“A rose by any other name would smell as sweet.”
As most of my readers I am sure will testify, I don’t often quote Shakespeare. But the confusion around the word profit in the construction industry has driven me to desperate measures. What do we mean when we speak of profit? Ask ten different construction professionals and you will get ten slightly different answers. Some have lost track of project profitability.
Surprise is No Surprise
Last week we talked about the surprise everyone concerned experiences when companies fail mid-project because they had run out of working capital. Years ago, I was surprised by their surprise and began to research why they were surprised. I discovered that the lack of attention to project profitability has its roots deep in the construction evolutionary process.
A Brief History
Most construction contractors start as a one-man shop or a small family business. They have just enough money saved up or loaned by relatives to get the first job going and then beg, borrow, or steal to survive long enough to collect front money from the next projects to continue in business. This method of capital financing continues unchanged until the company achieves critical mass enabling it to borrow sufficient working capital from local banks.
Earnings from completed projects are routinely removed from the balance sheet by investing in capital equipment or distributions to the owners. Rarely is any cash retained on the balance sheet to accumulate working capital. Many contractors feel that any cash left in the company is at risk and should be removed or invested. Since they were able to get by in the past with limited money, they see no reason why they cannot continue in the same manner.
The Business of Construction Contracting
As stated in the recently released new book, The Business of Construction Contracting, Thomas C. Schleifer, Aaron B. Cohen, Wiley, 2025, pg. 143,144: Unfortunately, the accounting practices required in construction companies can be complex, and the practices become more complex as a company grows. As the volume of work increases, so does the size of the payments received for the work, but so does the cost of the work and the size of the infrastructure (people, facilities, and equipment) required to complete the work. As the money flowing through the business increases, profit margins on larger contracts become smaller, and it is easy to overlook the erosion of profitability and the business’s overall net worth…
What is worse is that accounting for work in progress is based on estimates, which can be highly subjective. Nevertheless, accounting for work in progress is the most effective accounting method for construction businesses in which a significant portion of revenue during a fiscal year is composed of work in progress. But for the accounting to be accurate it needs to be widely understood by those in the company who contribute to the input and estimation of work in progress, and the entire accounting process needs to be closely managed by the executive team.
Musical Chairs
Revenue in construction is largely progress payments from multiple overlapping projects. The point-of-sale cut-off dates and the exact matching of expenses is not definitive. Because work in progress profit is difficult to calculate and sometimes uncertain, they are replaced by the importance of cash flow. If there’s enough money coming in to meet ongoing expenses, we are comfortable that the overall business is chugging along fine. We then begin to focus on growing the money pool to keep up with growing overhead by taking on bigger and bigger projects so more cash is moving through. We begin to play musical chairs and trust that as long as the music is playing no one will be left without a chair.
Without A Chair
But inevitably the music stops. The market slows, new competition puts pressure on pricing, a labor shortage inhibits performance, a new administration is elected, or the business climate takes a turn for the worse. Market variables limit top line growth, and the cash pool begins to shrink. If too many of the recent jobs are not as profitable as planned, and we have not retained past earnings on the balance sheet to build up capital reserves, the company might be in for a big surprise. When the music stops, there is no chair for the company to sit on.
Profit, Profit, Profit
Job-by-job profitability is the only source of capital reserves available to construction enterprises. Aggressive top line growth, extending supplier payments and bank lines of credit are not capital. Only owner’s equity and retained earnings are true capital that can be relied on when markets turn down. When the music stops, profit is the only chair available.
For more information on working capital, read more at: CAPITAL
For a broader view of the profit, read more at: PROFIT
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.
