In our first article we reviewed market diversification. In this second installment of our series on Construction Downturn Strategies, we will explore how you, along with help from your CFO or Accountant, can make your construction business finances stronger in anticipation of a downturn in the construction industry.
The construction industry is often the first to feel a downturn as capital is diverted and debt becomes more expensive. But what does this actually mean for your business?
Think of it this way: Money typically spent by companies for capital expenditures, such as building expansions, remodels, retrofits and upgrades, is redirected towards supporting their operating costs (overhead, payroll, marketing, etc.). They stop spending on these internal projects and keep that money in reserve as part of their own downturn strategy.
Similarly, as debt becomes more expensive (meaning that interest rates rise), it costs more to borrow money. Developers and investors typically reduce the number of new projects, or may even stop completely, as the costs of construction projects continue to increase. At some point, it just doesn’t make financial sense to build anymore – they can’t make a profit in a reasonable timeframe or recoup their construction costs fast enough to satisfy the loan payback. They may also worry about finding tenants for new properties – no sense in building something if nobody can afford to move in.
Maybe you're thinking to yourself: "This article is about private work. I only bid public sector work. This doesn’t apply to me."
Let's consider the revenue sources of the state or local government agencies you have bid and how they plan their capital projects. If there is a downturn, oftentimes government revenue drops and projects are put on hold by legislatures and local councils.
So, how do you apply this thinking to your own business? Taking time to check the financial health of your business and determining if it can handle the stress of a downturn is the difference between companies that survive and thrive and those that go out of business when times are tough. Although there seems to be a consensus that 2020 will remain a growth year, construction companies would be wise to use this time to make sure their finances are in order.
Although not an obvious choice, the first financial strategy to consider is: "Are my projects as profitable as possible?"
Are your project teams managing their project budgets to maximize profits? How productive is your workforce? What are your purchasing strategies to reduce material costs? Are your projects regularly completed on time? How often / how much does it cost to tend to call backs and warranty claims?
Start by ensuring you have reliable and accurate ways to forecast your project profits, or a means to accurately track your project costs against the budget. Ensuring that your project managers are strategic and mindful with their approach to schedule, quality and spending is imperative. If they’re not, now is the time to take corrective actions.
There are also corporate level strategies you can explore to further tighten up your business’ vital statistics.
Liquidity is a measure of how quickly you can convert assets into cash to pay short term obligations such as payroll and vendor material invoices. Should you find your revenue decrease, cash flow is also likely decrease. Do you have enough cash on hand or access to a line of credit to cover short term obligations?
- Do you know your weekly or monthly ‘burn rate’ (your standard overhead and operating costs, including payroll)?
- Do you know your Quick and Current Ratios?
- Do you have adequate cash reserves?
- What if your clients start to delay paying your invoices?
Exercise: Imagine you experience a 30% decrease in revenue. Doesn’t feel very good does it? When you do this pretty simple math stress test what do your liquidity ratios look like? What does your Overhead look like as a percentage of revenue? Will you be able to make payroll? Working through these scenarios on paper now is good practice to develop strategies to have ready and put in place when a downturn occurs.
Saving for a rainy day is a tried and true strategy that can give you access to cash in times of need. You accountant can help you decide how much you should keep in reserves in order to keep your business running if revenue drops, as well as the best strategy for how to stay liquid.
Although cash is the most liquid asset, there are other ways to access cash that might be good additions to your financial strategy:
- Have you put your money to work for you with short term investments? Bonds? Money Markets?
- A short-term debt strategy might also be an option. If interest rates are low, it might be better for you to borrow capital and invest your cash to earn a higher return elsewhere.
- Capital investments, like real estate, are the least liquid but another viable liquidity strategy.
Being as efficient as possible with those expenses to your business that are not recoverable (operating expenses) is something that smart businesses do as a matter of course. Costs incurred that are not offset with revenue are a direct drag on your profitability. In a down economy, revenue will decrease. Everything you can do to reduce operating expenses and preserve operating capital is worth looking into.
- When was the last time you took a hard look at your overhead expenses?
- Are there opportunities to reduce or eliminate spending in certain areas?
- Are there things you can outsource at a lower cost than self-performing (ex: professional services such as accounting, marketing, engineering)?
- Are there things you have outsourced that can be brought back in-house economically?
- If you are renting office space, do you have an opportunity to re-negotiate your lease? Perhaps buy the building as part of a longer-term investment strategy?
You can apply ancient wisdom (like our ant in the parable from Part I) to your construction business by working today to ensure your company has available financial resources in an unpredictable future. Having a plan today for decisions you may have to make in the future can remove the emotion and panic that can set in when you are not prepared.
In our third article, we’ll explore internal resource strategies that can be applied to manage an economic downturn.
Ready to start planning your downturn strategy but not sure where to start? The team as Ascent Consulting is here to help.
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