Benchmarks provide contractors valuable path to improvement
INSIGHT ARTICLE |
In today’s highly competitive construction market, it’s not enough for any contracting business to be just good enough: To stay ahead of competitors, a contractor has to work continuously to improve service, products and operations. One of the most fundamental and effective methods contractors can use to measure business performance is to compare themselves to others in the industry.
While benchmarking has been used to some degree in the construction industry for many years, interest has surged in recent years because of the availability of national performance data.
Today, construction companies can find a great deal of useful benchmarking information from construction industry associations and organizations, whose annual financial surveys can provide a wide range of information by region, specialty and company size, among other criteria.
Establishing a benchmarking process
The basics of successful analysis are fairly simple: Contractors identify those critical functions and practices they wish to track over time, then use the data to measure their progress against that of competitors and best-in-class companies.
When beginning the benchmarking process, contractors should first prepare a financial analysis of the company.
When developed properly, benchmarks can give contractors a revealing new perspective on long-time practices and can offer a valuable guide to weaknesses and opportunities.
So that benchmarking works to optimal benefit, data should be reviewed at a minimum on a monthly basis. Trends that show up in the data can then be addressed quickly in order to improve newly discovered weaknesses or to accelerate strategies that are showing the most success.
Commonly used ratios
When it comes to choosing ratios, the following scores are the most commonly used by contractors:
- 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.
- Current ratio: This measurement indicates the extent to which current assets are available to satisfy current liabilities. They usually are stated in terms of absolute values, such as 2-to-1 ratio or simply a ratio of 2:1. Generally, a minimum current ratio is 1, which indicates that current assets at least equal current liabilities.
- Debt to equity: This ratio equals total liabilities divided by total equity. The higher the ratio is, the greater the risk the creditors are assuming. Generally, a ratio of 3 or lower is considered acceptable.
- Profitability ratio: This measurement demonstrates the profit generated by the total assets employed. A higher ratio reflects a more effective employment of company assets. This ratio is generally stated in terms of percentages, such as 10 percent of return on assets.
- Days in receivables: This indicates the number of days to collect accounts receivable. A lower ratio indicates a faster collection of accounts receivables, therefore, more liquidity. In general, a ratio of 60 days or less is desirable.
- Days in payables: This ratio indicates the number of days it takes to liquidate trade payables. Usually a ratio of 45 days or less is considered adequate.
- Months in backlog: This measurement tells managers the number of months it will take to complete all side or committed work. A ratio of less than 12 indicates a need to secure new contracts in the next year to maintain a constant level of annual revenue.
- Underbillings to equity: This indicates a level of contract volume being financed by the stockholders. Usually stated as a percentage, a ratio of 30 percent or less is considered acceptable.
- Backlog to equity: This ratio indicates the relationship of signed or committee work to total stockholders’ equity. In general, a ratio of 20 or less is considered acceptable.
Whether a contractor uses general or highly technical benchmarks, information derived from the process provides a valuable map for improvement. Fact-based decision-making is dramatically easier in an industry ruled by tough decisions.
A version of this article was originally published in Texas Contractor magazine.