Running a successful construction business in the somewhat dog-eat-dog world of the sector isn’t easy. It’s a tough market to compete in at the best of times. Over the next 12 months we’re likely to see many smaller and medium-sized contractors facing some big challenges.
So, how do you set the right foundations for a stable, well-funded and profitable business?
Matthew Thorpe outlines the four cornerstones of a successful construction business and how they set you on the road to success.
1. Cost clarity and understanding your fixed overheads.
In the construction industry, having clarity around your costing is vital. This is especially true when it comes to your fixed overheads and the underlying costs associated with each job.
For example, if you bring in a project manager, your charge rate for this person likely includes their salary, benefits, car cost and all the sundry costs of employing them – and this all comes out of your gross margin on the project. The issue is, if a project closes down for a few weeks, or you have a gap between one job finishing and another starting, you still have to pay all these costs. Without a good handle on these costs, things can quickly spiral during a down period.
If you ask most people in construction what their fixed cost base is, they will give you the number that’s in the company accounts for overhead. But that isn’t your fixed cost base. You’re absorbing a huge amount of fixed cost through staff recharges and prelims on projects.
When the company’s trading and the wheels are turning, that’s all fine, but when things stop, like they did during the COVID-19 shutdown, it gets tricky. You still employ these people and have the same contracts, insurance payments and costs to cover, even if they aren’t working.
You need to know your true list of fixed costs:
- What are you committed to paying when it comes to overheads?
- What are your total staff costs, including site staff?
- What is the true cost of all the benefits and sundries you build into staff charge rates?
- What is a more realistic fixed cost base number?
If you don’t keep tabs on this fixed cost base, you can very quickly come unstuck.
Most contractors have a target for overhead as a percentage of revenue; many become fixated on it. It’s very easy to lose focus on the true, underlying costs your business is committed to when your focus is on absorbing costs ‘above the line’ to keep an overhead percentage low. Often when times get tough, overhead will spike at exactly the time you need to cut it as costs that are usually absorbed by a project, are dropped into overhead during a downturn. It’s this lack of understanding the difference between overhead and base cost that causes so many companies to struggle working out necessary cost reduction plans, even in the challenging times that we now find ourselves in.
It’s like going through your personal finances to make sure your salary covers your monthly spending, in a way. You need to include everything in that number and provide yourself with a more realistic and practical project budget to work with.
- Review your costs and get proper clarity.
- Streamline your spending and aim to bring that base cost number down.
2. Strong Cost Value Reconciliation reporting system
Cost Value Reconciliation (CVR) systems are critical in construction. CVR means looking at the financials of each project, using the relevant cost codes and understanding what’s being spent on each particular job. This includes accruing for costs incurred but not invoiced and looking to the end of the project for the likely total cost and contract sum. With so many twists, turns and variations over the life of a project, keeping the financials high on the project teams agenda will ensure you have accurate expectations about its outcome all the way through.
If you rely solely on what’s in your accounting system when planning your project costs then, frankly, you’re taking your chances. By looking at your accounts, you only have the approved invoices and accounted-for costs to work with, not the real project numbers. As any quantity surveyor will tell you, the project costs will very rarely tally with what’s in the accounts until three months after PC!
By the time you go through the application process, deal with queries, issue pay less notices, raise certificates and make payments; the information in your accounting software is likely to be two months out of date, on average, which isn’t helpful and doesn’t give you a good base for making decisions.
There are enterprise-level CVR software systems, but most companies still use Excel-based spreadsheets to do this, because they’re flexible and easy to customise. In essence, it’s about downloading everything out of the head of the project manager and site foreman etc. and getting every single cost logged and included in your calculations.
CVR is what quantity surveyors are trained to do, and it allows you to answer some really pertinent questions about project performance, for example:
- Where am I on the project right now compared to the original programme and cashflow?
- What costs have I incurred and are there any we haven’t been billed for yet?
- What’s been invoiced out to the customer and what’s still outstanding?
- What impact will delays, EOT’s, LAD’s or other variations have on the financial performance of the project?
Broadly speaking, most big and medium-sized contractors will use a good, robust CVR system, but many smaller contractors don’t – and that can be a big failing.
Without this information, it can be hard to know your true costs and negotiate final accounts that provide an adequate margin. For example, if you agree a fee based purely on what’s in your accounts, you may well find out, after the fact, that there were subcontractors who hadn’t agreed final accounts yet.
You can’t go back on that final price, once it’s agreed, so you can lose a lot of money.
- Use a good CVR system to track your project costs.
- Customise your CVR to meet the exact needs of the project.
- Keep your system up to date, with all the correct information.
3. Good integration between project reporting and your accounts
Being able to integrate your project reporting (the output from your CVR) and your accounts system is so important for getting real control over the business.
What you get incredibly regularly, especially if the business doesn’t have good controls, is one lot of accounts from the accounts software, and another from the project output, with no links.
The two worlds don’t tally and have no integration. That’s a nightmare if you’re having to make big business decisions based on incomplete, non-integrated information.
Until you get the auditors in to consolidate these two reports, you don’t know how you’ve performed. And this will leave you with a lot of questions
- What information is coming out of the site and what are our project costs?
- What are the latest actuals looking like from our management accounts?
- How can I combine these two reports to create a better picture of our project performance?
It’s shocking how often this bridge isn’t there. People just give up and accept that the information doesn’t work and isn’t integrated, They know the rates, expenses and sundry costs in their head, and have a semblance of an idea, but often the two sides just don’t tally.
In so many businesses, the quantity surveyor will factor in the costs, labour and will make allowances for things like insurance, software subscriptions and the like in charge rates when considering project profitability, but the accountant doesn’t see this. The accountant has an accurate record of what has been invoiced and what costs have been incurred but the quantity surveyor doesn’t see this. Everything is an inch away from fitting nicely together…. But it never quite does!
There is software that can keep track of everything, but really all you need is two good, accurate systems, and a good link between them. It’s not complex but it does need to be set up by someone who knows exactly what they’re doing. Once everything’s up and running, it’s a very simple job to combine the data and give yourself better foresight over your project performance.
- Use your CVR system to get accurate project information directly from the site.
- Keep your accounts up to date so you have accurate financial information.
- Build a bridge between the two to integrate these two data sets.
4. Strong credit control and debt management
In the construction industry, credit control is an ongoing problem. Late payment is common and that can have a profound effect on your debt and cash positions.
It’s not unknown for big companies to make it difficult for you to get your money paid on time. Accounts payable teams at large corporates will tell you that your invoice is in the wrong format, or that there’s information missing, and will make you wait as long as possible for the money.
This will raise some very pressing concerns:
- When can I reasonably expect our late-paying clients to pay up?
- Do we have the cash to cover our costs until the bill is paid?
- Can we survive if clients habitually miss the invoice due date?
To overcome these worries, you need to put things back into your control. If you can get your agreed payment terms with subcontractors and supplier up to 45 or 60 days rather than 30 days, that gives you more money to play with each month. If you can cut your own debtor days from 60 to 30, that gives you more money to play with and, if you can do both, well then you’re in the position of operating with a negative working capital requirement, which is the pinnacle of credit control!
It’s about being robust with your terms, getting things in writing and having a strong credit control function to back this all up. A large part of contracting is getting your contracts right and making sure they work in your favour.
If you’re not astute you will get burnt. If you want to get paid on time, every time, a ‘gentlemans’ agreement’ won’t get you there.
In the ideal scenario, you can achieve negative working capital where you’re already bringing in cash from the client before you have to pay your own suppliers. If that can be achieved, you’re always sitting on a surplus and can settle everything at the end of the project, with your profits already safely in the bank.
- Agree your payment terms in writing and ensure they work to your advantage.
- Use your credit control team to politely apply pressure on late payers.
- Try to get the client paying up before you have to pay your suppliers.
How we can support your four cornerstones
Getting these four cornerstones in place might sound complicated, but with the help of our specialist construction accountants, you can quickly set the ideal foundations.
Our advisers will help you:
- Carry out a gap analysis on the business to show you where you’re falling short
- Help you plug the holes in your processes and reporting
- Show you the best processes and provide you with reporting templates
- Give you hands-on training on how to get the best from your templates and information.
We know the standards in the industry and we know a huge range of people within the construction sector, so we understand your challenges.
Digging down into the numbers isn’t your day job, but with the right resources, advice and support we can help you to truly get in control of your construction business.
Talk to one of our construction accountants in Essex about building success into your business.
Want to know more? Call us on 01708 475220 or email firstname.lastname@example.org