
Top 5 Financial Planning Tips for Contractors
In the fast-paced and often unpredictable world of contracting, effective financial planning is essential for long-term success and stability. Here are five essential financial planning tips to help contractors build a stronger financial foundation, make informed decisions and achieve sustainable growth.
1. Evaluate Your Strategic Plan
Your contracting business should be continuously developing, setting and evaluating strategic business goals. When developing and setting goals, it is important to consider where you are now, where you want to be and what opportunities and threats could impact your ability to reach those goals.
It can be helpful to review market research data and economic forecasts that can be gathered through surveys and focus groups, and analyze secondary data like industry reports.
It is important to quantify your goals as much as possible to make it easier to evaluate performance and determine goal achievement over time. Budgeting is an excellent way to quantify goals; however, the use of a budget is only helpful if it is utilized to make future decisions and to evaluate actual performance results.
2. Perform Contract Reviews
Conducting individual contract reviews helps manage project costs, improve proactive estimating for future work, and enhance transparency for stakeholders. During the review process, be sure to review contract billings and costs compared to budgeted amounts to date. From there, investigate discrepancies and maintain adequate documentation for major changes from budgeted amounts. This will also allow you to evaluate whether you have opportunities for contract claims or change orders that can improve profitability.
Additionally, you should be preparing and analyzing contract work-in-progress (WIP) schedules on at least an annual basis, but ideally more frequently, to be able to make informed decisions for your company. The key financial components of WIP schedules should be presented for each contract from inception to date, as well as for the current fiscal year. Inaccurate WIP schedules and estimates can lead to poor billing practices and poor cash management that can be catastrophic for a business.
The key components of a WIP schedule include:
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- Contract price;
- Contract costs (both to date and for the reporting period);
- Estimated costs to complete;
- Gross profit (estimated final and actual to date);
- Revenue earned (both to date and for the reporting period);
- Billings to date; and
- Over/under billings (billings minus revenue earned to date).
3. Enhance Financial Statement Analysis
Financial statement analysis is vital for monitoring progress toward your strategic goals. The more accurate and complete the data is, the more informed the decisions that can be made. One often overlooked financial report that can be very useful for a company is the statement of cash flows. This report provides details on how cash was generated and used during the period under review and can inform both financing and investing decisions.
All financial reports should include current month and year-to-date amounts, as well as comparisons to prior years and budgets. Reviewing results at this level of detail will allow you to assess the accuracy of financial forecasts and projections and help to identify trends that may need to be addressed to help reach your strategic goals.
4. Evaluate Key Performance Indicators (KPIs) for Contractors
There are various kinds of financial metrics and ratios a company can use to gain insight into its financial health. The most common metrics used to evaluate financial standing and performance are:
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- Liquidity ratios (current ratio, quick ratio)
- Profitability ratios (gross profit, net profit)
- Financial leverage ratios (debt-to-equity, interest coverage)
- Efficiency ratios (inventory turnover, AR turnover)
The most important KPIs will vary from business to business, but are typically quantifiable, allowing comparison against industry benchmark targets or historical performance.
5. Review Insurance and Banking Needs
While often treated as a “set it and forget it” function, it is important that your insurance and banking arrangements are routinely reviewed, at least on an annual basis. The construction industry, your company, employees, customers and vendors are constantly changing, and so are your insurance and banking needs. For insurance, such as workers’ compensation and general liability, be sure to verify that payroll and sales projections are accurate and continue to monitor those projections throughout the year to avoid a surprise large audit premium bill later on. For banking, don’t forget to consider whether your line-of-credit limits and financial debt covenants still make sense given the current state of your company. Additionally, consider strategies to manage interest rate risks (e.g., refinancing options, high-interest overnight sweeps and interest rate swaps).
Final Thought
Sound financial planning isn’t just a one-time task; rather, it should be an ongoing process that requires regular review, adaptation and analysis. By following these five tips, contractors can make informed decisions, mitigate risks and improve overall profitability in a competitive industry.
Contributing Author: Ryan R. Delao, CPA, is an audit manager with extensive experience delivering audit, review, compilation and consulting services to a diverse range of clients. He specializes in serving businesses in the construction, architectural and engineering, and manufacturing industries. For more information on this topic, you may contact Ryan at rdelao@dmcpas.com or (315) 472-9127.