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Operating a Construction Business in a Declining Market

The Boom Times

There are countless stories at Sunday barbecues with people complaining about being unable to find good trades available. Bad news for customers. Good news for trades business owners; their business has been booming with plenty of work and healthy margins.

 

Take Peter and Brett. They’re running a successful plumbing business which employs 12 staff. Brett said, ‘Once Covid hit, we were booked out 9 months in advance, it was difficult to find and train new staff and we were struggling to meet demand.’

 

As their Virtual CFO and trusted business advisor, I knew the numbers and profit drivers of their business. I told them, “the pain points in your business are job scheduling and capacity management. The upshot is, gross profit margin is at 68%, operating profit is at 16%, and free cash flow is running at approximately $27,000 a month.”

 

Although they had their struggles maximising capacity and output, the numbers were solid.

 

Times were good.

Cost of Living Crisis

The new year 2024 has arrived and those times have changed.

 

The news is filled with stories about the cost of living crisis. Multiple interest rate rises since January 2022 has seen the average variable interest increase from 4.5 % to 6.5%. This means repayments on the average $500,000 mortgage have increased from $2800 per month to $3400 per month. An extra $600 per month out of the family budget.

 

Further, fuel prices at $2 impact more than the family budget, it also increases the price of groceries and most other items you buy at local stores.

And it doesn’t end there – good luck taking a family of 4 to a restaurant for less than $300.

 

What does all this mean?

 

Family budgets have been hit hard as now it costs more to pay the mortgage, fill the car, buy groceries and have a night off and entertain the family.

With less money going around households need to tighten the purse strings and this puts the brakes on demand.

Grace Period for Trades Businesses

In the Boom Times, trades businesses had their 6 – 12 month work pipeline full. So, although demand was slowing, trades business had an economic buffer.

 

How lucky.

 

However, as time moves on the buffer in the sales pipeline dwindles away as jobs are completed. The new reality for owners of trades businesses is fewer new requests for quotes and customers being more price conscious.

 

Cashflow Realities Setting In

In the boom times, many businesses scaled up; hired new staff, bought new equipment, moved into larger facilities to help the expansion.

This increase in overhead expenses is called fixed costs. Fixed costs because no matter what happens, every month the overheads must be paid.

Switched on trades business owners are thinking about the financial realities of softening demand and what they need to do to remain profitable.

 

Virtual CFO’s Have The Skills

VCFO’s (Virtual CFO’s) have the financial skills required to adapt your businesses finances to the changing market conditions. VCFO’s are your businesses financial ally.

 

Here are 5 reasons why a VCFO is the perfect solution to keep your business profitable in a changing market:

#1 – Revise budget to remain profitable

With softening demand, running different sales scenarios against the budget is key.


This involves assessing alternative sales forecasts. I recommend running three alternative sales forecasts. One being a high sales forecast, the other being a middle sales forecast and the last one being a low sales forecast. Running these alternative sales forecasts will allow you to assess profitability with each scenario.


When you understand how each sales forecast affects the bottom line, it allows you to forward plan business decisions.


For example, regular review of the monthly financial reports over a three month period may indicate sales are on track to meet the low sales forecast. You understand this means the business is on track to make a loss.


Low sales affects operations in that production capacity exceeds production demand.


The options therefore are either;

a) reduce production capacity to meet demand (e.g. reduce labour), or

b) take on more work to increase production output


Understanding the numbers means you can take management action to maintain business profitability.

#2 – Bookkeeping accurately maintained

The purpose of having bookkeeping accurately maintained is to have an accurate record of each financial transaction that occurs within the business.

 

 

This is important because when the VCFO analyses the numbers and strategies to remain profitable, they are undertaking this analysis based on accurate information.

 

 

For example, operating revenue must only include sales raised to customers and not industry grants or government subsidies. If grants and subsidies were included, GPM will be inaccurate, showing a GPM higher than actual. 

 

 

Business plans based on a higher Gross Profit Margin (GPM) than actual result in overestimating the profitability and financial health of the company, leading to inappropriate resource allocation, over-expansion, or inability to cover actual costs. Decisions based on inflated GPM risk the business’s sustainability.

 

#3 – Cash Flow Scenario Analysis

Off the back of the alternative sales budget scenarios, the VCFO can analyse how achievement of the low, middle or high sales targets will impact on business cash flow.

 

There are two elements here.

 

 

One, the business has cash at bank balance. All three sales scenarios can show how achieving each target will likely impact the cash at bank balance for each month ahead. This provides business owners with a higher level of cashflow awareness in the short term and allows them to plan accordingly.

 

 

Two, understanding the cash flow allows the business to plan for potential shortfalls by securing lines of credit or adjusting spending before a crisis occurs.

 

 

This proactive approach to cash management can be the difference between surviving a downturn or being forced to close the doors.

 

#4 – Daily Production Targets

Setting daily revenue targets is crucial in business as it helps in managing performance and meeting financial goals. It provides a clear benchmark for daily operations, enabling businesses to monitor progress closely. Moreover, it can motivate the team, encourage productivity, and identify any issues or shortfalls promptly. Ultimately, daily revenue targets contribute to the long-term financial health and sustainability of a business.

 

 

The key is to have the daily revenue targets aligned to the revised budget. Any deviation higher or lower than the target allows management to make daily assessments, fix issues and ultimately give the business the best chance of hitting their financial goals.

 

#5 – Monthly Review

With all the right tools in place; accurate bookkeeping, revised budget, cash flow scenario analysis and knowledge of your businesses daily revenue and production targets, you have your goals set. 

 

 

The final step is to review the monthly financial results and assess results against the target. As a VCFO, it’s crucial to review and analyse your financial performance each month. This includes reviewing key financial indicators, identifying any areas of concern, and recommending strategies for improvement. Regularly reviewing your financial performance allows you to spot trends, address issues promptly, and make data-driven decisions to ensure your business remains profitable.

The team at Next Level offers all the services you expect from accounting and bookkeeping to taxation planning and advice. With Next Level you’ll have a strong and experienced financial partner guiding you to reach your goals, ensuring you know your numbers. Book a Discovery Call today to keep your business profitable in a changing market!

 

Written by Lyndon Russell

Next Level Accountants

Managing Director & Founder

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