Nail Your Numbers: Essential Financial Analysis and Ratios for Your Construction Business

Preparing or analyzing financial statements can be a daunting task for owners or management with only an operational background or “on the job” accounting or financial experience. Financial statements or similar reports are useful tools for operating and managing a business, or planning for the business’s future. Knowing what goes where under generally accepted accounting principles, or what a user of your financial statements may be looking for can be difficult.

Revenue Recognition: Revenue for construction contracts is typically recognized using the percentage completion method, using the total costs incurred to date as a percentage of the total estimated costs on a given project.
Cost of Revenues: These are generally costs related to materials, subcontractors, and direct labor. To analyze, look for consistency and reasonableness in these expenses.
Gross Profit Margin: Use gross profit margin to assess how efficiently the contractor manages direct costs relative to revenue.
Overhead Expenses: These include general and administrative expenses, such salaries, office rent, utilities, or other overhead costs. Costs should be reasonable and in line with the scale of operations.
Work in Progress (WIP): Understand how WIP is calculated and whether it’s valued properly. This is crucial for assessing the financial health of ongoing projects and may provide information for future revenue expectation of those projects.
Cash Flow: Analyze the statement of cash flows to understand how cash is generated and used by the contractor. Pay attention to operating cash flows and capital expenditures.
Ratios: Financial statement ratios fall into a few categories: but there are a handful that are important for contractors.

What are some ratio types?

Liquidity

Measures a company’s ability to pay off short-term debt using short-term assets, or how effectively the company can meet its immediate financial obligations without raising additional capital or selling long term assets.
Examples: Quick Ratio, Current Ratio, and Cash Ratio

Leverage

Measures a company’s financial risk and ability to meet obligations by comparing debt levels relative to other items, such as assets, equity, or earnings.
Examples: Debt to Assets, Debt to Equity, Debt to EBITDA, Debt Service Coverage, and Interest Coverage

Efficiency

Measures how effectively a company uses its resources to generate revenue or profit. They show how quickly conversion to cash or sales occurs.
Examples: AR Turnover, Inventory Turnover, Asset Turnover, and Working Capital Ratio

Profitability

Measures a company’s ability to generate profit, manage costs, and create value. These ratios are used to evaluate financial performance over time.
Examples: Gross Profit Margin, EBITDA Margin, Net Profit Margin, Return on Assets (ROA), Return on Equity (ROE), Cashflow Margin

It is critical to remember that none of these ratios can explain everything about your performance and are simply a tool to help monitor financial health. By focusing on these areas, you can gain a more thorough understanding of construction contractor's financial health, performance, and potential risks faced. If you're not familiar with financial statement analysis or what to look for on your financial statements, consulting with our team experienced in the construction industry could be beneficial.

Suttle & Stalnaker, PLLC is ready to help. If you would like more information on how this applies to you, contact Chris Lambert, CPA, CGMA, CCIFP, at 304.343.4126.