It’s easy to get caught up in the day-to-day details of running a construction firm. You have deadlines to meet, orders to fill, and employee matters to deal with. So, the thought of taking a few steps back to do planning may seem complicated, even impossible. But if you want to control your firm’s growth (instead of letting it control you), it’s time to begin setting aside time for financial forecasting.
The Role of Forecasting
Financial forecasting requires you to evaluate the success of your current and past strategies. You’ll use this assessment to determine plans for the future, including cash flow allocation, budgeting, and contingency plans. Forecasting also highlights the impact of current expenses and will reveal ongoing financial problem areas and their causes.
Forecasting is also a way to foster and predict growth. You’ll create benchmarks, develop metrics for improvement, and create an environment of stability.
In fact, the greatest value of forecasting is not the finished product. The real value lies in the process of research. Putting the forecast together requires an executive to take a step back, evaluate, and analyze expenses and revenue as controllable, predictable parts of the business. This time spent in analysis will benefit almost every other part of the business.
Sounds Good. How Do I Get Started?
Most experts agreed that there are a few standardized components required for effective forecasting. They include:
- A review of the past three to five years of sales, including details on profit, costs, and expenses
- A competitive overview that includes a definition of territory coverage and an estimate of market share within that territory
- A twelve-month profit and loss projection with narrative
- A three-year profit and loss projection with narrative
- A cash flow projection
- A projected balance sheet
- A breakeven calculation
The Role of Narrative
While numbers and charts are essential to forecasting, creating a narrative for the numbers is also critical. Narratives are detailed notes on the sources of information, what numbers are based upon, relevant market factors, and any underlying assumptions. Narratives restate and interpret numbers and charts.
Narratives are a requirement for investors, but they’re also beneficial internally. After all, losing track of some of the logic and rationales behind forecasting is easy. Including comprehensive narratives for each set of projections ensures that information and forecasting will be apparent to you or any reader at future dates.
Three- to Five-Year Reviews
Before you begin forecasting, it makes sense to review past performance carefully. If you don’t have a set of reports like this, now is the time to prepare them. Start by gathering information that provides detailed reporting on sales each month and each year. Next, track fixed and variable expenses (if you’re not sure what these are, see the definitions in the “Breakeven Analysis” segment of this article) and develop ongoing P&L reports.
This history will serve as a baseline. You’ll be able to quickly assess patterns of profit and loss and see recurring issues as well as repeating opportunities.
Competitive Overview
No business operates in a bubble. Every company in every industry is directly affected by the competition. That’s why it’s smart to understand other companies in your field. Start by defining your territory. How far do you go for jobs? Ten miles? One hundred miles? For example, do you stick to work on Long Island, or do you also travel to Manhattan or the Bronx? The geography in which you do business is your territory.
Once you have your territory defined, start looking at your competitors in the region. Which firms are doing the same kind of construction? For example, how many general contractors handle $500k jobs in Queens? Let’s say there are one hundred. Do you know who they are? Do you know their reputation? What are their offices like? Do they have a sharp marketing program? How do they submit bids?
Start gathering information with online research. Which firms look like leaders, and which are hard to find? Are they offering the same services as you, or do they have other specialties or adjacent services? Do they list projects or work? What do their portfolios look like? Can you gather company information on them by paying for access to online databases like Dun and Bradstreet? Can you use your professional network to find out more about them?
Creating a spreadsheet of competitors, their services, size, strengths, weaknesses, and marketing efforts is a great way to understand where your business ranks. Are you doing better than your competitors, or are they gaining ground faster?
It’s also essential to think about your company’s share of market. If there are one hundred competitors in your market, are you getting one percent of the work? Do you want to get more? Who will you take that work from, and how will you gain market share? Take note and use this information to inform your forecasting.
Twelve-Month Profit and Loss Projection
This is the place to enter projected sales, cost of goods sold, and gross profit. Next, list expenses, net profit before taxes, estimated taxes, and net operating income.
Include a narrative that spells out the major assumptions used to estimate company income and expenses. Sales projections should align with your annual sales forecast. If historical performance is significantly different from your projections, explain why.
It’s also a good practice to keep detailed notes about the calculations of figures, formulas, and sources of numbers. This is required if you’re using forecasting for financial investment, but even if this is strictly an internal document, good notes help you explain the forecast to others and may even provide some shortcuts for next year’s forecasting exercise.
Three-Year Profit and Loss Forecast
While the twelve-month projection is the foundational building block of next year’s financial plan, it’s also a good idea to continue forecasts beyond year one.
A three-year plan will help you understand how improvements can provide incremental or exponential benefits. A small change in year one can reap big rewards in year three. A three-year plan will also help you question the logic of significant investments that eat away at the bottom line for years to come.
As always, provide a narrative for projections, and keep organized notes of your key assumptions, formulas, and sources.
Cash Flow Projection
While it’s best practice to keep close tabs on your ongoing cash flow, forecasting requires a cash flow projection. This forecast makes it possible to develop timelines for expenditures such as expanded inventory, new equipment, rent, and payroll. Budgeting for future expenses reduces the chances of depleting cash flow.
Projected Balance Sheet
As you create your twelve-month P&L sheet, you’ll also want to note projected balances.
As always, include a narrative to explain your projections and assumptions used for any major changes between your last historical balance sheet and the forecast.
Breakeven Analysis
What sales volume will you need to cover your costs over the next twelve months? When will the business break even? In addition to listing profit and loss projections, enter expected fixed and variable costs to determine where the breakeven point lies. We recommend this breakeven formula:
Fixed Costs / (Sales Price per Unit – Variable Cost Per Unit) = Breakeven
- Fixed Costs don’t change, even when output varies, such as rent, machinery maintenance, or loan payments.
- Sales Price per Unit is the selling price per unit or job.
- Variable Cost per Unit is the cost to create each unit. It changes depending on what type, how much, etc.
Example of an annual breakeven analysis:
- Fixed Costs $300K
- Sales Price per Unit $500K
- Variable Cost per Unit $400K
300K / 500K – 400K = 3 units or jobs. This means you will need to complete three $500K jobs to break even.
Another example of an annual breakeven analysis:
- Fixed Costs $200K
- Sales Price per Unit $500K
- Variable Cost per Unit $400K
200K / (500K – 400K) = .5 units or jobs. You will break even after completing half of one $500K job.
As you can see with these examples, by playing with a couple of different breakeven analyses, you can think about whether reducing fixed costs improves the formula. You could also play around with increasing project size or reducing variable costs.
Make Time for Forecasting
A good business forecast is not quick or simple. It requires a lot of time and effort. And that can be difficult for a busy contractor who is just trying to keep up with existing business. But investing time in analysis, evaluation, and projections is the only way to break away from the competition. If you want to gain control of your business, grow it in methodical and predictable ways, and maybe regain a little control of your own time in the process, thorough forecasting is the first step.
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