Construction has had a good run; but depending on where you sit, you may have started to see changes over the past few months. Even though some may not be positive, other niches remain relatively strong.

Construction is often at the forefront of economic downturns and upswings, which means construction business managers do not have other data sets or long lead times to consider when determining how to change their operations — whether that means pulling back on the reins or stepping on the gas.

This article explores the current state of the construction industry, as well as several areas of which contractors should be aware to ensure stability during potential future downturns.

The Current State of Construction

So, where is construction now? Good question, and the answer is no one’s sure. Over the past few years, the market has been very good. Many, if not most, companies benefitted from government stimulus money related to COVID-19, which offset losses or camouflaged management inefficiencies, propelling contractors to increase business revenues as well as margins.

The need for reliable contractors that could timely perform allowed companies, especially trade contractors, to increase pricing. Banks have been very lenient and access to capital has been (relatively) easy. And until recently, cost of funds has been at all-time lows.

Whether or not we’re in a recession depends on whether or not you accept the historically applied definition of two consecutive quarters of negative GDP growth.¹ And isn’t it true that historically the U.S. has seen a recession an estimated 80% of the time after yield curves have inverted (2/10-Year Yield Curve)?² The answer is yes. And haven’t we been in an inverted yield curve since summer 2022? Again, yes. So, now what?

Hedging Your Bets

Have a Plan

Take time to assemble key management and develop a plan that is not only financial (a budget) but also strategic. Define what makes your company unique and then seek to exploit it.

An annual plan may suffice in good times, but in times of uncertainty, revisit your plan frequently — more often than once a year. This will provide the opportunity to analyze and discuss how things are trending vs. initial expectations and ascertain why and what corrective action(s) may be necessary, if any.

For your financial budget, incorporate a balance sheet (if you do not already) — it speaks to liquidity and forces considerations around leverage models, capital expenditure spending, and working capital management.

In addition, set a few critical metrics or covenants. Especially if you do not have lender covenants on your line of credit or term debt, it is appropriate to calculate them for yourself, as they serve as early warning signs that something is off track. If you begin to approach or fail these metrics, then take them seriously — just as your lender would — and assess the reasons they’ve been triggered and identify corrective actions.

Understand & Manage Your Costs

When times get difficult, it’s not only more rational to look at your expenses, but imperative; and there is no reason to wait.

Expense alignment and management often lose appropriate attention during good times, and the influx of stimulus money has allowed businesses to not have to operate as lean as they might otherwise. Complicating matters, the past several years have exposed construction to wildly changing input costs — supply chain issues have meaningfully influenced costs of materials, and labor costs have greatly increased due to labor shortages and the Silent Resignation.

While supply chain issues appear to be abating — ultimately reducing supply premiums — inflation appears to want to have its own say, with real costs increasing significantly.

While expense management is always important, are you timely reviewing your standard costs or estimated costs to reflect current and real-time changes in input costs of labor and materials?

Have you updated these costs in your enterprise resource planning system and your proposal process? If you have acquired new equipment because times have been good (again, possibly because of the stimulus funding), have you updated your costing model to reflect these new equipment rates, which are likely higher? How is your utilization on that new equipment?

Bill Timely & Manage Cash

Innovatively work to improve billing terms in the contract so as to allow your company to operate in an overbilled position relative to the costs incurred and revenue recognized on its jobs.

Be diligent about sending invoices on time, proactively following up on payment, documenting “promises for payment” dates, and calendaring time for follow-up. Establish a pattern of intolerance for late payments, holding work performance when necessary and as warranted.

On the other side of the ledger, if you have the liquidity to do so, then ask your trade or subcontractors for discounts on early payment. An analysis should be conducted to evaluate your overall cost benefit of parting early with cash in pursuit of payment discounts.

Defend Your Core Business

Good times mask inefficiencies and poor management and create cash to invest in new services or markets — it’s a good thing, but do so wisely, carefully, and thoughtfully. Structure growth and new business in such a way that if the winds change, then you can readily pull back and be prepared to quickly protect the core business.

Project Costs, Bidding & Work-in-Progress Reporting

Now more than ever, slow down and dial in estimated costs on new bids. Discuss, consider, and negotiate escalators, and aggressively identify and bill change orders.

Once the project has commenced, engage others across functional departments in assessing the status of the jobs in monthly intervals at the least, and perhaps have project managers (PMs) occasionally review each other’s work (e.g., quarterly).

Work-in-progress (WIP) meetings should happen face to face, allowing for questions to be asked and answers to be provided. Don’t just circulate updates by email without appropriate discussion and context.

Preparing the jobs-in-process schedule is not just a finance/accounting function but should also include field operations people. Consider getting out of the office, as C-suite personnel can learn a lot by periodically visiting jobsites.

When preparing the WIP schedule, consider cash exposures. Job schedules most commonly do not include open accounts receivables (A/R) and open accounts payable (A/P) on the job. When included, you gain a better understanding of the cash remaining in the job and the overall exposure. Analyze relationships across common customers and vendors, not just at the specific job level itself.

Budgeting

Experience has revealed that most companies do an income statement budget but far fewer do project balance sheets (and statements of cash flow). Forecast cash so that you understand your liquidity, and if you utilize a revolving line of credit, then forecast the borrowings and needs on the line, especially where your business has seasonality or cyclicality.

Budgets are encouraged to be built up rather than top down, and it is easy to just “spreadsheet forecast” by rolling the prior year forward. As mentioned, if you have credit facilities, then model those as well and run some sensitivities on the assumptions to determine the operating ranges before you begin to trigger defaults, go out of borrowing formula, or have liquidity concerns.

Communicate With Your Primary Constituents

The budget — if shared with your lender — conveys management strength, leadership, awareness, and proactivity. It aligns your company with its financial partner and assists them in preparing for your (potential) future needs.

Situations have occurred in which the lender wanted to respond to a client’s request for help on short notice but could not, only to the company’s peril. Banks are institutions and most are governed by and through committees, and they need time to be responsive, take action, and prepare documentation. Help them help you.

Know Your Customer(s), Diversify & Align

In softening times, it is increasingly important to know your customers. Meet face to face and attempt to gain insights, not only into their business and strengths, but also to flush out any concerns they may have with you or others. Sometimes third-party interviewers can provide candid insights regarding customer experience and project performance.

These conversations can allow you to gain intelligence into the market, which also may identify risks or opportunities. Work to build your brand and reputation as a strong and ethical corporate citizen that adequately prepares for challenging times and can be relied upon to fulfill its obligations.

Exploit this reputation and work toward customer and supplier diversification. Diversification is not only a natural hedge to larger losses or business impacts should a customer or vendor fail, but accordingly, it increases your credit profile to lenders and other capital sources.

Similarly, align with strong and reputable financial and operating customers or vendors as your partners. There may be others with whom you can squeeze just a little more margin, but management of a business is, like many things, a marathon rather than a sprint. There will be good times and bad times, and alignment with strong partners will push you through the valleys when they come.