Why Contractors Fail
By Scott Scheef, CPA, CVA, Manager
In the last decade, the construction industry has experienced substantial growth, riding the wave of increased demand and low interest rates. As we look forward, how can contractors best position themselves for less favorable market conditions without forsaking the opportunities the current market presents?
The construction industry maintains a distinctive mix of characteristics from other industries. While not all of these are unique to construction, it is arguable that no other industry experiences all these combined characteristics. The market is extremely competitive due to low barriers of entry and the nature of project bidding. Coupling this competitiveness with a shortage of qualified workers, it can make securing the right new work in the company backlog a nerve-wracking process. For example, many business owners in this industry lie awake at night analyzing if they have enough work secured to ensure company profitability while also wondering if they have enough people to complete the work for the signed contracts that are already in hand.
The realistic truth is that a construction business is almost two and a half times more likely to fail than other industries. While company success and failure are dependent on multiple reasons, the following four considerations can typically separate successful companies from those that fail:
1. Unrealistic Growth:
Many contractors can develop an obsession with increasing the company’s gross contract revenue, ignoring red flags regarding the quality or type of the work. Contractors who do not recognize that all contracts are not created equal will eventually be left holding a contract that significantly weakens the company’s financial standing or potentially causes the company to fail. Contractors need to recognize what type of projects fit within the company’s sweet spot and be willing to turn down contracts that are outside of this area. This may cause the company to forego accepting a contract due to multiple reasons; including the contract size being too large, project staffing, geographic location, lack of experience in the market/niche, or inability to negotiate contact terms.
2. Succession and Character Issues:
In today’s business environment, the transition of business ownership and management duties are common in nearly all industries. The changes in leadership due to retirement, death, or sale can have some major impacts on a business if not properly planned for in advance. In addition to the loss of experience, the lack of a continuity plan can cause major concerns for lenders and sureties not familiar with the next in line. Although the company name may not change, the goodwill built with the surety and bank often will leave with the party stepping down. In an already leveraged industry, the new ownership needs to prove that it prioritizes the company profitability and balance sheet growth over their personal life.
3. Accounting Concerns:
While it is safe to say nearly all contractors did not go into business to become accountants, that does not mean they can ignore the accounting function altogether. The overall lack of an accurate reporting system can easily cause a company to fail. Whether it is due to lack of accounting experience, lack of attention, or being understaffed, management’s use of untimely or inaccurate information can lead to improper decisions that can wreak havoc on a business’s ability to remain profitable. Successful companies prioritize accounting with controls to ensure proper job costing with necessary communication between estimating and accounting functions.
4. Management and Performance Shortcomings:
Profitability on a job can deteriorate in the blink of an eye if not properly managed, and once it gone, it is hard to rebound. Job overruns, not submitting change orders and lack of proper oversight can cause a profitable job to become a liability. When issues on jobs arise, the project manager’s lack of ability to oversee multiple contracts at once, lack of a talented workforce, or just having the wrong project manager on job are often blamed. For these reasons, many companies need to review their policies to ensure adequate project management. Some common issues that companies may need to address are a lack of management training, using family or long-term employees versus talented outsiders, and not promoting a unified company mission/direction.
Whether is it determining your company’s revenue sweet spot, improving your accounting reports, discussing succession planning, or reviewing profitability by job to determine areas for performance improvement, HBE is here to help. For more information, please contact our office and ask to speak with a member of our Construction Industry Specialty Team.
