Measuring Success: The Role of KPIs in Construction

Ronald J. Eagar

In this challenging landscape, the use of Key Performance Indicators (KPIs) has become essential for companies aiming to excel. These measurable metrics provide critical insights into a firm's operations, empowering decision-makers to guide their organizations effectively.

KPIs serve as vital navigational tools for construction enterprises, offering clarity in decision making, opportunities for continuous improvement, an accountability framework, enhanced internal communication, sharper organizational focus, and improved operational efficiency.

By consistently evaluating KPIs and comparative data, construction companies can craft robust strategies for growth, track progress toward objectives, ensure team alignment with specific targets, facilitate ongoing performance discussions, identify core organizational priorities, and boost overall productivity.

Essential KPIs for construction companies include:

Profitability Ratios:

1. Return on Assets (ROA): This ratio indicates the profit generated by total assets employed. A benchmark of >10% is considered good.
2. Return on Equity (ROE): A healthy ROE is typically >20% of stockholders’ return on investment.
3. Gross Profit Margin: While benchmarks vary by industry segment and location, this ratio is crucial for assessing operational efficiency.
4. Net Profit Margin: This varies widely but is essential for understanding overall profitability.

Liquidity Ratios:

1. Current Ratio: A benchmark of >1.1 indicates a company's ability to meet short-term obligations.
2. Quick Ratio: A more stringent measure of liquidity, with a benchmark of >1.0.
3. Working Capital Turnover: This ideal ratio is <30; high numbers show a need for increased working capital.

Leverage Ratios:

1. Debt-to-Equity Ratio: A ratio of <3.0 is acceptable.
2. Equity to G&A Expenses: A ratio of >1.0 is desired.
3. Fixed Asset Ratio: Should be <1.0 to ensure sufficient funds for current operations.
4. Underbillings to Equity: A ratio of <30% is acceptable.
5. Backlog to Equity: Generally, a ratio of <20 is preferred.
6. Revenue to Equity: A ratio of <15 is acceptable. 

Recent Trends and Challenges
The construction industry advisors at Grassi study these KPIs regularly and have observed significant shifts in recent years, including: 

• Liquidity challenges: Current and quick ratios have deteriorated since 2020, partly due to the end of PPP and ERC programs and inefficiencies from COVID protocol compliance.
• Working capital pressure: The working capital turnover ratio has steadily declined over the past five years, indicating longer payment cycles and project timelines.
• Leverage fluctuations: While debt-to-equity ratios improved in 2021 and 2022, underbillings to equity increased due to pending change orders and billing challenges.
• Backlog concerns: The backlog-to-equity ratio has trended upward, potentially straining liquidity in an environment of slower collections and higher costs.

Financial Statement Red Flags
Construction companies and their strategic partners should be vigilant for warning signs in their financial statements, including:

• Recurring operating losses.
• Working capital deficiencies.
• Negative cash flows from operations.
• Significant over-90-day contract receivable balances.
• Growing underbillings on projects not being recovered.
• Consistent gross profit fades on projects.
• Inability to remit payroll taxes and union dues.

External factors such as legal proceedings, losing key customers or suppliers, and highly competitive bidding environments can also signal potential financial difficulties.

Preparing for Tomorrow's Challenges
As the construction landscape transforms, businesses must evolve their KPI strategies to maintain their competitive edge. Future-focused KPIs will likely reflect emerging industry trends, including sustainable building practices, technological advancements and shifting workforce dynamics. 

For more information, please contact Ronald J. Eagar, CPA, CCIFP Partner at Grassi, at reagar@grassiadvisors.com, through www.grassiadvisors.com or 516-336-2460.