A Few Key Indicators of a Healthy Contractor

Jim Mieritz, CPA, Auditing & Accounting Manager   email
June 2010

In these current economic times, it's not hard to find a company that has succumbed to the significant shift in the business landscape.  It is imperative that business owners constantly review key information to assess the health of their companies.  Knowing the numbers in financial statements and related analysis can mean the difference between just surviving and thriving in today's economy.  For contractors, keeping a keen eye on several pieces of information will help owners assess the current health and condition of their companies and allow them sufficient time to make necessary adjustments. 

The first item business owners should review is accounts receivable.  Receivables should be reviewed, at minimum, on a monthly basis, and owners should be persistent in the collection of outstanding balances.  Ideally, companies utilize a prequalification process to help ensure project owners and other customers have the ability to pay for the work performed.  Business owners should also ensure that there are no outstanding claims or change orders on a project that would postpone the collection of receivables.  The faster a company can turn over outstanding receivables the more internal cash it will have to fund business operations, resulting in less reliance on third-party financing.

Second, it is important to review profit fade, a trend analysis of gross profit, on contracts.  By examining the change in gross profit estimates at the beginning of the job to where the gross profit ends on the job, business owners can determine if the company needs to revisit the way it manages jobs and estimates costs and other charges when bidding jobs.  If a company does not properly factor in overhead or uses incorrect labor rates, gross profit will not end up where it was originally estimated.  Proper estimation of job costs and overall job management will help win bids by allowing competitive bidding, which is especially important in today's economic environment.  Companies do not want significant profit fade, and it's ideal to keep it to approximately less than 1 percent of total annual revenues.

Third, business owners should review tangible working capital.  By reviewing working capital, a business owner can determine the company's ability to pay current obligations with current assets.  In reviewing working capital, consider excluding items such as prepaids, underbillings and potentially inventory.  These items should be excluded as they are not assets that could be easily converted to cash to help cover current liabilities.  Depending on the type of inventory held, it may or may not be easily converted to cash.  Thus, it should be at the business owner's discretion whether or not to include it.  The amount of tangible working capital that a business owner desires to maintain will fluctuate based on the revenue the company earns.

Remember that the above items do not represent an exhaustive list of what business owners should focus on to ensure the health of their company.  There are various other indicators and ratios to review with the company's operations such as debt-to-equity ratios and a review of the company's backlog.

If you have any questions about any of these items, please contact Jim Mieritz at jmieritz@KolbCo.com at 262/754-9400, ext. 278.