There are three main reasons why the construction industry suffers from such thin margins and why so many companies don't earn economic profit at the end of the day. Let's go ahead and jump in. If you want to build a profitable construction company, one of the first things you need to do is to determine whether you're earning above or below industry average profits.

So I've made this really easy for you. In the notes below for this episode, you will notice a link. If you click on that link, which is coltivar.com backslash benchmarks, it will take you to a webpage.

And on that webpage, we have all the benchmarks for the construction industry broken out by segment. So you will find your segment. And then to the right, you'll notice that we have the average profitability by each of these categories.

At the same time, you're going to want to go to your accounting system and you'll pull an income statement for the last 12 months. Just make sure you're including only closed periods. So pull for the last 12 months, navigate down the financial statement, and then you'll notice a line item that says operating profit or operating income or profit from operations or some variation thereof.

You want to make sure you're looking at profit from your core operations in other words. So you're going to exclude things like other income and other expense. So for example, interest income, interest expense, the gain on a sale of a piece of equipment, et cetera.

So these things are non-core to your business. We want to just look at how much profit does your business generate from its normal operations. We're looking at EBIT in other words, earnings before interest and taxes.

You'll notice that we do want to have depreciation and amortization in the numbers. So make sure that you're accounting for that. We're not looking at EBITDA, we're looking at EBIT.

Now, there are a few nuances here. If your company just went out and bought a ton of equipment and you have a one-time large write-off for depreciation or amortization, for example, through section 179, if you don't know what I'm talking about, just ask your CPA or your accountant. You're going to want to make those adjustments to normalize your numbers.

Or if you have a one-off charge that's hitting your income statement and you need to normalize that, go ahead and make that adjustment. It doesn't have to be perfect science here. We're just taking the first step in your transformative journey.

So just keep that in mind. So even if you're not an accounting or finance person, don't freak out. We just want to keep this thing really simple and really high level.

So you'll pull your income statement, you'll find your operating profit, you'll divide that by your revenue so you can express that as a percentage of your revenue. Once you do that, go back to that page that I referenced, that benchmark page, coltomar.com backslash benchmarks. And remember, you're going to find your category and then you're going to compare your number on the income statement to the benchmarks that we provided.

And then you can determine, okay, am I above or below industry average? This is a really important step because essentially what this is telling you is does your company have a competitive advantage or are there things to fix in your business? And if you're above the industry average, great. Maybe it's time to scale your business if you want to go down that path. Years ago, I was speaking at the CFMA conference in Phoenix, right? So I was doing one of the workshops, the breakout sessions, and there were over 300 executives in the room.

And I asked them, I said, look, how many of you have a competitive advantage? And about 80% of the room, they raised their hands. They're like, I do. I do.

Right. And I'm like, okay, number one, that's impossible because if you're above industry average profit, that just means technically, if you look at the mean, you can't have more than 50% of the room raising their hands. And that's the thing in construction.

A lot of companies believe they have a competitive advantage and who doesn't want one? We're driven by our egos. Oftentimes we have pride in our company. Like we're excited of what we're building and we're proud of our work and what we're creating within our own company.

So we don't want to say, yeah, we're terrible. We suck. We don't have a competitive advantage.

And the truth of the matter is, is that a competitive advantage shows up on your income statement, because if you earn above industry average profits, you have some type of advantage in the marketplace. In other words, you're able to get price premiums, charge more, win jobs, not just based on price, or you're able to complete projects in an efficient manner. So you could actually earn profit, right? If you don't have profits that are above industry average, it's okay.

Like, no shame. I'm not trying to make you feel that at all. It just means that there's opportunity here and there's margin that's leaking out of your business.

I've been a CFO of a billion dollar company. I've been a CFO of multiple companies, mechanical companies, other trade companies. I've also started my own business when I was 16 years old.

I created a landscape business out of my sister's garage, grew it into a multi-million dollar business. And here's why I'm saying you don't need to have shame, because when I was running my company, I had no clue how to read financial statements, clueless. All right.

I was just grinding it out, getting work, doing work, getting work, doing work, and praying at the end of the day that there's money left over. That's a terrible way to run things. Right.

So in my second book, I wrote this book called Outsizing. And I did research as part of writing this book. And I researched the construction industry because this is where I've spent my entire career.

And in the book, what I did is I took 363 companies, and these were doing a million up to a billion dollars in revenue. And these were general contractor companies in the non-residential space. So I took these 363 companies and I computed their economic profit.

See, there's a difference between accounting profit and economic profit because on your income statement that shows accounting profit. But what about the cost of all that equipment that's sitting on your balance sheet, your property plant equipment? What about the cost of your working capital when you have money tied up in retention or in your over under billings, right? Your accounts receivable, et cetera. You have all this money tied up in your business.

What about that cost? That doesn't show up on your income statement. It shows up on your balance sheet. So what I had to do is I had to adjust their accounting profit to reflect their true economic profit.

So I did this, and then I graphed out these companies. So I created this chart and I organized them from the left to the right, the smallest to the largest economic profit. And then I broke it into tenths.

So out of the 363 companies, I had 36, 36, 36, 36, et cetera, right? You get the point. They're all in deciles. When I mapped this out, here's what I discovered in the construction industry.

83% of the economic profit in this sample, which I believe correctly represents the industry in the sample, 83% of the profits came from 20% of the companies. In other words, the top 20% of these contractors were earning 83% of all the profits, which is crazy, right? Think about that. The other 80% of the companies out there were fighting over the scraps.

Then what I did is I looked at the top 10%, the top 10% of the companies. So 36 companies out of the 363, we're earning 64% of the profits. So what about the other ones? They're just playing to play.

Sure. They're looking at their income statement. They're like, yep, we're making money, but they weren't accounting for the cost of invested capital in their business.

So, so many contractors out there are just playing to play. That's why I said, this starts with looking at your numbers. You have to look at your numbers and you have to face the hard cold facts.

So like I said, maybe you're below industry average. That's okay. Maybe you're above industry average.

All right, great. Let's take it to the next level. Now there are a lot of nuances here because we're just looking at things generally, just to get a general direction, how you're doing, because there are a lot of nuances.

Maybe you're like on the website, maybe your benchmark range is six to 7%, but perhaps you're in a competitive market where you should be earning nine to 10% because there's not a lot of competition. So even though you're above the industry average on the website that I was talking to you about, perhaps you're actually underperforming because of your specific geography. So there are a lot of nuances here.

Okay. If I wanted to build this out to be more dynamic, it'd be like a million pages and it'd be a massive spreadsheet. I'm just trying to be helpful for the construction industry and give you a starting point to start framing your around.

Are you competing well, or do you need help there? Do you need improvements? There are three main reasons why the construction industry suffers from such thin margins and why so many companies don't earn economic profit at the end of the day. And they struggle, they go out of business. And I know how it is because I've run a business of my own.

I've been a CFO. I've invested in companies. I've advised a ton of construction companies.

I've spent my entire career turning around and growing construction companies. And here's the deal. Like it's a grind.

You're grinding it out and you have talent shortages. You have material costs increasing. You have warranty claims.

I mean, there's, it's just such a grind and you're pouring your whole heart and energy, like all your time, your energy, your capital back into the business. And if it's not performing well, like nothing is more frustrating. Like, trust me, I have felt that before.

If you're feeling that right now, here's the three main reasons why I construction companies suffer and why they're not as profitable as they can be. Number one, the construction industry is notorious for not knowing their numbers. That was me when I was starting out.

Like I said, I couldn't even read a financial statement. Sure. I could look at an income statement and be like, this is my revenue.

This is my profit. But if you said, what are the three levers to increase your gross profit? I'd be like, uh, I definitely want to know that it's volume pricing and cost of its old, right? So most contractors don't know their numbers. Maybe you're feeling pretty good.

You're like, Steve, I know my numbers. I'm good to go. Let me ask you this.

Do you know what your return on marketing spend is? Do you know what your throughput is? Your revenue per hour, your gross margin per hour, how much gross profit do you earn per super? How about what's your gross profit per super day? There are so many different questions. Like your return on invested capital. I could keep naming off a ton of different metrics, but most contractors don't know their numbers and that's okay.

Like you could go out there and you could build a company and you do great work and you can get away with it for a little bit. But over time, if you don't know your numbers, all it's going to take is something to change in the economy or within your segment or with your customers and everything will be, will come crashing down. I went to work for a company as a CFO is a billion dollar company.

They're around for 50 years. They lost money two times in their history. Once was during the economic downturn of 2008, 2009.

And then the next time was when something changed with their key customer. So it's not always an economic change. It can just be something different with your business and in your market and it totally disrupts your business.

So I don't want that to happen to you. So knowing your numbers is number one, you don't have to be a nerd, right? But understanding your income statement, your balance sheet, your cashflow is really critical. Knowing what those numbers are telling you so you could then go act on them to change your business around is really important.

So like I said, you don't need to be a nerd doing debits and credits in the back office, but you do need to know how to read financial statements and then how to take action. You need to know the story behind the numbers. In other words, okay.

Reason number two, why companies aren't profitable is because they have a poor estimating and job costing system or rhythm. Let me explain for specialty contractors, especially having a bidding system is step number one. So many contractors, they just make stuff up or they use Excel spreadsheets that are like super complex or super dirty and prone to all these errors or they're using unit pricing, which is a terrible way to bid jobs, right? It's a terrible way.

But think about this. Let's say you are estimating a job or you're estimating several jobs. Let's say you have 50 employees out in the field and they work on average 2000 hours a year.

50 employees times 2000 hours a year is a hundred thousand labor hours that you're essentially bidding on and putting in into work, putting into place. Let's say you don't know your numbers and you're just guessing at your labor costs. You're like, I think it's like 33 bucks per hour.

And you put that on your bids and you do that for an entire year. Let's say you're off by $1, just $1 that's a hundred thousand dollars in lost margin. All right.

So just amplify that across your company. And so many businesses like, sure, it's easy to do a takeoff and to determine your materials, right? The quantity of your materials and the cost of your materials. Most companies get that right.

It's their labor. It's their throughput. It's the jobs they pursue.

It's all that lumped into their estimating combined with the methodology that they're using to come up with their pricing and to recover their overhead. So that that's the first thing. Then when it comes to job costing, they don't have a really good system to job cost or it's overly complicated or overly burdensome for their back office.

But more importantly, I'm not going to get into job costing per se. I'm going to keep this high level. I'm going to do it.

I can do a whole nother episode on this, but with job costing, here's the problem. When it comes to job costing and estimating, it's a system, it's a rhythm. And I can't tell you how many times like in my own company, there'd be this fight between the office and the field.

The office is like, all right, field, you need to be more productive because we can't add more hours to our bids. We're already like high priced and customers are balking at our pricing. They're like, you need to be more efficient and get these jobs done so we can bid them appropriately and get more work.

And then the field is always complaining that the estimators aren't including enough hours and they're unrealistic in their budgets. So it's always this like bashing, right? This, this clash between the office and the field. So that's where the rhythm comes in.

You have to get really good at estimating jobs because you're hypothesizing, this is what I think it's going to cost this, how many labor hours I think it's going to take. And then you go out in the field and you execute and then you learn. So it's this build, measure, learn, adjust, build, measure, learn, adjust rhythm that needs to exist in your business.

And this is where data analytics and knowing the numbers is so critical because when you have a system, you'll know, okay, we did this job, but our labor costs are actually off by 50 cents. Cool. Change that with your estimating or you're doing work and you're like, okay, every time we're like short on wire, right? We're short on wire.

You go back into your estimating system. You're like, ah, the calculation's wrong. Right.

Or we don't have enough waste factor in there. I call that the fudge factor. So you have to ensure that you have a system to estimate, go do the work and then learn, make adjustments to your estimate and constantly get really good.

So you can be super competitive out there in the market and get the jobs you want. Number three is limited strategic focus. I think we just get busy.

Like we're building jobs. We're trying to get work. We're, you know, we're doing all this stuff.

It's just a grind. And it's hard to step back as leaders and be like, all right, let's come up with a strategy. So then we just keep doing the same thing.

And that's terrible. So many construction companies struggle with strategy. Strategy is not mission, vision, values.

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I think years ago, a strategy ferry went around the construction industry and said, yeah, mission, vision values, because every website, like the majority of construction websites, it's like, I could tell you, you go up to the navigation, you go to about, they have mission, vision values, and they list out integrity, innovation, technology, whatever it is. Right. I'm like, that's great to list out your values and list out your mission, but how are you actually going to execute on that? What kind of jobs are you pursuing? When I was a CFO of this large company, we were losing money.

I went in there, I looked at our different segments and the whole hypothesis of the team was we should pursue jobs in healthcare because the margins are higher. The fees are higher and they're like poo pooing retail. And that's what they built their business on.

They're like, retail is not good. The margins are low. It's terrible.

So I did an analysis. What I found was that our throughput on healthcare jobs was actually super low. So sure.

We are earning higher fees as a GC, but it took us a lot longer to close out these jobs. So our gross profit earned per day wasn't sufficient to cover our overhead. So this is what I'm talking about as far as knowing your numbers and then knowing your numbers will inform your strategy.

I just did a strategy engagement with another contractor in the utility space. And we were looking at the feasibility of expanding the business. So we built a financial model and we put some inputs in there.

Then we crafted a strategy. We took the strategy, made some modifications to the financial model, and just did this iterative process. And what we found is that going down this path would be a terrible idea because the return on invested capital would be so low compared to the risk.

So the lack of strategic focus kills companies. You don't have to be this big strategist. You don't have to make it super complicated, but you should know how to set a strategy for your business.

So you're pursuing the right type of work and your team knows exactly what to focus on so you can have accountability in your business. So if you want more margin in your company, I'm going to walk you through our system here. And then in future episodes, we're going to get more granular, but I make it very simple.

I just spell out margin as an acronym. First is money. So if you want more margin and I'm not just talking about financial margin, I'm talking about more margin, like financially, operationally, and leadership, like from a leadership perspective, because you can have all this financial margin, but then your operations are a mess.

You can't scale, right? Or your operations are in check. You're earning this money, but from a leadership standpoint, you don't even have time to build your team. And then at home you're struggling because you're always working.

You know, your wife's nagging you, you don't see your kids or whatever it is. Like it could be your wife, your partner, but I've seen so many business owners who make it financially. And then their home life is a mess.

They end up divorced. Their kids don't even know them. They relapse, whatever it is, but terrible things happen.

And I don't want you to go down that path. So that's what I'm talking about with margin. Okay.

So M for margin is money. So you have to have money. And that's why I kicked things off in this episode by saying, look at your operating profit and just if you are above or below industry average.

So getting your financial house in order is super important at coltivar.com under tools, you'll notice we have all these calculators, like the four levers profit calculator. We have the breakeven calculator there. There are all these tools there to help you to get your financial house in order.

So be sure to check those out, but money is key. Okay. If you don't have money and you don't have financial margin, you're going to be out of business.

That's the first thing. A and margin stands for alignment. So you have the money, you need strategic alignment.

That goes back to the whole strategy focus thing. You have to know where you're competing, how you're competing, and ultimately how you're going to win, right? When you get that alignment and you create this alignment with your team, you're going to be moving forward in the right direction. And as a CFO, I remember running this company and I'd go to our different offices and I'd be like, all right, what are you guys focused on? What are your initiatives? And they would say some random stuff.

I'm like, we just met yesterday and I laid out the strategy. Now you're saying some other things. So maybe your alignment problem, if you're struggling with this is that you're not saying it enough.

And maybe you lack specificity too, but alignment is key. Okay. R and margin stands for rhythm.

It's creating a rhythm between estimating and ops. It's creating a rhythm of your financial strategy reviews and your quarterly strategy reviews. It's this rhythm to build, measure, learn, adjust, build, measure, learn, adjust.

And most companies, they don't have a defined rhythm. And because of that, they struggle from a financial and operational standpoint. But if you get your rhythm, right, then it leads to the next letter in the acronym margin G for growth.

So you have your money, you have your alignment, you have your rhythm. Then you start to grow and you grow profitably. You don't want to grow your business.

If you don't have the other things in check, because you will grow yourself out of business. I've seen this happen so many times G for growth. There's smart growth.

There's dumb growth. Make sure you're pursuing the right type of growth. That's profitable.

And that's sustainable. Then I, in the acronym margin stands for insights. Do you have a KPI dashboard? Do you know your numbers? Do you have a forecast? Insights are key.

You can't just make decisions from the gut. I've tried that before. I could tell you terrible idea.

So don't do that. Having insights, having a KPI dashboard is super critical. All the companies we work with have a KPI dashboard.

They know exactly what's our revenue per hour, our gross margin per hour, our return on invested capital, our gross profit, our day sales outstanding, our retention ratio, our backlog to equity ratio. Like all these things they know in one spot. They could look, they know exactly where they're at, what their target is, and then they can make database decisions.

All right, that's I. Then we move on to N for navigation. Think about this. You go on a road trip, you have your map, right? Your Apple's map, your Google's map, your Google map, whatever.

And it's giving you a path, right? And it says 20 minutes. You start going down that path and then there's an accident. And it's like rerouting you.

Turn right, save two minutes. That's exactly what a navigation system does. When you have all this stuff, money, alignment, rhythm, growth insight, and then a navigation system, you can make adjustments along the way.

So you need a system in your business. You need a system. That's the key.

That's the biggest thing that I struggled with when I was running my businesses or when I was a CFO. It wasn't until we had a system in place that things started to work and we started to scale without all this extra chaos. All right.

So that's what I have for you in this episode. Be sure to get your benchmark, pull your income statement. Don't just listen to this and not do anything.

Pull your income statement, get it from your CPA, your controller, your accounting team, or pull it yourself. Look at your operating profit divided by revenue. So you can understand what is your operating profit as a percentage revenue.

Compare that to that benchmark page. Remember the link is in the notes below. So just click on that link.

And then you'll know whether or not you're above or below industry average. All right. So that's the first step.

That's all you need to do today. And then meet me back here for the next episode, where we'll take the next step on this transformative journey to make your construction company more profitable. All right.

Take care. Cheers. 

Right off for depreciation in 80, which I believe represents the, and because of that, if it, and then meet me back here. Yeah.