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4 leading measures contractors can use to evaluate operations

INSIGHT ARTICLE

As contractors prepare for another year, knowing how they stack up against others in the industry is a valuable tool in evaluating whether existing operations—and the processes that drive them—are all they can be.

Fortunately for contractors, data that can be used for the purpose of comparison are compiled and made available each year by the Construction Financial Management Association (CFMA). The most recent survey, issued by the association in 2015, provides a great many industry ratios and benchmarks, including the four leading measures contractors can use to assess viability: liquidity, profitability, leverage and efficiency.

Liquidity

Among the liquidity ratios, one of the most important is current ratio, which indicates the extent to which current assets are available to satisfy current liabilities. The ratio is usually stated in terms of absolute value, i.e., 2-to-1 or simply 2.1. Generally, a minimum current ratio is 1, which indicates that current assets at least equal current liabilities.

In the CFMA study, the average current ratio for all construction companies in the nation was 1.4. For companies with revenue under $50 million the figure is 1.6, and for companies of $50 million or more the figure is 1.4. In the Southwest, the percentage is 1.2, while in the Southeast it is 1.4 and in the Northeast it is 1.3.

Regarding days of cash, or how long a construction company could operate solely on its existing cash, the report says the average in 2015 was 19.7 days. In the Southwest, the figure was 21.2 days, which falls in the middle among all regions surveyed.

For all contractors, working capital is the all-important basis of liquidity. The CFMA survey includes a category for working capital turnover. This ratio is a product of total revenues divided by working capital (the net of current assets minus liabilities) and indicates the amount of revenue being generated by the available working capital. A ratio exceeding 30 may indicate a need for additional working capital to support future revenues.

Among contractors who have annual revenues of $50 million or less, the average working capital turnover in 2015 was 11.4, and for companies with revenues above $50 million it was 13.6, according to the survey.

Profitability

A profitability ratio demonstrates the effectiveness of utilizing assets and equity in the business. It measures profits as a percentage of the owner’s investment in the firm. Investors and business owners often use this ratio to determine management’s overall operating efficiency and level of return on capital investment.

According to CFMA’s study, the return on assets among all construction companies in 2015 was 17.4. For companies of less than $50 million, the figure was 18.9 and for companies of over $50 million the percentage was 15.5.

Return on equity for all companies in 2015 was 45.5 percent, according to the report. The figure for companies under $50 million was 42.9 percent, and for companies over $50 million the figure was 49 percent.

Leverage

This ratio is a means by which contractors can determine their long-term staying power. That is, their ability to meet all financial obligations over an extended period of time. The simplest way to determine the leverage ratio is to divide total debt by equity (net worth).

Debt-to-equity is one of the primary ways a leverage ratio is determined. In the CFMA report, the debt-to-equity ratio for all companies last year was 1.9.

In revenue to equity, CFMA lists 7.9 as the average ratio for all companies.

Efficiency

This ratio indicates whether a construction company has enough capital to fund its backlog of work. Perhaps the most important measurement in determining available capital is the average-backlog-to-working-capital ratio. Among all companies, this ratio averaged 5.9 in 2015. Among companies of under $50 million, the ratio was 3.5, and among companies over $50 million it was 9.2, according to CFMA.

Another category that should be of particular interest to contractors is the report’s study of days in accounts receivable. In 2015, the average among all companies was 53.8 days. Among companies under $50 million, the figure was 46.9 days and for companies over $50 million it was 49.5 days.

As for accounts payable, the report states that among all contractors the average number of days in accounts payable was 35.6.

Additional ratios

In addition, the study noted:

Ratio Average (2015)
Revenue per full-time employee $390,448
Gross profit per full-time employee $44,384
Cash and cash equivalents 16.8%
Contract receivables currently due 40.9%
Direct costs:  
Direct labor 16%
Materials 18%
Subcontracts 36.5%
Equipment 3.5%

 

Published In: January 2017 Texas Contractor.

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