Wall Street investment advisors are beginning to act like contractors. Hedge fund managers now value tech companies based on a multiple of future revenues rather than a multiple of past earnings. Revenues trump profits. Just like many contractors.

Risk in Construction

Contractors fail suddenly because they run out of capital not because they run out of work. There is always a revenue stream around the next corner but construction companies that run out of capital cannot finance access to future revenue streams. In other words, risk in construction can be defined simply as “the inability to finance access to future revenues”.

What Do I Mean by Capital?

Capital (not the technical accounting term) is the fuel that keeps the enterprise engine running. There are three components to capital as I use it here: owner’s equity, retained earnings, and borrowing power.

1. Owner’s Equity - A fancy name for the money invested by the people who own the business. This may be an initial investment or ongoing contributions, but it is always an infusion of capital on the part of the owners of the company. Construction Contractors, for the most part, start as small family-owned or privately held businesses with a minimum of initial invested capital. They rarely sell stock (ownership) to the public to avail themselves of additional owner’s equity, so their main source of capital is profit from ongoing work.
2. Retained Earnings - This is the profit that contractors earn on each project they complete that is not distributed to the owners of the company but rather is left in the company coffers to invest in access to future work. If ongoing work is not profitable no further contribution to this pool of capital occurs.
3. Borrowing Power - Banks provide contractors with “working capital” and bonding companies provide payment and performance guarantees based on the stability of the contractor’s financial statement. That is to say, if small closely held construction firms who start with minimal initial capital demonstrate their ability to make a profit on work completed, they will gain access to working capital through borrowing power and access to additional work through expanded bonding capacity.

Main Street not Wall Street

Contractors work on Main Street, not Wall Street. They struggle to grow their companies one profitable job at a time. They normally expand financial capability through hard-earned profits not by selling part ownership to the investing public. In the long run the definition of a successful contractor is “a profitable contractor”.

For 30 years I studied both successful and failed contractors in an attempt to analyze the difference. The results of my research taught me that most successful contractors manage their organizations in a similar fashion, and all contractors could increase their chances of long-term profitability if they would emulate successful (profitable) practitioners. To enable contractors to emulate the most successful, I designed the Construction Company Self-Analysis Program that can be found on the Simplar site at https://simplarfoundation.org/blog/.

Construction Company Self-Analysis Program

The program isolates the factors that contribute to world-class profit performance by construction firms. It will enable any contractor to identify whether his/her company possesses the success factors in financial management and business management that mark the most profitable practitioners in their field. Research suggests that most managers understand construction methods better than the multi-layered business side of construction and the complicated interdependent relationships between marketing, production, and accounting. This program is designed to provide construction professionals with a comprehensive insight into the complex functional areas of their business and how closely their management techniques resemble the best-in-class.

Financial Management - Compares your company’s functional areas in accounting, financial reporting, cash flow management, debt management, and receivables management to the functional areas of the best-in-class.

Business Management - Analyzes your company’s handling of organizational structures, record keeping, overhead management, change order management, subcontractor management, project selection, personnel management, multi-year business plan, succession planning, control, risk management, and dispute resolution.

In The Eye of the Beholder

When valuing tech firms’ future revenues over past earnings, Wall Street gurus value growth over profitability. Many contractors do too. But success is in the eye of the beholder. By taking a step back and looking at the industry through a long lens, I observed the high construction industry failure rate and asked, “why do some contractors succeed while others fail?”

Take a minute to fill out the Construction Company Self-Analysis Program and find out for yourself. The results will tell you how your organization compares to the most profitable companies and indicates where you might improve your company’s profitability.