Let’s grow those profit margins: a general contractor’s guide to the business side of their business.

When we think of competitive industries, it is hard for us not to jump to the wild world of general contracting. Every aspect of it is filled with competition. Let’s start with the fact that 72% of general contractors (GCs) predict that labor shortage will be their biggest hurdle in the upcoming year. [1] Contractors are fighting to fill their salaried and hourly craft positions before their competition. Not to be outdone, the job bidding process pits contractors against each other for limited desirable projects. This competitive environment has created several business challenges for contractors, and studies of the industry are painting an alarming picture. Only 36% of contractors are making it to their 5th year in business, with small (1–99 employees) to medium sized (100 –999 employees) contractors taking the biggest hit. [2] In fact, the construction industry has the worst long term success rates as measured by Small Business Trends. Those GCs who do make it past 5 years are facing their own challenges.

Perhaps the most concerning of these is the profit margins they are able to capture. Since their reported all-time high in 2012 of close to 30%, margins have plummeted and continue to fall each year with industry averages falling below 5%. Even the largest construction companies in the industry haven’t been able to escape a decrease in their numbers. 85% of them reported they had margins lower than 10%. [3] Why is this the case? The reasons are numerous. Increased competition has driven underbidding, and poor estimation of costs has compounded the issue. Nearly half (44%) of all projects resulted in loss for GCs instead of a profit. [3] Through our own surveys and research, we have tried to dive into this issue. What we found is that many small (1–99 employees) to medium size (100–999 employees) companies share a similar story. Originally their owners were working right alongside their crews, starting a contracting company based on their skill and experience as contractors. As the company grew, they found themselves wearing multiple hats: owner, accountant, HR rep, hiring manager, project manager, and estimator. GCs usually show great resilience and learning over their years growing their company, but as the company grows so do its needs and the complexity of the financial situation they face. The numbers don’t lie. Only 20% of GCs were confident they had an accurate understanding of the true cost and financial picture of their company. [4]

To achieve long-term success, and grow profit margins, owners need to shift their focus. Gone are the days of underbidding on jobs just to keep your team fully utilized. Your focus and strategy need to make a 180 degree turn, from utilization to profitability. Your business needs to be run for what it is — a business. Far too often, GCs simply forget to monitor the key metrics that show the financial health of their organization. Imagine getting in your truck and simply never looking at the fuel gauge. Odds are, you will eventually find yourself stranded on the side of the road as the drivers who did check their fuel gauge that morning pass you by. In this post we are going to break down the metrics you should be tracking to grow your profit margins over time, and hopefully get you started on the path to more accurate job costing and long-term success.

Let’s Talk Numbers

For just a second, let’s go back to the fact that around 20% of GCs really know the cost of their business. The end goal of healthier profit margins all comes back to having a solid understanding of the important numbers to keep your eye on. If you don’t know where you are at, you can’t possibly know where you should be going. Let’s break down some of the basic metrics that you should always be aware of:

• Profit
• Equity
• Overhead
• Sales
• Cash
• Job Costing
• Contracts and Receivables

Profit Margins

A business can’t be profitable without an understanding of profit margins. Some people point to their sales numbers when asked about profitability. Revenue does speak to how much money is coming in the door, but profit tells you what percentage of that money stays in the company and is available to invest in continued growth. There are several profit numbers you should be tracking:

• Gross Profit: Your revenue minus immediate costs of your products or services.
• Operating Profit: Your operating profit takes your gross profit and factors in operating expenses like labor and overhead.
• Net Profit: Often referred to as the bottom line, net profit is what is left after taxes are taken away from your operating profit.
• Break-even point: This is the point where the total costs of your business and the total revenue are equal. This means no loss or gain but is important to know for product pricing, sales goals, and evaluating business ideas and plans.

Know each of these numbers and track them over time. If one starts trending in the wrong direction you will have insight into where potential inefficiencies exist and where corrections need to be made.

Equity

Equity is just an accounting term for the net worth of your business. This metric is vital to the setting of profitability goals. To set your net profit margin goal above the appalling industry average of 10% you need to know what your equity is and set a goal based on it. The basic calculation for equity is Assets — Liabilities = Equity.

Overhead

The simplest way to understand overhead is that it is the costs you will have to pay regardless of whether you have crews working jobs, or you are bringing money into the business. This includes things like rent and utilities for facilities, insurance premiums, administrative costs, and more. Knowing your overhead is vital because it informs a business of how much they need to charge in order to hit your break-even point and reach profitability.

Sales

Sales volume is a crucial metric for any contractor, and you will need to set sales goals to hit your profitability goals. Let’s say you have $300,000 in overhead costs and your net profit goal for the year is $200,000. Added together, that gives you a gross profit goal of $500,000 dollars. If you know that your gross profit margin is 66%, you will need to hit sales of just over $750,000 for the year.

Cash

While this may seem obvious: you can’t run a construction business successfully if you aren’t aware of how much cash you have on hand. Cash is important not only for covering day to day expenses to long term investments for the health of your business. Track your weekly and monthly cash flow to monitor how money is moving through your business and whether your cash reserve is dwindling or growing.

Job Costing

Let’s spend a little time on this one. The ability of a GC to stay profitable can quickly be undermined with poor job costing and bidding practices. It is fair to say that more than any other metric we have discussed to this point, job costs have the greatest potential to impact your ability to stay profitable. This is especially true of small to mid-cap GC’s who will probably not have a substantial financial buffer in the case of projects that end up in loss instead of profit.

As we looked at earlier, the industry is highly competitive, and GCs often find themselves in bidding wars for desirable contracts. The results are clearly not favorable: almost half of the jobs taken are for loss instead of profit. Some GC’s intentionally take a loss on these projects in order to ensure that their crews stay working. But Industry profit margins are clearly showing that loss that keeps you working is still loss.

To be profitable, you need to make money on your work. Accurate job costing is vital to developing estimates that ensure you maintain positive margins. By eliminating guesswork, you may even win more bids as you can bid low with confidence that it is your best number. You will also avoid jobs that may result in poor quality work, deadline delays, a damaged reputation, and even contractor default. So how do you accurately estimate job costs? There are tools and services to track your labor rates, fleet costs, equipment costs and more. Some companies hire a salaried estimator whose sole purpose is to provide you with accurate estimates. However, a modern solution to consider is a construction estimating service or software. These can allow you to reduce your overhead and leverage multiple cost estimators’ experience.

Contracts and Receivables.

Tracking your contracts and receivables is vital for long term success. A GC should know which contracts are open and closed, what the bid for those contracts was, how profitable each of their past contracts were, and how they are currently doing on open contracts. Some of the software mentioned above has contract management built in, but you can also find dedicated accounting software for contractors.

When contracts are completed, you need to get paid. Don’t let payments slip through the cracks. Create an accounts receivable aging report to make sure that getting paid by customers in a timely fashion is a priority in the business.

Back to the Topic of Too Many Hats

Just a guess, but some of you might be thinking “If I wanted to deal with all this I would’ve gone into accounting.” It comes back to the fact that many GCs started their companies because they were highly skilled at construction work. The reality remains that the success of your work has the potential to be your downfall as the complexity of your organization increases. Our goal with this post is to get you thinking about the fundamental metrics you need to keep your eye on to escape the low profit margins that plague the industry. It will take work and time to change the habits and practices you currently have in place, but that better that than to continue to make marginal profits or even worse, be operating at a loss.

If you have any questions about next steps and how to begin tracking and growing your profits, we would love to learn more about you and your organization. Just click here to get in touch.

References:

1. AGC. (2020). 2020 Construction Outlook Survey Results National Results. Arlington, VA.
2. Shane, S. (2020, March 20). Small business failure rates by industry: The real numbers. Small Business Trends. Retrieved September 14, 2021, from https://smallbiztrends.com/2012/09/failure-rates-by-sector-the-real-numbers.html.
3. Muhammad Bilal et al. Investigating profitability performance of construction projects using big data: A project analytics approach, Journal of Building Engineering, Volume 26, 2019.
4. DeKorne, C. (2020, October 8). The physical duress of the building trades. JLC Online. Retrieved September 14, 2021, from https://www.jlconline.com/training-the-trades/the-physical-duress-of-the-building-trades_o.