Financial diagnostic: 10 Questions you MUST ask to stay financially healthy
"If you don’t know what “normal” looks like you won’t see “abnormal” coming"
August 6, 2019 by canadiancontractor
By Steve Ryan
An ability to understand your numbers and use them to make better decisions is no luxury. It is a key to success. If you think it’s time to take your financial management up a notch, These are the questions you need to answer before you can do serious financial forecasting;
1. HOW MANY PROJECTS DO YOU DO IN A YEAR (actual number, not estimated)
You need the actual number, because if you aren’t counting you should be. The number of jobs you do can dictate the resource requirements of your company just as much as the size of each job.
2. HOW MANY PROJECTS COULD YOU DO WITHOUT ADDING PEOPLE, EQUIPMENT OR PROPERTY
You need to know your capacity in order to respond to opportunities. Odds are if you want to take on new business you will need to beef up some element of the operation. When you know where your constraints are, you can assess opportunities better and prepare for action more effectively.
3. HOW MANY PROJECTS WOULD YOU WANT TO DO (What size do you want to be)
You’ve heard Einstein’s definition of insanity: “doing the same thing repeatedly and expecting something different to happen”. He was being an optimist. In this industry, if you keep on doing the same thing something different will happen. The world will change around you and you will be left behind. Set a target. Yes the future is unpredictable, but you will still get closer to a moving target when you take aim than you will by leaving it up to circumstance.
4. WHAT IS THE AVERAGE SIZE OF A PROJECT (in dollars, actual number not estimated)
Sure your jobs can range from very small to immense, but most organizations have a sweet spot. Your crews, equipment, office support, project management, all have a scale at which they are most efficient. You probably already have a sense of your “typical” or “ideal’ job size. Now compare that to the size of job you are actually doing. Either adapt your operation to the work you are doing, or target your sales effort toward the type of work you are best equipped to perform.
5. WHAT IS YOUR AVERAGE MARGIN ON A PROJECT (percent, actual number not estimated)
There is so much riding on the margins you achieve, it’s going to be hard to keep this brief. Start by understanding what the word means. Each job earns a margin. The difference between what you earn to do a job (your sales) and what you spend specifically to do that work. This is not your profit, because you typically have “fixed” expenses (rent, vehicle leases, insurance etc…) that must be paid whether or not you got the job. An estimate, or gut feel won’t do much for you here, because success or failure in the construction business can hinge on one or two margin points. If you don’t know how to calculate your margin, you need to learn.
6. WHAT IS YOUR “BREAK-EVEN” MARGIN ON A PROJECT (actual number not estimated)
Remember those “fixed” costs you still have to pay after the project work is paid for (rent, vehicle leases, YOUR SALARY). We all know what it’s like to feel pressure on our pricing and it can be too easy to “sharpen our pencil” to get pricing down to where it needs to be to win work. If we don’t know where our limits are, we might accept a price that doesn’t leave enough to pay those “fixed” costs. In the heat of pricing negotiations, you must be crystal clear on where to hold the line. Builders who know their break-even margin and stick to it, are much less likely to price themselves out of existence.
7. WHAT IS YOUR TARGET MARGIN
It may be reassuring to know the point at which you will break-even. But you’re not in business to break-even. You are entitled to a reasonable profit, so incorporate that into you planning and into your pricing. As we have already suggested, you will come closer to a target when you know what you’re aiming for.
We talked of financial “guideposts” that let you focus on the things that matter and your margin is one of those. Most of what we mention up to now are one-time (or once a year) exercises. They tell you what to look for so you can focus your energy where it has the greatest impact. So now the question is:
8. WHICH PROJECTS DON’T ACHIEVE YOUR TARGET MARGIN
This is where your planning and goal-setting meets hands-on management. When you know the margin you need/want your projects to achieve, you can isolate the outliers. For each of them, there is a reason for the miss (weak pricing, poor cost control, specific people dropped the ball). There may also be jobs that came in above your target margin. Find out which jobs they were, look for how it was achieved. Adapt your operation to control the things that caused poor results and reinforce the practices that brought success.
Financial management is also about protecting the investment and a couple of key questions can keep you on top of that:
9. HOW MUCH MONEY DO YOU OWE (Suppliers, Sub-trades, Bank, Credit card balance)
Most of us have an instinct that we shouldn’t owe more than we own. But we have less instinct for how rapidly things can change. You should always have an accurate knowledge of your debts and know what financial buffers you have available. Most critically, you need to know what sources of funds are available to you on short notice.
10. HOW MUCH MONEY IS OWED TO YOUR BUSINESS (unpaid receivables, loans you have made)
Most contractors, have major amounts tied up in ongoing project work. You can be profitable but have no funds available because so much is invested in work in process, or tied up in unpaid customer invoices. Your company may have money, but if it’s tied up and you can’t get at it, you may have to borrow money to pay your bills. That on it’s own isn’t a bad thing, until things get out of balance. Even companies that appear large and successful can fail when there is no cash in the bank for immediate expenses.
We can’t fully explain here all the principals that make these questions relevant. All we hope to do is illustrate how some things that seem like abstract topics for another day, are actually critical to what you do today. More importantly, they are vitally important to what you may achieve in the future. As a business owner, you will be a lot more effective in making decisions, setting priorities and preparing for what comes next, when you have clear reference points that define your company and it capabilities. If you don’t know what “normal” looks like you won’t see “abnormal” coming. More than this, you won’t be able to see what’s needed to become extraordinary.