Business Toolbox: When should contractors say no to new business?
Many contractors would likely cringe at the idea of turning down work. After all, construction is a cyclical business, and there is often a "get it while you can" mentality of taking on new projects. But experienced contractors warn there are a number of good reasons not to take on too much.
For instance, William Finfrock, president of Finfrock, said his company will do about $300 million in sales this year, making it one of the biggest locally headquartered general contractors in central Florida. Parking garages account for around 50% of its business, with the rest coming from student housing, multifamily dwellings and office buildings outside of Orlando in Apopka, Florida.
Finfrock is careful about the projects it constructs because it wants to control the process. The design-build company self-performs about 40% to 60% of the work on its projects, employing around 40 in-house architects and approximately 50 engineers, in addition to crews of welders and other tradesmen. The company also manufactures precast concrete systems at its 93-acre production facility.
"We've learned what part of the market we fit well in and what part we don't," he said. In a healthy economy, some contractors take on projects that don't necessarily fit with their core business, he added. But venturing outside of Finfrock's specialty areas would not be good for the company nor its clients.
Finfrock said the company turns down projects if the customer's values don't align with its own. During the Great Recession, the company had to work for some clients that didn't fit with its culture, the owner said, such as "those that don't feel they can win unless someone else — like the general contractor — loses." Finfrock said the scuffles that inevitably come with that type of client can quickly turn the job into a lose-lose scenario for both parties.
Lack of capacity
Lack of capacity, Finfrock said, is another reason to turn down jobs. A construction company has to be able to increase its staff right along with new growth. How much product the Finfrock's manufacturing operation can churn out is very predictable, he said, and to increase the plant's capabilities would be expensive. So the company always questions whether new work will justify the cost of increasing capacity and if the necessary expansion can be done in time to accommodate the opportunity.
But it's a balancing act, he continued. "Today, you can certainly be more choosy," he said, "but you can't be too choosy, because you still want the sale."
Another factor that plays into the issue of capacity is the labor shortage. Finfrock said many contractors complain about the lack of training, and it is something the industry needs to address, especially when it comes to trades like welding.
"Obviously, we'd love more vocational training … but we can't sit there and complain," he said. "We have to figure a way to create more skilled labor, and some of it has to fall on [contractors]." To that end, the company has an in-house training program that potentially can take an employee from unskilled laborer to foreman.
Too much work can be worse than not enough
It's tough for contractors to turn their backs on new work, said CPA and practice leader Steven Goldstein with accounting and consultancy firm Grassi & Co. They typically don't want to disappoint a potential customer and, strategically, would like to get a foot in the door and establish themselves as a priority choice with as many clients as possible in the case of a downturn.
But in this environment, Goldstein said, too much work could be as destructive to a construction company as too little. For example, he said one contractor he's familiar with started his business at the end of 2016 and made $25,000. In 2017, his company had more than $2 million in sales and is on track to finish this year with $30 million in revenue. Now his time is taken up with trying to secure financing and bringing in partners so that he can handle that much work.
It's possible for companies to achieve that kind of growth successfully, Goldstein said, but contractors must have a solid business plan in place to prepare for it. "I sometimes see them putting the cart before the horse," he added. "They will take on a job and worry about getting it done after the fact."
If contractors don't have the capacity, the accountant said, then they should really consider not taking on additional work until some or all of their current backlog is complete.
Scrutinize financial results
Contractors also need to review their finances. Goldstein said many construction company decision makers judge their firms' financial ability to take on more work by looking at profit and loss statements, which show revenues and expenses. However, management should also take look at the balance sheet and check the equity line. A company's equity is the value of its net assets — assets minus liabilities — but also represents the ownership's "skin in the game," he said.
Problems arise when that figure includes underbillings that exceed equity. A high amount of underbilled work, whether it's because the contractor is waiting on a change-order approval or the accounting department is slow to turn in invoices, can put a strain on cash flow. If the contractor can't absorb underbillings, then there's a risk of falling short of the company's working capital needs.
Focus on responsible growth
Because the decision of whether to accept new work has so many facets, the project development process at Gray Construction in Lexington, Kentucky, includes feedback from various departments within the company, including accounting, project execution and design, said Jeff Bischoff, executive vice president of business development.
Gray Construction, which specializes in manufacturing and warehouse facilities, is on track for record sales this year, Bischoff said, so the firm is focusing on responsible growth — and that means sometimes turning down work.
Choice opportunities, he said, must be in the company's core markets and provide acceptable profit margins. The next question revolves around project delivery type. Will the job use a familiar contractual method, i.e. design-build, construction manager at risk, etc.?
"Everyone has a contractual method that best suits [their] companies," the executive said. "Stepping outside that is putting yourself at risk."
Most of Gray's work, Bischoff said, is either negotiated or the company is one of a few contractors invited to bid. The company's development process, however, is such that it considers all leads and opportunities and then culls the list down to those that are the best fit. "We're working that process over months," he said. "It doesn't really come to a head all at one time."
Gray also makes sure its subcontractors can handle the work before they are hired for a project. "As diligent as we are in checking subs' financials during a down market, we're that much more diligent during an uptick," Bischoff said, adding that Gray scrutinizes subs' bonding capacities and other aspects of the companies to make sure the subs aren't "biting off more than they can chew."
What it comes down to for Gray, Bischoff said, is using risk management methods and controlling overhead to make sure an investment in the company will be a future benefit. "You won't see the ramifications from the decisions that you make today until many, many months down the road," he said.
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