What other ratios does a company need to analyze?
Another important ratio is current assets versus current liabilities. Current assets are assets that are either cash or that will be converted to cash within a year, and current liabilities are liabilities that must be paid within one year.
Generally, you want to see a current ratio of about 1.2-to-1. If your current assets exceed your current liabilities by anything less than 1-to-1, that probably indicates the company is experiencing or may experience cash flow difficulties in the next 12 months because there are more obligations that have to be satisfied in the current year than there is available cash. Remedies for a deficiency in your current ratio include your company receiving an infusion of cash, restructuring some of its debt or increasing profitability in the next 12 months.
How important is it to measure gross profit as part of the analysis?
Measuring gross profit is very important. Gross profit is the ratio of profit on your jobs versus their total revenue. What a third party — a bank, insurance company or surety — is looking at is consistency in gross profit, whether it is year-to-year or job-to-job. The concern is that a company, on the surface, could be showing a steady gross profit, but it is because the company had one good job and 10 that were not profitable. For a general contractor, gross profit could be 3 to 5 percent; for a specialty trade contractor, it could be as high as 15 to 20 percent.
What are the benefits of analyzing these ratios?
Analyzing ratios gives a company some insight into the actions that management may need to take now or in the near future in order to sustain its business.
What would you say to business leaders who say they don’t have time to do an analysis and benchmark?
Benchmarking has to be done because the credit markets are much tougher and tighter than they used to be, and a number of banks will not lend to contractors. But a lot of companies tend to overlook benchmarking. This type of analysis is something a company has to do on top of the day-to-day things, and in the construction area, accounting departments are usually staffed very thinly. Benchmarking can be done quickly with the resources out there, and those that do not have time to do it should ask their service provider to do it as part of their yearly engagement.
Mark McMahon is a partner at Moss Adams LLP. Mark can be reached at (858) 627-1432 or [email protected].