If you haven't taken your company’s financial pulse recently, it’s time to review your system for analyzing financial information. The 2006 Financial Performance Report (FPR), compiled by the National Electrical Contractors Association (NECA) from financial data reported by electrical contractors for the 2005 fiscal year, provides a wealth of information to get you started. In this two-part series, we’ll review the information contained in this tool and look at some examples of how you can use it.
Why is the FPR valuable to you? First, the report provides a concise, user-friendly format for calculating a range of ratios. Even if you don’t consider yourself financially sophisticated, you will find it simple to understand the definitions of each ratio and how it is used to measure performance and financial health. Second, the collected data provide a true “peer group” comparison for professional electrical contractors and a ready-made system for benchmarking your financial trends. Finally, the report is a great negotiating tool to show bankers, bonding companies, suppliers and even the IRS that your company conforms to actual standard industry practice.
The first section defines measurements and provides formulas and desirable targets. A review of the cash flow cycle, including measurements, is particularly useful.
Next, you will find an executive summary, including bar graphs comparing key ratios by sales volume category. These include profit, sales revenue growth, key expenses, debt and liquidity.
The bulk of the report provides supporting data, categorized in several ways. There is a section comparing high profit companies with the entire reporting pool. Another section showing results by sales volume includes six categories, ranging from less than $2 million to more than $30 million in revenue. A third section provides geographic information from 10 districts in the United States, plus data for Canadian firms.
The same ratios and line items are shown for each section. One page provides key ratios. Several others use line items from the balance sheet and income statement converted to percentages. Balance sheet line items are shown as percentages of total assets. Income statement line items are shown both as percentages of sales and direct labor. Having the data in several formats enables you to set up many types of comparisons. You can use the information to help you understand your own financial information in a larger context, decide whether to expand your company, reduce particular expense items, or change profit or debt strategies.
The appendix summarizes the demographics and methodology used in the data gathering and reporting. The number of respondents in each type of category, organizational type (such as C corporation) and accounting method percentage (cash or accrual, for example) are provided. There is a concise review of ratios, and a submission form is included if you wish to participate in the next survey and report.
Using the FPR is quite simple if you remember ratios are just fractions comparing line items from your balance sheet and income statement. Some are shown as percentages, some in days and others as the product of two measurements. Here are some ways to use the report and interpret the information it contains.
The current ratio (current assets ÷ current liabilities) measures the ability to pay your 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. All firms show healthy liquidity ratios (between 2.22 and 1.90). The smallest companies (less than $2 million in sales volume) show the highest ratio, but there is no direct relationship between liquidity and volume for the remaining volume categories. Since most contracting businesses struggle to achieve acceptable liquidity levels, you should track this ratio often.
Improving your profit on sales ratio (profit before or after tax ÷ sales revenue) enables you to reinvest in the assets you need to support future growth and modernization or improve the return on owner investment. All companies report 3.55 percent before tax, but the high profit firms, at 7.01 percent, achieve almost double that figure. Both percentages are substantially higher than those on the 2004 report (1.71 and 4.52 percent) and far surpass the usual industry averages.
By volume, the picture is bleaker. The smallest firms (under $2 million) report a mere 1.07 percent, and the largest (more than $30 million) show 2.64 percent. However, the $10–20 million firms report the highest profit by volume, at 5.09 percent. Growth does not necessarily result in improved profitability, and the results shown here are reiterated often throughout the report. If you are considering growth beyond $20 million in sales, you may want to take a closer look at the ratios shown in this category, compared to those for higher and lower volume companies.
Now that you have an overview of the report, tune in next month, and we’ll review some other performance indicators within the FPR. EC
NORBERG-JOHNSON is a former subcontractor and past president of two national construction associations. She may be reached at firstname.lastname@example.org.