Rising interest rates and their subsequent impact on construction has highlighted the industry’s need for solid financial management structures. Managing this element of your business is always critical, but particularly so during tougher times when the right approach to finances can make or break you.
Financial success is not beyond any company. In fact, it boils down to three pretty simple steps:
- Financial management
- Having the right measurements in place
- Ongoing review and maintenance
Financial management
The biggest pitfall for businesses in their financial management is often cash flow - don’t underestimate the importance of it! It sounds obvious but this is where organisations can come unstuck. If your earnings are growing steadily but your cash flow is heading south, you should probably start questioning the strength of your business’ fundamentals. Cash flow can be divided into three key areas – net income, reinvestment ratio and working capital.
Net income
A critical performance metric, net income should see your total sales end up significantly more than your costs. If the former is up and the latter down, it’s likely you have a favourable cash flow.
Reinvestment ratio
Optimally, you should have a reinvestment ratio less than or equal to one. That is, depreciation expense divided by plant and equipment expenditure should sit at one or below. If depreciation outstrips the value of P&E (i.e. the ratio goes above one) you haven’t been investing in plant and equipment, which could mean that it is outdated or less efficient than your competition.
Working capital
If your accounts receivable and inventory are down and accounts payable are up, your business is probably in good shape cash flow-wise. This scenario also indicates you’re utilising your cash efficiently.
Considering the following questions can also put you in a better position to effectively manage your finances:
- Is your plant and equipment leveraged for growth?
- Do your financing terms on your plant and equipment match the economic life of your assets?
- Could you lower your debt payments to relieve your cash flow?,
- Do your debt payments reflect your business cycle?
If you can answer yes to all of these, you’re probably already seeing the benefits of properly structured finance; if not, it could be time to start asking yourself (and/or your financier) how you can tip your balance sheet the right way.
Measurements
Managing sustainable growth and financial success requires a disciplined approach. At GE, we hold strategic planning sessions on a yearly basis where we assess the market and our competitors, develop a business strategy for the next one to five years and ensure our people, technology and market dynamics are integrated. At the same time, we develop an annual operating plan covering budgets, investment funding, sales projections and cash flow commitments. This sort of planning can be applied to any construction company, irrespective of size or structure.
Review and maintenance
One of the easiest ways to ensure the financial side of your business remains robust – and, again, this can be done at any organisation regardless of its size – is to implement a rhythm of review. This can include a regular (ideally monthly) review of the core elements of an organisation:
- Highlights, risks and opportunities
- Detailed profit and loss plan
- Business metrics
- Customer metrics
- Progress on key initiatives
These meetings will not only give you visibility of the important pieces of your business, they will also allow you to appropriately allocate resources to meet the changing needs of the organisation.
By thinking about these ideas and how they can be incorporated into your unique organisation, you’re well on your way to successful financial management.