By Claire Wilson, Siteline

Effective financial management is crucial for success in any industry. But in an industry that involves substantial and frequent upfront investment, like construction, thorough financial oversight is especially important. Accounting teams rely on metrics (or key performance indicators) to assess business performance, manage risk, and make informed decisions that will ultimately propel growth.

Whether you’re preparing to present your company’s financials to leadership or seeking ways to improve your current financial reporting processes, we’ve compiled a list of the top financial metrics you should keep track of in the new year and beyond.

1. Gross Profit Margin

Gross profit margin (also known as gross margin ratio) is the total revenue generated by a company before deducting the cost of goods sold (COGS), which is basically equipment, labor, and materials costs. It’s typically expressed as a percentage of sales.

The formula for calculating gross profit margin is: Gross profit margin = (Revenue – COGS) / Revenue x 100

A higher gross profit margin indicates that a company is making more money on its projects. On the other hand, declining margins may indicate increased production costs or pricing issues. Therefore, construction company owners and CFOs should review this metric every month to ensure that operations are running smoothly and the company’s pricing strategy is sound.

2. Net Profit Margin

So, what’s the amount of money your company is making after operating costs (e.g., interest and taxes) and COGS are subtracted from the total revenue generated? That would be your net profit margin—also expressed as a percentage of sales. (Think of the percentage as the amount of actual profit each earned dollar yields.)

The formula for calculating net profit margin is: Net profit margin = (Revenue – COGS – Interest – Tax) / Revenue x 100

Similar to gross profit margin, the higher your company’s net profit margin, the more money it’s making. It’s also recommended you review your net profit margin at least monthly, if not bi-monthly, to stay on top of any changes. For instance, if you notice a decrease in your net profit margin, it’s possible that operational inefficiencies or rising costs are to blame. In fact, the latter may be a signal that it’s time to raise your own prices.

3. Operating Profit Margin

While net profit margin offers a comprehensive view of your company’s profitability by considering all expenses and income, operating profit margin specifically shows how efficiently your company generates profits from its primary business activities. Think COGS, wages, rent, utilities, and other operating costs. This is because it doesn’t include extraneous costs like taxes and interest.

The formula for calculating operating profit percentage: Operating profit margin = (Revenue – COGS – Operating Expenses – Depreciation – Amortization) / Revenue x 100

A higher operating profit margin means that the company is managing its costs related to production, distribution, and sales more efficiently. This, in turn, highlights areas that can be optimized or improved.

4. Net Cash Flow

Cash flow is all the money moving in and out of your company (or a project) over a specific period of time.

The formula for calculating cash flow: Net cash flow = Cash in (over a given period) – Cash out (over a given period)

Reviewing cash flow is a great way to measure the short-term financial health of your organization. It serves several important purposes:

• Tracking revenue sources: It provides a comprehensive view of where your company’s cash is coming in, shedding light on all its income streams.
• Identifying potential cash shortages: A negative cash flow means your company is spending more than it’s earning. This isn’t always a cause for concern, particularly if your company is in the early stages of a significant growth phase, but it still warrants attention to prevent future shortfalls.
• Predicting future cash flow: By regularly assessing your company’s incoming and outgoing funds, you can better predict its future cash position, aiding in proactive financial planning.

5. Working Capital

Working capital is an important metric that measures a company’s short-term liquidity and its ability to meet financial obligations. This metric should be reviewed on a monthly basis.

The formula for calculating working capital: Working capital = Current assets – Current liabilities

Current assets include:

• cash on hand,
• accounts receivable,
• materials and supplies for ongoing projects (a.k.a. inventory),
• work in progress, and
• retainage receivables.

Current liabilities include:

• accounts payable,
• accrued expenses (e.g., wages, utilities, interest),
• short-term debt,
• billings in excess of costs, and
• contract retainage payable.

If your company’s working capital is negative, that means you don’t have enough cash on hand to pay your bills. Therefore, managing assets and liabilities efficiently is crucial for maintaining adequate working capital to sustain operations and complete your current projects.

6. Accounts Receivable and Payable Turnover

Tracking how fast your company gets paid (receivables) compared to how quickly it pays its bills (payables) shows how efficient your financial system is. That’s why monitoring your accounts receivable (A/R) turnover and accounts payable (A/P) turnover monthly is important for maintaining a healthy financial balance.

A/R Turnover

The formula for calculating accounts receivable turnover: Accounts receivable turnover = Net credit sales / Average accounts receivable

Keep in mind that the construction industry is known for its slow payments, particularly if you’re in a commercial trade where the average time to payment is 90 days. However, staying on top of your A/R turnover can help you detect collection issues before they spiral out of control.

A/P Turnover

The formula for calculating accounts payable turnover: Accounts payable turnover = Total purchases / Average accounts payable

The faster you pay your bills, the lower your A/R turnover will be, and the less likely your company will incur additional interest charges or other late payment penalties.

7. Net Overbilling

Net overbilling is the difference between the amount that your company bills to clients and the revenue recognized by the percentage of completion method. Its primary purpose is to identify instances of overbilling, which occurs when the client is charged for more work than has been completed. For example, if a contractor completes 30% of the work but bills the client for 40%, this would be considered overbilling.

The formula for calculating net overbilling: Net overbilling = Amount billed – Revenue recognized

While some level of overbilling is usually acceptable on the subcontractors’ part, it’s important to keep an eye on this metric to ensure that it’s within reasonable limits. This not only helps prevent borrowing from other projects in case the estimated costs to complete a contract exceed the remaining amount of money to be billed but also aids in maintaining a healthy financial standing for the project.

8. Cost Variance

Cost variance compares the actual costs incurred on a project with the budgeted costs for that project. Basically, it helps assess whether the project is within the planned budget.

The formula for calculating cost variance: Cost variance = Actual costs – Budgeted costs

When there are significant differences in costs, it usually means that the cost estimation or project management is not going as planned. That’s why it’s important to keep regular tabs on this metric to quickly identify areas where actual expenses may have deviated from the plan and make necessary adjustments to bring the project back on track.

9. Quick Ratio

Quick ratio (also called acid-test ratio or simply “quick”) is a handy little metric used to measure a company’s ability to pay its current liabilities with its liquid assets. It excludes inventory and focuses solely on cash, cash equivalents, and accounts receivable.

The formula for calculating quick ratio: Quick ratio = (Current Assets – Inventory) / Current Liabilities

The more assets and fewer liabilities your company has, the more confident banks and other financial institutions will be in its ability to repay its loans. As a general rule, ratios between 1.5 and 3 are considered good.

10. Return on Investment

While likely a staple metric in your financial reporting toolkit, return on investment (ROI) is worth highlighting because it is one of the most valuable tools for assessing the profitability of your projects over the course of the year. Specifically, it measures profitability by comparing gains and losses generated to the amount invested.

The formula for calculating return on investment: Return on investment = (Net profit / Investment cost) x 100

A high return on investment is a positive indicator of the overall health and success of your company’s projects. As such, it plays a pivotal role in resource allocation, strategic planning, risk assessment, and performance evaluation, ultimately contributing to the financial growth of a company.

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While this list is not exhaustive, it provides a strong foundation for monitoring the financial health, profitability, and efficiency of your company. Regularly tracking these metrics empowers your team to navigate financial reporting with confidence and make informed decisions that steer the organization toward sustained growth in the coming years.

About the Author 

Claire Wilson is Head of Construction Solutions at Siteline, the only pay app and lien waiver management software for trade contractors. Previously, Claire was a project manager at Tishman Construction in New York City where she worked on monumental projects including Hudson Yards and JP Morgan’s Corporate Headquarters. She has a BS in Civil Engineering from Bucknell University and now serves on the board of the Bay Area Subcontractors Association (BASA).