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Attention contractor owners: What is your return on investment?

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Michael Strahan

When a person invests in the stock market or any other income-producing venture, it's prudently presumed that the investment is monitored against a return expectation. If it is under-performing, you would likely take the time to analyze why the investment was not performing to the return expectation, and then make a conscious decision to stay the course or take corrective action. The same can be said for an over-performing investment. You would want to know why the investment was doing so well, and how can you replicate this success. Well, being that you are an "investor" as an owner in your construction company, or any other venture for that matter, do you take the time to plan annually and set a targeted return on investment off of which you benchmark? Considering the extreme risk taken in the construction business and the significant dollars invested, why wouldn't you? It seems too many contractors are focused on securing more work as the means to grow the bottom line. The correlation between more work and a higher return on investment (ROI) is questionable if you don't have the systems, procedures and monitoring abilities in place to manage growth. All you may be doing is piling on risk with little return. Frankly, you should work backwards when planning for the year ahead. Start with your targeted ROI, and then work through general and administrative costs/indirect costs, and gross profit objectives to come up with the revenue needed to meet your goals. Following is some food for thought as you go through the annual planning process.

? ROI: Establish this at a level that makes the risk you take acceptable. Obviously, you need to take into consideration some of the unique aspects of running a private business when doing this. ? G&A/Indirect costs: This is probably the biggest drain on profits and also the easiest one to get away from the shareholders. What are your costs? Do you review them to make sure you are operating efficiently? Do you track them versus the budget? Do you budget this at all? ? Gross profit: The gross profit target you set should be at a level that will cover any indirect costs generated while still achieving your required ROI. Is the figure you come up with realistic based on historical profits? ? Revenue: Take into consideration backlog entering the year and then back into how much additional work is needed in order to achieve your gross profit needed -- and ultimately, your ROI. Is this a realistic figure based on cash flow requirements, bonding capacity, management abilities, etc.? If you have the capacity, you may decide to take on more work than necessary. However, don't drop your margin below what you determined is needed to meet your ROI.

Once you have a handle on the above information, you should establish, at the minimum, monthly income statement forecasts as your benchmark. These should be reviewed at least quarterly. Ideally, you should be able to produce a monthly balance sheet, income statement and cash flow forecasts based upon your annual plan. Without forecasting, how are you able to monitor your investment and take any corrective action? Considering the level of risk that you take as a contractor, it is extremely important to monitor your investment and make educated business decisions.


Submitted by Cavignac & Associates

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