Good Times Can Create False Confidence

By Jim Jordan

With a healthy 2006 wrapping up, wise contractors are those who know exactly why they are succeeding and are remaining alert for warning signs.

Jim Jordan is director of construction services for Dallas/Fort Worth-based Weaver and Tidwell LLP.

At industry conferences and around the water cooler, the word among contractors is that 2006 brought back the good times. Statistics seem to bear that out: For the first eight months of the year, total construction on an unadjusted basis came in at $460.6 billion, a 3 percent gain relative to the same period a year ago, according to a monthly report from Robert Murray, vice president of economic affairs for McGraw-Hill Construction, publisher of Southeast Construction. In August alone, construction starts were up 3 percent over the previous month.

Without a doubt, dirt and concrete were flying fast in the Southeast this year. Driving the activity was a fairly strong regional economy - and a national economy that performed better than expected in most sectors. In relative terms then, 2006 truly has been a year offering good times for the construction industry.

All of which means the yellow caution light is flashing, and all contractors should pay heed. Good times often mask underlying problems and tempt contractors to relax financial scrutiny. Suddenly a dedication to ratios and benchmarks seems not so important. The result, unfortunately, is that today's good times may prove to be tomorrow's death knell.

For many contractors, periods of prosperity can easily create false confidence. They think their accounting and management processes are strong, while they are in fact badly out of kilter. Try to tell that to some contractors and their retort will be something along the lines of "the proof is in the pudding.'' Unfortunately, that isn't true. A better cliché might be "even a blind hog occasionally finds an acorn."'

The fact is, good times can actually mask a contractor's procedural weaknesses. Where such weaknesses exist, a pattern emerges when work volume suddenly surges. Some contractors begin to hire too many workers without considering the future. They can become overly compensatory, lavishing themselves and clients with perks, junkets and financial rewards. The result of such unrestrained spending is new overhead expenses that can be difficult to rein in later.

For the best-of-class firms, periods of prosperity are viewed as more than just an opportunity to enjoy the fruits of their labor. Such firms use periods of high work volume to determine which methods -- and people -- are producing the most revenue. At the same time, they work to put their financial houses in order. They use strong cash flow to build up reserves, pay down bank debt, purchase equipment, cross train employees and improve technology. Once a healthier balance sheet is in place, they may have the opportunity to seek better terms from lenders and surety companies.

These contractors aren't distracted from their central goal, which is to make money. Continuing to remain focused, they watch their benchmarks and ratios carefully, and continue to market themselves aggressively. They are preparing for the next economic downturn.

Experienced contractors are on the lookout for the first signs that they may be slipping out of a positive financial environment. These signs most often show up when cash flow begins to tighten and shortages are experienced; accounts receivable and accounts payable begin to age; working capital begins to decline; bank lines of credit are increasingly used to pay current bills without subsequent repayment; liquidity and debt ratios begin to slide; margins on new jobs, and revised margins on existing jobs, are decreasing.

Most contractors have learned that even a record workload does not always produce record profits. The climbing cost of construction materials and insurance alone can quickly turn windfalls into negligible gains or losses. That's why it is critical that managers never take their eyes off expenses. With costs climbing, managing job expenses and overhead is as important as building volume.

Yes, times are good for many contractors right now. The great irony, however, is that some contractors who today are making more money than ever may not be around in a few short years. Their demise will have more than a little to do with their inability to manage periods of prosperity. When the money is rolling in, some contractors assume they are very good at what they do. What they fail to admit is that practically all contractors -- well managed or not - have strong revenues during periods of high volume.

During periods of prosperity, it is critical that contractors know why they are succeeding and remain alert for warning signs. Armed with that knowledge, they can better navigate tougher economic times when they arrive.