Loans for contractors are difficult to obtain, but benchmarking can increase your chances of success by helping you improve your balance sheet, says Mark McMahon, a partner at Moss Adams LLP.
“Benchmarking means analyzing your financial statements to make sure that the warning signs of difficulties are bubbling to the surface quickly so that you can do something about it,” says McMahon. “It’s important that contractors be aware of what the entities that provide credit are looking for so they can be proactive in implementing steps to improve their performance and their balance sheet.”
Smart Business spoke with McMahon about how to analyze your financial statements to put your company in the best position to succeed.
How can a company get started with benchmarking?
To get started, the first thing you need is your company’s financial statements, which include your balance sheet and profit-and-loss statements. The second thing you have to do is calculate the important ratios, the relationships between the accounts that are imbedded in your financial statements. The third thing is to compare the results to those of your peers in the construction industry.
Benchmarking is important because the primary readers of your financial statements are banks, insurance companies and the surety underwriters who write performance bonds. A surety wants to make sure the contractor is viable in order to underwrite the bonds because the surety is extending credit. The banks rely on the financials because they are providing credit, and it is a very difficult environment for contractors to receive traditional credit from banks. The insurance companies rely on financials to make sure the company can pay its premiums. The users of financial statements are looking at important ratios at a company, and business leaders need to be doing the same.
What kinds of ratios should a company be looking at?
The first ratio a company should look at is debt to equity, which measures the amount of the liabilities that a company has versus the amount of equity that the owners have retained in the business. The standard is liabilities can exceed equity by about two times. If your liabilities exceed equity by more than that, it may mean that you are taking on too much work and that you should slow down in terms of the work you take in, or work off your backlog.
In the current environment, debt versus equity is a real concern among lenders and surety underwriters because there isn’t the ability to earn income to increase equity like there was in the past. As a result, these entities may require companies to continue to reduce the amount of backlog.