Navigating Tough Times: Financial Traps to Avoid for Construction Businesses

Navigating Tough Times: Financial Traps to Avoid for Construction Businesses

January 26, 2023

We’ve been hearing a lot in recent months about the possibility of an impending recession and how to buckle up and prepare for it. It makes sense that the thought of a recession can be overwhelming for many company owners and industry leaders, and conjure up images of widespread layoffs, fiercer competition, or even worse, bankruptcy.

As a business leader in the construction industry, you know that recessions are a challenging time for your business. Unfortunately, the construction industry is often one of the first to feel the effects of an economic downturn.

But it’s crucial to remember that good companies with solid fundamentals will continue to succeed under these circumstances. Yes, growth might be a little slower than usual, but businesses with solid plans and safeguards will survive, continue to earn the trust of their clients, and even expand their portfolios.

In fact, data from November 2022 Associated Builders and Contractors (ABC) Construction Confidence Index 1 actually shows that contractor confidence was still very high. According to ABC’s chief economist Zack Fritz, only a small percentage of contractors intend to reduce their workforce in the upcoming six months. Most contractors anticipate increases in their revenues, and industry data from Dodge Data and Analytics 2 also identified certain construction sectors that are anticipated to grow during the year.

As you know, the construction industry has its own set of financial pitfalls that can hurt your bottom line. But don’t worry: by remaining educated and taking the necessary actions, you can avoid these pitfalls and position your company for long-term success. Here are some financial traps to avoid:

Reducing markups to win new contracts and clients

As a construction company, you may be tempted to lower your prices to win more contracts, but this could be a costly mistake. When you reduce your markup, you earn less money on each project, making it difficult to cover your overhead costs and turn a profit. But it’s not just your immediate financials that are at risk. By not investing in new technology or equipment, you limit your ability to be more efficient and take on more complex or higher-paying projects, ultimately limiting your earning potential in the long run. And by consistently undercutting your prices, you risk setting unrealistic expectations with your clients. It’s important to weigh the short-term gain of winning a contract against the long-term financial health of your business.

Failing to use markup percentages that fully cover annual overhead expenses

As a construction business leader, it’s crucial to make sure you’re using markup percentages that fully cover all your expenses. This includes small items and equipment like ledgers, cellphones, and the like, which are often forgotten when setting the bid amount. You may struggle to pay bills, purchase materials, and meet payroll without enough markup. You may also face difficulty obtaining financing for future projects and budgeting and forecasting for upcoming projects.

Excessive dependence on credit

Construction businesses often rely on loans to finance their projects, but borrowing too much money to fund new projects might lead to significant complications. Excessive interest rates might pile on top of the loan, making repayment even more difficult and causing a domino effect on financials and operations. To prevent these issues, your finance department must be meticulous in assessing how much credit is smart to utilize and carefully monitor interest rates to account for unexpected increases over time.

Failing to set up an up-to-date equipment inventory system

The construction industry is well known for sticking with manual processes and spreadsheets, especially when it comes to keeping an inventory of equipment and tools. Investing in up-to-date equipment inventory systems that accurately track your equipment lowers the likelihood of equipment loss, boosts productivity, and makes it easier for you to budget for additional equipment and unexpected project costs.

Payment delays

Payment delays can be a big problem for construction companies since they cause cash flow issues and make it difficult to make on-time bill payments. To prevent this, it’s important to have an effective invoicing and collections process in place, to follow up on past-due invoices regularly, and to consider providing discounts for early payment.

Employing uniform markup rates for all projects

It’s a common industry practice, but construction companies shouldn’t always apply the same markup percentage to every project. Remember that every project is unique, with its own costs and difficulties. You may have to raise your prices for larger and more difficult projects in order to cover the additional expenses, while you may opt to charge less for more competitive projects so you can maintain an edge over other firms. It’s essential to be flexible with your markup because the actual cost of labor and materials can vary greatly between projects.

Neglecting insurance

Insuring your projects can help protect your business from potential losses and ensure compliance with legal requirements. Think about it this way, accidents happen, and unexpected events happen on construction sites, but with insurance, you can have peace of mind that you’re covered. For example, workers’ compensation insurance can help cover the cost of their medical treatment if someone gets hurt on the job. And, if something like a storm damages equipment, equipment insurance can help cover the cost of repairs or replacement. And it’s not just about protecting your business, it’s also a way to meet legal requirements and contract terms. Many contracts require a certain level of insurance coverage, so ensuring that you are adequately insured is just smart business.

Avoiding new technology

Despite the advances in technology that help the industry become more efficient and streamlined, many firms still see tech tools and software addressing construction industry inefficiencies as an unnecessary expense. Technology helps construction businesses weather the impending recession by streamlining projects and workflows, ensuring that skilled personnel are focused on high-value activities instead of wasting time on repetitive and easily automatable tasks. From notice management to automating Request for Information (RFI), many functions in construction can benefit from specialized tools. While many companies have embraced platforms like ERPs to digitize a portion of their high-level operations, there’s a lot of room for optimization, especially in more granular day-to-day tasks that take up a lot of time and resources.

Tracking the wrong metrics

Sometimes, construction firms can get hung up on monitoring metrics that don’t fully paint an accurate picture of the business’s financial health. While tracking metrics on number of change orders, hours worked, or number of RFI’s tell a portion of the story, savvy firms must also put focus on financial metrics like DSO (Daily Sales Outstanding), DPO (Days in Payables Outstanding), Net Profit Margin, and Gross Profit Margin, which are a better gauge for current financial status.

It’s a good idea for construction firms to be mindful of their finances in 2023, as we all deal with inflation, rising interest rates, and other potential economic headwinds. Remember that several financial traps can catch business owners off guard, and falling into these pitfalls, particularly in the construction industry, can result in severe financial loss down the line.

You can set your business up for long-term success by staying informed, planning for contingencies, effectively managing cash flow, using and extending credit responsibly, putting up modern equipment inventory systems, having the right insurance coverage, embracing construction technology, and tracking the right metrics. By taking these steps, you can help guarantee your business’s long-term success and sustainability.

  1. Construction confidence index – News releases — Page. (n.d.). ABC National > ABC.
  2. Outlook 2023 E-book. (2022, December 16).