Cash greater than 5% of annual revenue (non-borrowed): Contractors should maintain an available bank line of credit of at 'least 5% of annual revenues; in addition, cash as reported on the contractor's annual financial statements must exceed overbillings, with any differences maintained or tracked through accounts receivable.
Tangibility equity greater than 15% of annual revenue-Stated equity as reported on a contractor's financial statements is adjusted to remove goodwill, related-party receivables, prepaid expenses, and off-balance sheet tax liabilities, including subsequent distributions to the owners for taxes and deferred tax liabilities, which represents tangible equity
Tangible working capital of at least 10% of annual revenues (5% minimum) -Stated working capital as reported on the contractor's financial statements is adjusted to remove prepaid expenses, underbillings, current pass-through tax distributions, non-turning inventories and old receivables (over 90 days outstanding), which represents tangible working capital. tangible working capital excludes a "13-month line of credit that is secured by short-term assets, which is a planning tool often used by contractors to manage working capital presentation
Low debt ratios: Low debt ratios include maintaining an interest-bearing debt to tangible equity of less than 50%. This is a baseline that varies within certain trades of a contractor; for example, heavy highway or equipment-intensive contractors usually carry a higher interest-bearing debt ratio around 80%. Additionally, total liabilities to equity ratios are recommended to be less than a 3 to 1 ratio.
No significant underbillings (costs in excess of earnings): Underbillings is the highest indication of risk on a contractor's balance sheet Underbillings usually indicates poor billing practices and often represent a loss or fade that is realized in subsequent periods. Contracts should analyze correlation between underbilled jobs and subsequent profit fades.
Overbillings (billings in excess of costs) should exceed 2% of annual revenue or uncompleted backlog (if less): Best-of-class healthy contractors know their costs and how to properly estimate a job, including how much of the total estimated costs represent strict budgets for each trade, general conditions, potential cost savings, and contingencies. These contractors usually have a higher gross margin recognized on completed contracts than estimated gross margins on uncompleted contracts, underpromising and overdelivering on contract estimates. A contract should analyze 5-year gross profit trends by type and geography to identify trends that may require additional focus and review.
Profit fade or gain less than 10% of the original gross profit percentage: Best of class healthy contractors know their costs and how to properly estimate a job, including how much of the total estimated costs represent strict budgets for each trade, general conditions, potential cost savings, and contingencies. These contractors usually have a higher gross margin recognized on completed contracts than estimated gross margins on uncompleted contracts, underpromising and overdelivering on contract estimates. A contract should analyze the 5-year gross profit trend by type and geography to identify trends that may require additional focus and review.
Use of profit estimates less than historical profit until job is 50% complete: Some contractors take conservative approaches, using zero profit estimates for new jobs until 10% complete, a common planning tool to manage tax and GAAP financial statement reporting. Increased profits over historical profit estimates based on completed contracts is rare in the construction industry. A contractor should maintain a contract schedule sorted by type of work, customer, location, and project manager, as each could impact the estimated gross profit estimates.
Good cash flow: The contractor manages cash flow on projects by front-end loading cash (permanent job borrow), which is a common practice of overbilling to the owner on contracts. In addition, managing the receivable collection period of less than 30 days (45-day max) and collection of retainages on completed projects within 90 days are other common practices that best-of-class healthy contractors use in maximizing cashflows.
Low fixed general and administrative costs: Depending on the industry or trade in which the contractor operated, the G&A percentage of revenue should be 2–5%. Subcontractors usually use a higher percentage than general contractors. It is important that contractors properly identify indirect contract costs and use full absorption job costing through labor burden rates to minimize general and administrative costs and properly eliminate job costs.
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