August 29, 2005

Construction companies have long neglected the idea that their employees should understand financial management. This is madness. Owners trying to create personal wealth with employees who do not know money management fundamentals. If your employees don’t know financial concepts, how can they deliberately influence it?

Furthermore, if an employee is causing profit losses for the firm, owners are quick to dismiss them. Simply put, finances are critical to any business’ success. Why don't we do more to further its understanding?

Finances make or break a construction firm. Superior financial management is a keystone to continued success for each organization. Conversely, the loss of money erodes a company’s ability to perform and then kills it.

Every owner starts with limited funds and a few projects. He or she learns very quickly the importance of good financial management. As the firm grows, others take over the daily responsibility of building projects and managing cash flow. Do they have the same deep understanding of its importance?

Senior managers must have a laser-like focus on financial matters. They know it affects every aspect of a business. Not knowing enough can lead to a slow but steady downward spiral. All activities expand or curtail due to money. Adopting technology, hiring, office expansion and bidder list qualification, just to name a few. Well-managed firms keep clients, attract talent and build value for its owners.

Middle managers make the most money for the construction firm. Profit is made on the project. Field supervisors and project mangers make it happen on the job. Shouldn’t they be the most knowledgeable of all middle managers?

Look at these statistics that reflect most categories of contracting.

3% - average profit before tax
10% - average overhead
87% - direct job costs.

Middle managers influence or control 87% of the project. They are key to profitable construction and therefore profitable companies.

Overall, three people have the greatest impact. 1) estimating Manager 2) field supervisor 3) project manager. Each of these people has profit and loss responsibility. However, financial management is more than that.

As an example, cash flow is a key indicator. It is sources and uses of funds. Some activities require cash and others do not. Knowing the difference improves the performance of the firm. In my research, long term negative cash flow is a precursor to bankruptcy.

Let’s start with some basic questions that lead to improved results:

- What is the the first rule of business?
- What is the true cost of loss, theft or mistakes? (see below)
- What is the cost of rework?
- How do you decrease the cash conversion cycle (days) of your firm?
- How do you improve the Return on Investment of a project?
- What are the key financial control measures one should be reviewing at least, monthly?
- Which construction factor is the true profit opportunity for most firms?

Do your middle managers know these answers? Do they actively try to increase the financial performance of your firm? Could education in these areas help them work smarter?

As an aside, understanding risk is part of any financial management improvement. Ignore this at your peril. The construction industry is one of the top five riskiest industries in the United States based on bankruptcy statistics. Your employees must have this type of financial education to keep you profitable.

Building the value of a firm is the ultimate goal for most owners. However, most employees are not given the basic knowledge to help achieve this goal. Construction companies who address this will win a competitive edge. In fact, “Best of Class” contractors are determined by their financial result not there technical ability.

The cost of loss, theft and mistakes has to be repaid by profit. Profit is a function of revenue. This is an illustration of how we must generate a substantial amount of revenue to pay for losses. Some of these losses are easily identified such as safety, job cost overruns, theft, rework etc. Other types of losses are less clear. Efficiency, morale, lack of paperwork, unrecognized change orders, jobsite favors, etc.

This illustration below effectively portrays the huge cost to companies in effort that they must expend to make up for loss.

Example:
An employee loses a $1,000 tool.. The company's net profit is 3%.
This means that the company has to earn $33,300 of revenue to break even on this loss.

Wouldn’t some of your employees act differently if they knew this?

What if the loss was $10,000?

Isn't it time for financial education of your construction staff?