Long term thinking in Building & Construction

[ Reading the Play - by Michael Garrone & Josh Smith ]
by Michael Garrone Published

Statistically it is far harder to be a business success than it is to be a business failure.  Anyone who has been in the building and construction industry long enough will know the time and effort it takes to be successful.  They will also know that it has its ups and downs. To be successful in any industry it’s critical to understand how your market operates and “read the play”.

What do we know about the building and construction industry?  It’s certainly a cyclical industry.  We know that there will be growth periods, slow periods, downturns and peaks. This is the market everyone operates in and the market in which decisions need to be made. You only need to look at the mining services industry to see how important it is to read the play. 

Everyone in that industry knew the mining growth cycle was going to come to an end.  They also knew the pain would be significant for some, and yet what actions did everyone take?  How did they prepare for the inevitable slow down?  We know that there is still a lot of mining services work out there. 

So what differentiates those that survive and are able to thrive as competitors exit the market?  Some will exit on their own terms, some won’t and some of those left will be greatly diminished struggling for profitability.

As the south east corner of Queensland has got moving again and we see new entrants into the building and construction industry we need ask ourselves what have we all learnt from the last downturn and just as importantly what can we apply now?

1. You need to bank cash in the good times
It’s an amazingly simple aim but something that is always difficult to manage.  We all live in a cyclical industry and we know there will be downturns, so one would think it makes sense to bank excess cash. What’s amazing about cash is that when there is a downturn no one needs to panic. There are no forced sell downs, you have flexibility of thought and decision-making allowing you to sell down assets where prudent, contract the business where appropriate, or chase different target markets that might have some synergies. In other words all options are open. So what might be called a lazy balance sheet (if there is such a thing) might just be prudent for you.  Businesses with solid cash reserves were able to survive during the downturn and take on work that others couldn’t because they had the cash to do so.

So what did we see from 2008 to 2013 with those who had built up a cash buffer?  Most still made good profits throughout the period.  It’s also worth noting that these businesses also paid their owners a commercial wage throughout this period. So they were still receiving an acceptable return over and above a commercial wage. Even if you do have solid cash reserves things can still go wrong.  Some people didn’t react quickly enough to the market changes, didn’t examine their overheads or reflect on the fact that they were in a cyclical downturn where future revenue wasn’t just going to drop in. It’s very easy to eat into a lot of your cash reserves very quickly before you realise what has occurred.

2. Understand your market
Good operators understand how the market is affecting margins and customer behaviour.  If the market is changing then you need to change with it.  Most of us have now realised in recent years that it doesn’t matter if you’re in building and construction or a service industry … a lot of the ways of doing business in this new era are changing. Everyone understands the Telstra copper wire syndrome [Sunk cost with reducing revenue].  We have always seen this happen with technology companies, but we know it can happen in any industry these days. What makes money today may not make money tomorrow. Those that thoroughly understand their market are the ones who survive and thrive, and keep pace or lead the market.

3. QBCC licensing
Since you need a licence to trade and make a living, losing it will be a business ending event.  So if you can’t meet the ongoing financial requirements for licensing, then you won’t be around in any cycle, good or bad.  If your business is so reliant on this one thing then why don’t people do enough planning around these financial requirements? A good question to ask yourself is would you survive any downturn or slow period and still comfortably meet the requirements. Would any prudent business owner really want to live on the edge?

4. Too much financial leverage
Leverage can certainly pose some serious problems when things slow down.  Whether it is business debt or personal debt, you should ask yourself what impact is this having on the business and is it sustainable in the long term. This debt must be serviced somehow and when the cash dries up how are you going to pay off the debt? Too often we see people leveraging to a point that is only sustainable in peak years let alone good years or downturns. Clearly this isn’t prudent in a cyclical industry.

5. Understand your marginsYou really need to understand your margins as you go through any upswing.  Despite the last cycle from 2008, many will forget that there were periods before this where profit was still hard to come by.  This happened through rapidly rising costs where wages and materials went up but couldn’t always be passed on immediately. You might have had a lot of work but you weren’t necessarily making great profits. So as things turn around now it is worth remembering that having enough work on is nice but it won’t necessarily translate into margins and profit unless you are on the ball.

6. Keeping a lean overhead
You need to have the right overhead with the right people for your business and target market. You then need to prudently manage waste and think of better ways of doing things to continually keep managing that overhead. A lean overhead not only makes you more profitable but makes you more able to adapt to the changing market.

7. Taking on loss making jobs
Why would you take on a job with no gross profit let alone overhead contribution?  This has always been difficult to understand but there always seem to be excuses.  Consider why you are taking on these jobs, which are not only costing you money but also distracting you from the jobs that will make you money.  Bear in mind that all too often the actual losses on these jobs tend to be larger than originally anticipated.

8. The rolling forecast
How hard is it to keep a rolling forecast with good software these days?  Why is it that a rolling 12 month forecast isn’t the norm?  How hard is it to estimate what your overhead is month to month?  After all most overhead costs are relatively fixed.  The tricky item is always going to be estimating revenues.  While most businesses will know the jobs that are contracted, you should also have a good feel for what tender jobs you will win over the next 12 months. A rolling forecast allows you to identify revenue holes, profit holes or cash flow holes in advance allowing you to do something about it now before it’s too late.

With a new more prosperous cycle emerging in the South East Corner in 2015 it is a good time to think about your business and what it will take to survive and thrive.  Hopefully we can all learn something from the cycles to help us as a new cycle emerges.

Join the conversation! Send me an email with your comments or share some of your own tips and thoughts below on things that everyone could do better.

Remember, it’s all about understanding your business better and being able to #makeithappen for your business in 2015!

For more information on managing your business better, view the previous instalments in the series below or contact one of our experts.

Previous business & construction articles:

Managing growth in your building & construction business

Cash is King

Tips for knowing your break even

QBCC Rules

Michael Garrone
read more by Michael Garrone

Michael is our Tax Specialist Director as well as the head of our business advisory niches of Building and Construction and Property.

With Michael's extensive experience and a real interest in these niche areas he is able to provide practical business and tax advice that is unique to the Building and Construction and Property industries. His tailored advice helps guide these businesses through start-up phase to succession and sale. Michael has many years’ experience in solving complex problems involving corporate tax, restructures, international taxation, Capital Gains Tax and GST. 

Michael also has a strong background in self-managed superannuation and is an authorised representative of superannuationDEPOT. In this area Michael provides strategic advice on SMSF structures and in particular limited recourse borrowing arrangements. Through this diverse experience Michael has developed expertise within a wide range of industries including building and construction, property, professional services (legal, engineering & finance), technology and software and manufacturing.

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