Customers Can Become Casualties - On the Numbers
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SECTION: On the Numbers

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Customers Can Become Casualties

By Garry Bartecki

Article Date: 06-01-2009
Copyright(C) 2009 Associated Equipment Distributors. All Rights Reserved.

Offer these solutions to help your contractor customers achieve profits in the era of bidding wars and negative cash flow.

It’s a tough market out there and, in an attempt to just get work, your customers are often in the unfortunate predicament of pricing themselves right out of business. In short, they bid the job to get the work, but don’t adjust their cost structure to produce positive cash flow.

To gain better insight into this problem, I contacted our friend Ken Hedland of Somerset CPAs. Ken is a CPA and consultant who spends the bulk of his time in the construction industry. As you would expect, he and his team have been busy educating contractors on how to become or stay profitable.

I asked Ken: What options do contractors have? How can they achieve or maintain profitability? And how can they adjust to the market? Ken says they have three options:

1. Keep your price stable, reduce overhead where changes are obvious, and make the same or more money.
2. Go with the flow and reduce margins to get work.
3. Raise prices and get whatever work you can, knowing it will be profitable.

The Impact of Adjusting Margins
If your customer is going to play the margin game, keep in mind that cost adjustments are a part of it.
For example, if they do $10 million in billing at a 30 percent margin, they generate $3 million to cover overhead and administration expenses. Cut that to 20 percent and you lose $1 million of margin. In other words, they would have to increase billing by 50 percent to $15 million to earn the same $3 million of margin. If increasing billings is out of the question, then $1 million in cuts are required to earn the same bottom line.

Managing margins means knowing their overhead and cost structure so they know when and where to cut costs. This requires being able to predict profits and cash flow for different levels of business and margins. If they cannot manage and predict cash flows to produce a reliable result, their chance of making it through these bidding wars intact is doubtful.

This process also requires an assessment of the contractor’s risk tolerance, because there are jobs out there they should stay away from: Some will be too big, some will require working capital they don’t have. Some will require skills outside of their comfort zones. It just doesn’t pay to take on a job that could put them out of business.

Current financial markets also add to their problems. A lack of borrowing power or financing means a lack of working capital and higher equity requirements to run and finance their business properly.

Making the Adjustments
There is no doubt profit is very important. However, it’s only half of the equation, because maintaining adequate working capital, equity and cash flow are also critical. This being the case, it is imperative to have meaningful 30- to 60- and 90-day cash flow estimates, along with a plan to keep cash flow positive.
The current market environment produces less work and more competition, which translates into lower gross profits and slow pay. In addition, backlogs are decreasing, which means annual revenues will decrease and cost reductions are necessary to maintain cash flow. This same scenario applies to contractors who do work for each other – it becomes their responsibility to perform the due diligence to ensure subs can complete their assigned tasks.

The questions your customers must now ask themselves are: Can we do this, and can we make adjustments as required? If not, they may need a guy like Ken to help out – he will be at Executive Forum, so bring your questions.

Of course, contractors want to sell their ability to get the job done on time, as well as their expertise, and their office and field management team. They want to mention their equipment fleet is available to start work immediately. Overall, they want to show off the value-added components they bring with their proposal, which could make a difference.

Some contractors may decide to keep pricing at their standard rates, knowing the result will generate less revenue. They will make a decent profit on the work, but have to cut overhead to push the profits through to the bottom line. If they have the ability to manage their expenses in this fashion, they can reach their goal, knowing they can always bring price cuts into the equation.

The ability to manage finances is key to being able to aggressively price jobs to get work. Risk and financial ability have to be assessed, and a thorough understanding of cost structure is a must to keep cash flow positive.

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Article Categories:  Customers/Contractors  »  Financial  »  Management  »  Association