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Financial metrics are crucial for evaluating a company’s financial health and performance. Specifically, these measurements help accounting teams identify areas for improvement, track performance over time, and spot trends for better decision-making.

But choosing the right financial metrics can be challenging in an industry as complex as construction. This article explores why metrics tracking is important and curated a list of the top five financial metrics subcontractor billing teams should follow to achieve their business goals.

The Importance of Financial Metrics in Subcontracting

In construction, every job starts in a negative cash position. Therefore, effective cash flow management strategies — like monitoring the right financial metrics — are vital for a construction company’s survival and growth.

Key metrics offer quantitative insights into:

• Solvency and liquidity, which are essential for determining whether your business has enough liquid assets to cover immediate financial obligations (e.g., paying suppliers and meeting payroll).
• Working capital, which ensures your business can operate smoothly and take advantage of growth opportunities.
• Cash flow, which is critical for forecasting cash movements, thus enabling businesses to make informed future investments to prevent cash shortfalls.
• Bargaining power, which reflects your financial reliability to creditors and investors, enabling you to negotiate for the most favorable terms when seeking additional funding.

5 Essential Financial Metrics for Subcontractors

While not exhaustive, this list covers the most essential metrics for financial success as a subcontractor and why measuring each is important to your bottom line. The goal is to provide you with a solid foundation to build on (without overwhelming you with too much, too quickly).

1. Net Profit Margin

At the top of our list is net profit margin, which provides a comprehensive view of a company’s overall profitability after accounting for all operating costs (labor and materials) and the costs of goods sold (COGS) (rent, utilities, administrative costs, etc.).

Net profit margin is typically expressed as a percentage of sales (the percentage being the actual amount of profit each earned dollar yields).

The formula for calculating net profit margin is: Net Profit Margin = (Revenue – COGS – Interest – Tax) / Revenue x 100

Tracking your net profit margin is important because it shows what your business is clearing after expenses. The higher your company’s net profit margin, the more money it’s making. If you notice a decrease in your net profit margin, then it’s possible that operational inefficiencies or rising costs are to blame. The latter may signal that it’s time to raise your prices.

2. Net Cash Flow

Cash reigns supreme in the construction world, so it’s no surprise that this metric made the list. Put simply, cash flow is all the money moving in and out of your company (or a project) over a specific time period.

The formula for calculating cash flow is: Net Cash Flow = Cash In (Over a Given Period) – Cash Out (Over a Given Period)

Regularly reviewing cash flow is a great way to measure the short-term financial health of your subcontracting business. Specifically, it helps you:

• Track revenue sources by giving you visibility into where your company’s cash is coming in and where it might be drying up.
• Identify potential cash shortages. For instance, negative cash flow means your company is spending more than it’s earning. This isn’t always a cause for concern, particularly if your company is in the early stages of a few projects, but it still warrants attention to prevent future shortfalls.
• Predict future cash flow by regularly assessing your company’s incoming and outgoing funds. This provides a better understanding of your future cash position, aiding in proactive financial planning.

3. Working Capital

This metric measures your company’s short-term liquidity, also known as its ability to meet financial obligations. Working capital compares your current assets (e.g., cash on hand, accounts receivable, materials, and supplies) with your current liabilities (e.g., accounts payable, accrued expenses, short-term debt).

The formula for calculating working capital is: Working Capital = Current Assets – Current Liabilities

As mentioned, contractors are always forced into negative working cash cycles. Therefore, maintaining a healthy working capital is paramount for sustaining operations and completing projects. Plus, it helps identify potential cash shortages, empowering your team to make smarter decisions to strengthen cash flow.

4. Days Sales Outstanding (DSO)

Days sales outstanding (DSO) measures the average number of days it takes a company to collect payments. This metric directly informs accounts receivable (A/R) aging.

The formula for calculating DSO is: DSO = Accounts Receivable / Credit Sales x Days in Period

Monitoring DSO helps you quickly ascertain who’s paying you the fastest — and, more importantly, who’s paying them the slowest. With this information, you can take proactive steps to retrieve outstanding revenue and reassess future relationships with notoriously slow-paying general contractors.

5. Cost Variance

Cost variance compares the actual costs incurred on a project with the budgeted costs for that project. Basically, it helps teams determine whether the project is within the planned budget.

The formula for calculating cost variance is: Cost Variance = Actual Costs – Budgeted Costs 

Significant variances between actual costs incurred and budgeted costs are a clear sign that the project’s cost estimation or management is not going according to plan. Therefore, closely monitoring cost variance allows you to quickly identify areas where actual expenses have deviated from the original plan, prompting you to make the necessary adjustments to bring the project back on track.

Tips for Selecting the Right Metrics

Of the countless financial metrics out there, how do you know which are worth measuring? Unfortunately, there’s no one-size-fits-all list. Knowing which metrics are most important for assessing the financial health and performance of your company requires a deep understanding of your business operations and objectives, plenty of research, and an iterative approach to see what sticks.

Here are some steps to help you choose the most relevant metrics for your business.

1. Define business objectives. Identify the specific goals of your construction company, especially those that are revenue related. Pulling together a list of questions about your revenue targets and lucrative projects can be helpful in determining your objectives.
2. Understand industry benchmarks. Research industry benchmarks and standards to learn which metrics are most commonly used. This provides a baseline for you, in addition to helping you stay relevant among your competitors.
3. Consider stakeholder needs. Account for the needs and expectations of various stakeholders, including investors, clients, and internal management. What will they value most? What information do they require to make strategic decisions?
4. Evaluate data availability and accuracy. If the data you’re measuring isn’t reliable or current, then how can you trust what your metrics are indicating? Carefully choose which metrics can be consistently and accurately measured to ensure meaningful, trustworthy insights.
5. Review and adjust regularly. Just like your business goals, metrics are not static. Therefore, review your chosen metrics regularly to confirm alignment with your construction company's evolving needs.
6. Employ the right software. Use centralized software that integrates subcontractor billing data into visual reports and dashboards to easily monitor things like DSO, backlog, and project efficiency.

With this financial intelligence at your fingertips, you can make smarter decisions to improve your company’s bottom line.