CONSTRUCTION Accounting ARTICLE -Key Financial Measures for your Construction Business

Target Audience: Construction Industry Professionals, Business Owners, Project Managers, Contractors, Construction Accountants

The rough economy and its slow recovery have been frustrating for many contractors. But it’s also been a reminder that the construction business, like many professional sports, is a game of adjustments.

As your local market picks up or slows down, you need to know exactly where you stand financially to reasonably decide whether to move boldly forward or pull conservatively back. And when it comes to determining your financial standing, the more accurate and precise you are, the better. That’s where certain key financial measures come into play.

Calculating your Return on Assets ROA

Your construction business is very much an investment, so it’s important to keep tabs on how (or whether) that investment is paying off. To do so, you can calculate your return on assets (ROA), which indicates how profitable your company is relative to its total assets. To calculate ROA, divide net income before taxes by average total assets. The higher the ROA, the better, because it shows that your assets are being used effectively to generate profits.

For instance, a commercial roofing contractor earns a net income of $800,000 and total assets of $3.5 million, for an ROA of 23%. A competing company earns the same net income but has total assets of $5 million for an ROA of 16%. Thus, the first company is better at converting assets into profit.

Another “return” amount to look into is return on equity (ROE). ROE tells you how efficiently your construction company is managing its assets and generating a return to your shareholders. The calculation: Divide net income by shareholders’ equity.

For example, say you’re a general contractor with $600,000 in net income and shareholders’ equity of $5 million. Your ROE would be 12%, a pretty low result. For this or any other metric, you need to work with your construction accountant to get a sense of how your company compares with similar construction businesses.

Examine your Asset Utilization and Working Capital

We mentioned assets in the ROA calculation above, but it’s important to look deeper at your asset utilization as well as your working capital.

One way to look at asset utilization is to determine your fixed assets to total assets ratio. To calculate this you should divide total fixed assets — construction equipment and company computers, for example — by total assets. (Appraising your assets is a subject for another article. Check with your CPA on the best way to do so.) A high result could indicate a disproportionate amount of your company’s funds are tied up in fixed assets, which means your business may lack the liquidity needed to fund current operations.

For your construction company’s working capital, calculate current assets less current liabilities. Your working capital turnover ratio measures how much revenue is being generated from each dollar of working capital available — to calculate this ratio, divide sales by your working capital.

Generally, the higher your working capital turnover, the better, because it means your construction business is generating more sales compared with the money it uses to fund those sales. Too high a ratio, however, may indicate that you’re overextended and may have difficulty paying bills from time to time.

Debt-to-equity ratio

In a difficult economy, your debt can have a major impact on your ability to effectively do business. So another key metric to consider is debt-to-equity ratio, which measures your company’s ability to borrow and repay money by dividing total liabilities by shareholders’ equity.

Lenders look closely at this number because a high ratio may jeopardize your potential to repay loan payments. Sureties will also look at debt to equity when making bonding decisions.

Getting a clear picture

When times are tough, it’s easy to put your head down, work as hard as you can and hope things turn out right. But, financially speaking, you’re better off getting a clear picture of how your construction company is performing to better ensure that any forthcoming surprises are pleasant ones.

Find out how our expertise in construction accounting can add value to your business. Email us or call us at 1 (888) 875-9770.

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