The 2002 Financial Performance Report (FPR), compiled by NECA from financial data reported by electrical contractors for the 2001 year, is a valuable business tool. The ratios used to analyze the data provide a true peer-group comparison for professional electrical contractors, as well as a ready-made system for benchmarking your financial trends. It’s also a great negotiating tool to show bankers, bonding companies, suppliers, and even the IRS, so that your company conforms to actual “standard industry practice.”
Using the FPR is quite simple if you remember that ratios are just fractions comparing line items from your balance sheet and income statement. Some are read as percentages, some as one thing multiplied by another, some in days. The data is grouped by sales volume, direct cost, payroll cost and geographical district, and consolidated for all respondents, with a breakout for “high-profit” firms. Here are some examples of what the FPR measures.
The Current Ratio (Current Assets/Current Liabilities) measures a firm’s ability to pay its bills from available cash and receivables. A healthy target is $2 in Current Assets for each $1 in Current Liabilities, but anything over 1.25 is fine. Both high-profit firms and all firms show healthy liquidity ratios (2.49 and 1.94).
As your Profit On Sales ratio (profit before or after tax/sales revenue) improves, you can increase your reinvestment in assets to support future growth and modernization, or improve the owner’s return on investment. All companies report 2.12 percent, but the high-profit firms, at 4.79 percent, are more than double that meager number, and far surpass the usual industry averages.
Return On Assets (profit before or after tax/total assets), and Return On Net Worth (profit before or after tax/net worth) also measure profitability. The first measures how efficiently management uses assets to make money, and the second measures the return on the owner’s investment.
Return on Assets (using profit before tax) is higher for firms under $2 million in sales volume (16.45 percent), and for high-profit firms (20.50 percent), than for all firms (9.48 percent), and lowest for those with $2 to $5 million in volume (8.78 percent). Return On Net Worth targets should be 20 to 30 percent before tax, since electrical contracting is a high-risk business. The 21.28 percent shown by all firms reporting is adequate, but high-profit firms are showing 39.77 percent.
Another key category measured in the FPR is Financial Structure, or Leverage. Leverage means doing more with less, and one key measurement is the Debt-To-Equity ratio (total liabilities/equity). The closer this ratio is to 1 ($1 in equity for every $1 in liabilities), the easier it is to borrow money, since the owners still own more of the company than the lenders do. Ratios as high as 2.5 are still acceptable, but the 0.94 for high-profit firms and 1.23 for all firms reporting are far more conservative.
The banking industry views lending to contractors as an “exception,” so a conservative Debt-To-Equity ratio is imperative if you’re going to grow the company, since debt is the principal way to fund growth.
Lending is increasingly based on cash flow (liquidity) rather than assets (collateral), which makes the relationship between Accounts Receivable and Accounts Payable significant. The FPR provides two comparisons of AR and AP. The first is the ratio of Accounts Receivable/Accounts Payable, which should fall between 2 and 3. High-profit firms show 4.10, with all firms reporting 3.73, so everyone is financing customer jobs at an unacceptable level.
The second measurement subtracts Average Payable Days from Average Receivable Days, and the acceptable range is 30-45 days. The average collection cycle for high-profit firms is just over 65 days, about one day less than for all firms. The smallest firms (< $2 million in sales) have the best collection cycle (about 49 days) and the largest (> $20 million in sales) the worst, at 76 days. Growth usually means more financing of customer jobs, and looser collection procedures.
The payables cycles of about 14 days for high-profit firms, and two days more for all firms, indicate aggressive early payment. That is fine if these firms are receiving discounts for early payment, but it puts the measure of AR-AP in average days at 44.58 days for all firms, and just over 46 days for high-profit firms, at the high end of the acceptable range. The key is keeping the receivables and payables cycles in balance. If you’re over-financing customer work, the only way to stay within the 30-45 day range is to pay your bills later, and perhaps lose the discounts.
These are just of few of the things you’ll find useful in the FPR. Now that you know what a valuable tool it can be, get a copy, use it, and plan to participate in the next data collection survey. Information is power, especially in today’s competitive market. EC
NORBERG-JOHNSON is a former subcontractor and past president of two national construction associations. She may be reached at email@example.com.