The construction industry is perhaps the best example of an industry built on firmly held but largely unexamined beliefs. Most contractors I have worked with over the last 30 years believe that: top line growth in sales is always good; their company can build anything; owners will pay when it suits them; capital is just an entry on a useless balance sheet; and, if estimators and project managers do their job, profits will follow. I have made it my career to examine these (and many more) widely held construction industry beliefs to see if they are true. To sum up the results of my research I might say simply that they are ALL – FALSE.
A Closer Look at Construction Industry Beliefs
We might call the ten beliefs below the Top Ten. They are all false and, for that reason, lead to risky business decisions.
- Contractors sell finished building projects for a contracted price to ultimate owners. (This is a misperception of the service a building contractor provides.)
- Low-bid acquisition is the way the construction industry does business.
- Revenue growth is more important than individual project profitability. (Nothing is more important in any business than profitability. Profit is the sole purpose of business activity.)
- Because multiple jobs evolve at different paces, it is difficult if not impossible to determine either individual project or company-wide profitability on an arbitrary cutoff date. A guestimate is the best we can do when preparing financial statements. (The way Generally Accepted Accounting Principles are applied in our industry, uses estimated rather than hard financial data.)
- The balance sheet is only a derivative of the income statement and not a useful management tool. (The balance sheet is perhaps the most important management tool when used to evaluate the financial condition of the company and uncover trends that could lead to more profit.)
- Owners and their designers, not contractors, decide how much each progress payment will be and how promptly it will be paid. Contractors can only submit invoices and “attempt to prove” to owners that the amount is an accurate reflection of work completed and due upon receipt. In other words, every progress payment is contingent and depends on the whim of the owner.
- Retainage is a necessary evil used to protect owners from incompetent and unscrupulous contractors. (Retainage is a punitive concept that costs contractors a share of their rightful profits.)
- Because you don’t know where your next job is coming from, business planning is largely an academic exercise. (Not knowing what your next job will look like is the very reason a business plan is a critical tool for managing risk.)
- We can build anything. (Only experts make money.)
- Growth is always good. (Growth is only good when the company has the capacity to execute new work for a profit.)
Beliefs Re-examined
Adhering to the beliefs above increases contractor risk and reduces profit. This week let’s reexamine the first three a little more closely.
- Contractors are not selling physical assets. Contractors are service providers who are selling their company’s construction expertise. Reputation should be the only determinant of price.
- Low-bid acquisition is the contractor’s death knell. It became standard industry practice when decades ago the State of New York passed a law requiring open bidding on all public projects to prevent unsavory politicians from taking bribes for awarding work. The more recent trend is away from having to select the low “price” bidder and factoring in reputation to identify the low “cost” and best contractor for the project. Tend to your reputation and success will follow.
- Accurate work in progress accounting has always been a problem in determining accurate monthly construction company profitability.
- If the revenue cutoff does not match the expense cutoff exactly, the mismatch either understates or overstates ongoing company profitability.
- Unfortunately, the “percent of completion” of a project that determines the amount of a progress payment is estimated by the owner’s representative.
- Because revenues are recorded as progress payments are made, matching it to expenses, overstates or understates profitability as projects go along.
- This “guestimate” accounting is the method used to create construction company monthly financial statements.
The industry should implore the Financial Accounting Standards Board to take a closer look at this accounting method and come up with a more “hard data” work-in-progress accounting methodology. Improving this accounting methodology would encourage banks, capital markets, sureties, and contractors themselves to have more confidence in monthly construction financial statements. That confidence would go a long way in opening capital markets to the construction industry and would motivate contractors to utilize their financial statements to manage their business more effectively.
Next week we’ll take a closer look at the next three “bad” beliefs. See you there.
For more information the role of effective accounting practices, read more at: ACCOUNTING
For a broader view on financial management, read more here: FINANCIAL
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Please circulate this widely. It will benefit your constituents. This research is continuous and includes new information weekly as it becomes available. Thank you.
