to-day decision making.
Many construction industry managers view financial statements as documents they need only to send to their bank and surety. Too many do not see them as the critical management tools they need, however, timely and accurate financial statements, interpreted correctly, are analytical and diagnostic devices that no CEO should be without. They provide a deeper insight into the company’s current status and future prospects and offer you a view of your company from three different perspectives:
- LOOKING BACK– With careful scrutiny, the financial history of a company reveals both positive and negative trends that are not otherwise readily apparent to management. Construction companies go out of business gradually, not suddenly. If management can see the trends (positive and negative) that their day-to-day decision-making produces, they can alter course and produce more positive outcomes.
- LOOKING AHEAD – As we described in our discussion on the use of liquidity ratios last week, certain financial ratios can alert management to impending danger or affirm future prosperity. They render management clairvoyant by informing them of what they can expect in the future if they continue to do the same thing they have been doing in the present.
- LOOKING SIDEWAYS – We recommend to our clients that they utilize a program of financial “benchmarks” by comparing their financial ratios to the industry at large and to their competitors. This “sideways” look verifies efficiency, productivity, and financial stability when compared to other successful firms. Deviation can alert management to problems they may otherwise overlook.
Examples of Useful Financial Ratios
- Solvency Ratios like the Current Ratio measure the extent a business can cover its current liabilities with those current assets readily convertible to cash. We recommend a ratio above 1. to 1.
- Collection Period is helpful in analyzing the collectability of accounts receivable or how fast a construction company can increase its cash supply.
- Known as Key Performance Indicators, certain ratios help reveal trends in past performance and therefore can predict future outcomes.
- Gross Profit,for example, clearly tells management if their bidding and execution are professional and efficient. We need to achieve a minimum gross profit a few or more points over general and administrative costs. Anything less probably means that as you progress through a project, you are using cash rather than providing cash. That is a trend that will gradually put you out of business if not detected and corrected.
- The Overhead Ratio as a percent of gross revenues should be charted over time to measure staff efficiency under varying market conditions. A sharp CEO knows that if he or she is profitable at a given volume at a certain overhead ratio they need to be able to maintain that percent in up and down markets (see blogs on flexible overhead). As the company grows the overhead ration should be reducing. If it increases profits suffer. One problem is that management is not informed aware of this key performance metric until the end of the year when corrective action is too late.
- Benchmarking can be applied by an organization to measure and compare performance against results from industry standards for the purpose of identifying the strengths and weaknesses in performance, then using lessons learned to determine best practices that can lead to superior performance when adapted and implemented.
The Flash Report
Traditionally, performance metrics and financial ratios were seen as a “report card” at the end of the year for the board, the banker, and the surety. Even though construction industry top management may be aware of these metrics, they must be produced on a timely basis to be used as an effective management tool. We recommend that the CFO of every construction concern, both large and small, be required to produce performance metrics on a monthly basis and, if necessary, on a weekly basis in the form of a what we call Flash Reports for management. Once the CEO understands the usefulness of each ratio and metric, he or she will require a one-page report on a timely basis (weekly or at the very least monthly) so that they can constantly monitor their company’s performance.