How Contractors Can Optimize Cash and Debt Strategy for Competitive RFQs

In an increasingly competitive and costly environment, contractors face a growing demand to meet strict financial thresholds just to bid on projects, even smaller ones.

Business owners, including contractors, truly need money to make money by ensuring target margins are met, regardless of the current stage in the overall life cycle. From well-established service providers to startups, the need to prequalify and expand opportunities to achieve growth requires ongoing assessment of financial strategies and planning.

Consistently Track and Report Financial Performance

The focus for those in the construction trades should remain on optimizing balance sheets and creating appropriate ratios of liquidity.

However, managing operations and job sites often takes precedence over collecting and developing financial performance metrics and then working to reach levels needed to meet almost any basic RFQ requirements. Focusing on the big picture by assessing financial targets early and often ultimately helps minimize barriers to pursuing needed opportunities to fuel growth. In many cases, businesses can achieve this consistent tracking and streamline operations through automation tools that are built into the platforms and technology they already rely on, especially within commonly used accounting, finance, and payroll software.

All construction businesses should look at creating a dashboard of performance ratios aligned with what banks and bonding companies typically analyze to make decisions about lending opportunities that enable larger operating volume or expansive projects. These collaborative opportunities can provide competitive advantages that increase profitability and business valuations while providing access to higher credit limits with better terms and increased bonding capacity.

Analyze Key Ratios to Better Understand Reporting

Completing a ratio analysis gives business owners information to compare the company’s performance to prior periods (e.g., year-over-year or quarter-over-quarter) and, even more importantly, against their industry.

A few ratios to consider in the management of a construction business include:

• Liquidity ratios: The liquidity ratio will determine a company’s ability to pay short-term debts and operating expenses. Generally, the higher the value of the ratio, the larger the margin of safety the company has to meet short-term operating obligations.

o   Current Ratio = Current Assets / Current Liabilities; and

o   Quick Ratio = Cash and Accounts Receivable / Current Liabilities.

•      Solvency ratios: This ratio shows what percentage of assets belongs to outside creditors and what percentage belongs to owners of the business (owner’s equity). A low ratio is good because it means the company has low leverage and the owner has a lot of equity in the business.

o   Debt to Net Worth = Total Liabilities / Net Worth.

•      Profitability ratios: These ratios will determine your gross profit margin (operating profit) and overhead analysis. These two ratios are highly useful in performing industry analysis and period-over-period analysis.

o   Gross Profit Ratio = (Sales minus Cost of Goods) / Sales;

o   SG&A (Overhead) Ratio = SG&A / Sales; and

o   Profit Margin = Net Income / Sales.

•      Management or cash flow ratios: These ratios will help you understand your cash position, cash flow and management of the company.

o   Working Capital = Current Assets - Current Liabilities;

o   AR Turnover = Sales / ARs;

o   AP Turnover = Cost of Goods / APs;

o   Inventory Turnover = Cost of Goods / Inventory; and

o   Debt Coverage Ratio = Earnings + Interest Expense + Taxes + Depreciation + Amortization (EBITDA or Cash Flow) / Total Principal and Interest Payments on all Debts.

The above ratios are a good start to a reporting dashboard that can help steer a company toward high performance. A banker, CPA, and trade associations can help with additional ratios and industry analyses to fine-tune a dashboard to meet specific goals and objectives.

Five “C Factors” of a Financial Relationship

Ultimately, most banks will look at some combination of five “C factors” to determine the depth of a financial relationship with a construction business: character, capacity, capital, collateral, and conditions, which are the backbone of every credit decision a lender makes.

In turn, access to credit and capital puts businesses in position to avoid setbacks and maintain preparedness in RFQ processes.

However, not all growth can be considered good growth. When considering the overall strategy, consider the following questions related to cash flow:

• Do you have enough capital in your business to sustain a growth trajectory?
• Do you have access to cash to cover five months’ worth (or more) of expenditures before collecting any receivables?
• Does your business have the financial expertise in-house to handle budgeting, forecasting, and analysis?
• Can the company generate the same amount of gross revenue at a higher margin?
• Will doubling the size of your company generate the same amount of gross revenue at a higher margin?

Business owners should take a proactive approach in keeping creditors up to speed on business conditions within the construction industry as well as information regarding historic and current performance ratios and projections. This type of mutual investment in financial viability helps contractors successfully meet the demand for specific thresholds in competitive bidding processes.