Five ratios every contractor needs to know
Financial ratios are useful tools that translate your accounting data into information that allows you to keep a pulse on the health of your construction company. This week we’re discussing the top five ratios and how to use them in your business.
Topics we cover in this episode include:
- Ratios and year-end planning
- Working Capital and the Quick Ratio
- Days of Cash
- Debt to Equity Ratio
- Underbillings to Working Capital Ratio
- Net Income after taxes
- Return on assets
- Backlog Gross Profit
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Rob Williams, Profit Strategist | IronGateESS.com
Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | McWins.com
[00:00:00] Rob Williams: Welcome to the Contractor Success Forum. Today we’re discussing the top five ratios contractors need to know. This is an amazing episode here on the Contractor Success Forum, because we discuss how to run a contracting business more profitable.
And who do we have with us today? We have three experts of the industry. We have Wade Carpenter, Carpenter, and Company, CPAs. And I just love that new logo on your background there. And we have Stephen Brown with McDaniel-Whitley Bonding and Insurance agency. The experts, these two guys, on ratios. And I am Rob Williams with IronGate Entrepreneurial Support Systems.
So guys, my God, we’re gonna duke it out today to figure out what these top five ratios are for contractors, man.
[00:01:03] Wade Carpenter: It may be a good thing you’re in Memphis and we’re in Atlanta. because I think we were talking before, we need any fights here, but.
[00:01:11] Stephen Brown: Well, everybody’s got an opinion on financial ratios. Don’t they?
[00:01:16] Rob Williams: Yeah.
[00:01:16] Stephen Brown: I guess our listeners need to know, what is a financial ratio? Well, what are we talking about? Financial ratios are ratios that you use from your accounting data to tell you how your business is doing. And they’re great tools. Rob, did they not talk about this when you were in MBA or was this in regular business school? Where did this come up?
[00:01:39] Rob Williams: We talked about some ratios and we talked about a bunch of big corporate stuff, but it just didn’t mean much until I had a decade or two under my belt to get what these numbers were. And I was joking with you guys earlier, I still have to look these things up sometimes to remember exactly what they are. But it’s so important and where do we get these as contractors? Where do we get our information about these ratios? And unfortunately we get them from ourselves sometime instead of the experts of what these ratios should be and even what they are. I think we get in these contractor groups and talk about them, and we have a lot of misconceptions of these ratios and what they mean and even which numbers are included in the different ratios, and who looks at these and why do we even need these things?
[00:02:27] Stephen Brown: Well, you just said, who looks at the ratios? That’s a huge question before we start arguing about what the best ratios are for contractors and what range they should be. Hey, we could do that all day long, but who looks at it? First of all, you need to look at it.
[00:02:42] Rob Williams: Well, that’s who should look at–
[00:02:43] Stephen Brown: That’s right. Whether you look at them or not, your bonding company and your banker, they look at them.
[00:02:50] Rob Williams: I think that’s why we look at our ratios, because we know that the bankers are gonna be looking at the ratios. We look at profit margins and some other things, but not the ratios as much. Some of the contractors may look at them on a more regular basis, especially if they’ve got a CFO or something like that.
But yeah we look at them because they’re looking at them.
[00:03:10] Stephen Brown: I tell you else looks at them. If you have a good construction oriented CPA like Wade Carpenter, they’re looking at them. They’re looking at–
[00:03:17] Wade Carpenter: You trying to make up now, I guess the check’s in the mail.
[00:03:20] Stephen Brown: Okay, But they look at them because it’s their job to help their clients interpret their numbers. You help provide a year-end financial statement for your contractors, and you also help them interpret the numbers, right?
[00:03:34] Wade Carpenter: Right. And you know, exactly what Rob said, that, a smart contractor is going to be looking at these numbers, not just because it’s gonna affect your bonding or your banking, but it’s also the health of your company.
And, I did also wanna point out that, and I, may not should say this on our podcast, but bonding companies are gonna look at your ratios a lot more. They’re gonna scrutinize it a lot more than a banker would. Sometimes there are things that, you can get by a banker that you can’t get by your bonding company. But I think learning what the bonding companies are looking for, they’re looking to make sure your financial health is there. And I think that’s a great way to look at it is, looking at it through their standpoint.
[00:04:19] Stephen Brown: Hey, financial health. You know when you get your blood work, you get that chart and then there’s a line that goes down the middle and that’s the normal range. And if it goes out, maybe your doctor circles it and makes a little note to you to follow up on this or follow up on that. That’s the exact same thing with ratios.
[00:04:35] Rob Williams: Yeah. I have to tell you one big point about this. If contractors will look at their ratios, they can actually control these if they understand them. Because when I talk about a ratio to a contractor the first thing, and I bet Wade would say this too, is yeah, but. They always know something about that. They have an explanation about that ratio and they’re probably not sitting there with somebody that’s looking at this thing. And there’s often something they can do about it.
Oh yeah, well, we coded this to this, or I haven’t done this yet, or something. Sometimes there are huge ratio things that you could fix or do something about that would be the difference of getting bonded or not getting bonded. Or getting your loan pulled, or not getting your loan pulled.
I think there’s a misconception that the contractors say, I’m just gonna run my business, and then these numbers are here. If you know what these are, some of them, you can really control them, one for the health of your business, but sometimes it is something that’s just not in the right place, or you need to ship some material to something so you can count it. So there’s something that you can control very easily that would make a huge difference in your ratio because you know your company is healthy, but it may not be reflected on that ratio just because the “yeah, but…”. You know that explanation that you’re not sitting there in front the underwriter to explain that.
[00:06:02] Stephen Brown: Yeah. We’re both bobbing our heads. Yes, you are correct on that, Rob.
Ratios and year-end planning
[00:06:07] Wade Carpenter: We’re recording this, getting towards the end of September. About this time, October, November is when I’m sitting down with our contractors, we’ve done some episodes on, what you should be doing for year end planning.
But when we’re looking at tax purposes versus financial statement purposes, that’s where we look at the ratios. If you’ve got a good CPA, they’re looking at these ratios in October, November, and then they’re reaching out to the bonding company, the bond agent, and saying, What do you want these to look like, and how can we dress these up?
Not by cheating, but saying, do we need to leave our cash in there? Sometimes people will pay their cash down at the end of the year just to save on taxes. Doing that may be wrecking their cash ratios or working capital. The other point about what you just said the fact that, number one, understanding the, what the ratios mean.
But number two, I think Stephen would agree with me is that, when you can explain there is something out of the ordinary, but there’s a reason for it. And not making excuses, but sometimes things happen and Stephen, I guess I’ll let you comment on that, but just like the contract schedules, things happen.
[00:07:16] Stephen Brown: You made my day saying that. Both of you. This was not scripted, listeners. You absolutely made my day, Wade, because it’s that time of year. Accountants look, you know when football season’s coming, you know when deer seasons starts, you know when duck seasons starts, you know these things instinctually.
And this time of year, if you have a December 31st year end, you should be meeting and talking with your construction-oriented CPA. Folks, you don’t learn construction accounting in college. It’s an art form. You have to do it all the time. All right, I’m finished with that. But please get together with your CPA and do a little bit of talking before the year-end’s produced, because you’re right. Construction oriented CPA generally know what’s gonna affect your taxes and what the bonding companies need. General rule of thumb. And if they don’t, involve your bond agent and just go over that together.
[00:08:12] Rob Williams: The one thing, what Wade just said, that I think contractors have a misconception of is the CPAs talking about changing these numbers. Our impression is the CPAs are just smart and I’ve got this smart guy and he’s gonna move things around in the numbers. He’s not just moving things around, he’s talking to you so you can do something in your contracting business that legally and correctly changes the numbers that will be reflected on there. It’s not that the CPA’s doing it on his own and just moving things around on where he codes stuff.
He’s not cooking the books. I mean, some may, I don’t know. But that’s not what we’re talking about. We’re talking about real business changes that he needs to go back and forth, or she needs to go back and forth with you as the contractor to focus on getting you to some of those financial ratio goals.
So anyway it’s not that they do it by themselves. They need a relationship with you and go back and forth. I think a lot of times they’re just so separated. I had some CPAs that were more just reporting and filing my taxes that didn’t get involved in my business and that’s not what I needed. So anyway, Okay.
Back to the number one. So Steven, what’s the number one? What are our number one ratios?
[00:09:29] Stephen Brown: That was a great point. Oh, he could not have gone on without that point. Thank you. Okay.
Working Capital and the Quick Ratio
[00:09:34] Stephen Brown: Ratios, financial ratios. First ratio of bonding tells us about your working capital. And guys, working capital is current assets minus current liabilities, and that produces what’s called the Quick Ratio.
Quick Ratio. So you take your current assets, that’s all your cash and cash equivalents, including receivables, and you subtract it from your current liabilities. That’s everything you owe within the next 12 months. And if that ratio is a one or above, that means you’ve got enough cash to pay your bills. So working capital is also a percentage of your sales tells us what kind of bonding program the bonding company’s comfortable doing. Doesn’t that make sense? If you were a bonding company, wouldn’t you wanna know that contractor had enough cash?
[00:10:27] Wade Carpenter: Yeah, let me comment on that too. I guess I, I would say actually agree with you. Number one is working capital. But the way that a bonding company is going to look at that differently than say a bank or traditional finance, you’re gonna just take your current assets minus your current liabilities, which is basically a ratio of, again, do you have more assets than liabilities?
Thinking about the way a bonding company, they’re going to throw out things like prepaid expenses. If you have any inventory at all, they’re probably gonna give you maybe 50%, if any credit for it all. There are other things, like if you got loans to shareholders they’re gonna throw that kind of stuff out.
So understanding what that working capital, or I refer to it as adjusted working capital. Cause it’s not, there’s not a traditional textbook definition of it. It’s the way that bonding companies look at it.
[00:11:22] Stephen Brown: Right. I guess that was kinda sneaky of me by overgeneralizing that. It is adjusted by the bonding companies, but that’s why you need a good bond agent. They’ll roll up their sleeves and duke it out with them. They’ll explain, Well, You need to look at this. You may be talking to deaf ears, but different companies have different feelings about that. They really do. But you’re right, as a general rule, they are gonna throw this out and that out.
[00:11:46] Rob Williams: Well, I know what I thought was the number one. Did–
[00:11:49] Stephen Brown: What?
[00:11:49] Rob Williams: I think the working capital is the most popular one that’s looked at, but I’ve got a different play on this. To me, the number one ratio is the ratio that is the most out of line for the company, because I have seen that–
[00:12:06] Wade Carpenter: He’s going theoretical now. I don’t, it’s like
[00:12:09] Stephen Brown: Oh man.
[00:12:09] Rob Williams: Because I’ve actually dealt with a lot of companies where the working capital for years and years is just not very important with them. They don’t have an issue with it. But maybe their debt is a big problem or maybe some other things. So to me it’s the maybe. Okay. I thought that was a really good answer.
[00:12:25] Wade Carpenter: I think we’re going philosophical now,
[00:12:27] Stephen Brown: Yeah, but , It depends on the type of contractor you are. It changes.
[00:12:32] Rob Williams: I think it’s not the same for everybody. Yeah, it’s different for everybody. But giving that I do think the most popular and the most common one that I see is the working capital. When the working capital’s off, it’s a huge problem. You know? So, but it’s not always the most important one. It’s actually very frequently, it’s not important because it’s in line.
[00:12:52] Stephen Brown: Well, let me tell you about how Liberty Mutual Surety breaks their ratios down. They break it down into five categories. They broke it down to liquidity ratios, like this quick ratio or current ratios we were talking about. They have leverage ratios, profitability ratios, cash flow ratios, efficiency ratios, and backlog ratios.
That’s what they look at. And each one of them has different type of ratios in there that go into that category. For example, liquidity. We always talk about cash is king. So that’s why the quick ratio is so important because it’s a liquidity ratio. But other categories that, for example, Liberty Mutual uses in their benchmarking studies are the days of cash. Days of cash is how many days worth of cash do you have on hand to pay your bills? So, if it’s 60 days worth of cash, you got enough cash to pay 60 days worth of your bills.
And then they have another ratio called working capital turnover ratio. That’s your net sales divided by your average working capital. So what does that mean? Why do they care about that, Wade?
[00:14:05] Wade Carpenter: Well I think all of them are a different form of looking at the working capital ratio. And, I guess from my standpoint, the one reason I put working capital ratio as number one is yes, it is the liquidity. And I know you said one to one is you’ve got at least as much working capital as current liabilities.
But typically they’re gonna look at 1.4 or higher to say that’s a healthy company.
[00:14:33] Stephen Brown: That’s right.
[00:14:34] Wade Carpenter: Number two is I think, bonding capacity. There’s a general rule of thumb and Stephen can tell you it doesn’t always follow the rule of thumb, but your bonding capacity is, generally speaking, 10 times your working capital.
[00:14:48] Stephen Brown: Absolutely correct. That’s a general rule of thumb. But different type of contractors, that percentage varies.
[00:14:56] Rob Williams: Well, which it is important because you pointed that out to me, Stephen, when I was in business. If you’ve got the experience and you’ve got some other things, don’t eliminate yourself because you think you have to have 10 times. Because I thought that was a hard and fast rule, but sometimes you can get bonded at 20 times or 50 times even, if you’ve really got a lot of experience in that.
[00:15:16] Stephen Brown: That’s right.
[00:15:17] Wade Carpenter: If you’re, less than three years old or something like that, you may not get 10 times. There are circumstances.
Days of Cash
[00:15:23] Rob Williams: I’ve got one more thing that days of cash before we lead this liquidity. Right now I’m seeing a problem with this covid and some problems. This days of cash where you don’t have your receivables in there is really important right now because I’m seeing a lot of really long receivables happening.
[00:15:41] Stephen Brown: Well, it’s the days that you can cover operating expenses.
[00:15:45] Rob Williams: Yeah. Without your receivables. That’s the thing. When I get a contractor that’s in trouble, that’s calling me, it’s usually, that’s when they call me they don’t call me when they’re healthy. A lot of times when they’re in trouble, most of the time, at least recently, it’s been because their receivables are so high. And that days of cash doesn’t put that receivables in there. It’s that cash number. When I was a contractor, that was the really important number for me was days of cash, because receivables was often a really big problem. And I think a lot of these ratios are assuming that your receivables are coming in.
[00:16:20] Stephen Brown: Good point.
[00:16:22] Rob Williams: Right now, days of cash is actually more important for me in my practice than the whole working capital is. So.
[00:16:29] Stephen Brown: So there we go.
[00:16:31] Rob Williams: All right.
[00:16:32] Wade Carpenter: Let me throw out my number two, which goes along with the same line of thinking is, what are the things that affect our bonding capacity? And I know Stephen knows where I’m going with this. The debt to equity ratio and you’re basically having your equity.
Generally there’s a rule of thumb that 10 times your equity is one of the other general ways they figure out your bonding capacity. Facts and circumstances may affect that, but…
Debt to equity ratio
[00:16:57] Stephen Brown: Debt to equity ratio is your total liabilities divided by your equity. And your equity is what shows up on your year-end financial statement. That’s equity. It’s your net worth. It’s your, how much equity you’ve built up in the company over the years. So if your debt to equity is, say, one to one, then that means you can think, well, I guess I’m partners 50/50 with the bank. But if your debt to equity ratio is three times that, then you could say legitimately, well, the bank really owns three times more of this company than I do. So you think to yourself, well, if I’m going to a bank for another loan and this ratio is high, they’re gonna tap out at some point. They’re gonna say I just don’t want to be this much in bed with you. I don’t want to own and operate and run your company. I can’t do it. So that’s huge, Wade. No fighting here. I would consider that the most important leverage ratio there is.
[00:17:59] Wade Carpenter: That’s exactly where I was gonna go with that. It’s a measure of leverage.
[00:18:03] Rob Williams: To me, I look at that as a longer term ratio, versus a short term, day to day ratio.
[00:18:11] Stephen Brown: I like to think of leverage ratios as, what is a lever? Picture putting a big long piece of wood over a rock and using it as lever to push something outta the ground. Who’s got the leverage of telling you what to do? Maybe I’m overestimating this, but leverage ratios, debt to equity, that’s kind of an important thing to know, guys.
[00:18:31] Wade Carpenter: Yeah, and again, I think we had a recent episode, we talk about debt. And if you’re using your debt to grow your company properly, then I think that’s smart. If you’re not aware of how you’re using your debt or, you know, foolishly using debt, then that’s when you get in trouble.
[00:18:49] Stephen Brown: That’s exactly right. And what do you do when you have a lot of cash and you’re not using it to increase your sales and grow your company? Are you using your own cash or are you using the bank’s cash to do that? And how smart is that? How are you gonna finance that?
[00:19:05] Wade Carpenter: Yeah.
[00:19:07] Stephen Brown: I’m sorry. That was a bummer topic. Everybody’s sad now. Sorry.
[00:19:11] Rob Williams: I liked it. I liked it.
[00:19:12] Wade Carpenter: Nobody said.
[00:19:13] Stephen Brown: Hey, it’s very important. So if you have a high debt to equity ratio, It’s time to get with your construction oriented CPA like Wade Carpenter, and say, what can I do to fix this? What are some options?
[00:19:27] Rob Williams: Yeah, because I think a lot of the discussion about that with the debt is whether you want debt, whether you don’t, you have the fast growing companies and what is smart debt and what are you using it? We’re not gonna get into that in the ratio conversation, but I think what that number is can depend on how you’re using it.
A lot of times we’ll see it as mainly just receivables. Then it s hould be rotating in and out a lot. And a lot of times it’s all capital. But then sometimes it’s coming into just having debt for like startup costs or overhead costs and things like that. And that’s, that’s a problem.
That debt is a really good indicator, sort of, I think about value with that, Wade. And I know Wade’s been an expert on valuations at times and I think about looking at that debt with the value of the company. People forget about that. We got a lot of people next few years exiting their companies, and their company might be worth a whole lot more to them if they don’t have so much debt.
I’ve seen scenarios, real profitable companies, and they thought they were, you know, having five or 10 times the worth of their company and they’re growing really fast and getting up, but they’ve used so much debt to get it that their company’s worth almost nothing because they’ve been using that as debt and they don’t understand that.
And they’re coming in thinking they’ve got that as a retirement, think over that. But they got $10 million of debt that’s out there that they’ve got to clear in addition to whatever their worth of their company is. So yeah, that, that’s a big important one. Debt.
Underbillings to working captial ratio
[00:20:52] Stephen Brown: Yes. Good point. And another leverage ratio that’s important to bonding companies is Underbillings to Working Capital. So you want that number to be low. You’re underbillings are costs that you’ve incurred that you haven’t billed for yet. So that generally shows up as a current asset on your financial statement because you’ve incurred the cost, but you haven’t billed it yet.
But then the bonding company will just say, well, maybe I’ll throw that out. How much is too much underbillings? How much is too much overbillings? Well, that’s something bond underwriters think about all the time. Hey, they don’t discuss it with the client all the time, but they think about it all the time.
So, anyway, you don’t have to wade into bond underwriters talking ratios all day if you don’t want to. That’s your bond agent’s job.
[00:21:38] Rob Williams: I think another ratio that the contractors would vote number one are these profitability ratios. That’s all we really know sometimes cause we don’t even know what those other ones are. Who wants to talk about some profitability?
[00:21:52] Wade Carpenter: Let me jump back to what Stephen said on the underbilling to current assets or one of the underbillings to equity or things like that. The reason that makes a lot of difference to the bonding company, well, number one, if you’re too high underbilled, that can indicate cash flow problems. So if you end up running into problems, if you’re too far underbilled, it can be an issue. Conversely, if you’re too far overbilled, the bonding company is worried about, hey, you’ve got all this money ahead, but you’ve got more to finish on this project. You’ve been front loading it and maybe you’re running out on something. So.
[00:22:29] Stephen Brown: Right.
Listen guys, think about this. Say you get your year end financial statement and you show a bunch of overbillings on the financial statement. Well, overbillings show up as a current liability on your financial statement, but say you don’t have enough cash to meet the estimated expenses for the continuing work you show on your financial statement. You’re overbilled, but the cash in there, that means you’ve been robbing Peter to pay Paul. You’ve been taking that cash you’ve been overbilling, and you’ve been using it to deal with other problems or financing equipment or whatever else you wanted to do with it. So wouldn’t you be a little bit nervous if you were a bonding company and you saw that?
[00:23:12] Rob Williams: I’m glad as a residential contractor, when I had that, they didn’t have an overbilling bank draws category to report on our thing. Because we were so front end loaded on our slab draws. We had the same ratio from the 1970s and apparently it doesn’t cost as much as a percent to put a foundation in as it does now. And so we would get so much extra cash on the front end load, but that didn’t show up anywhere.
[00:23:40] Stephen Brown: Listeners, front end loading, if you don’t know, is how you get as much cash as fast as you can on that job. You might front load a lot of profit in the early parts of it and not as much toward the end of the project. So front end loading, wow. We need to do a podcast on that, don’t we?
[00:23:57] Rob Williams: Yeah. The answer is when you need some cash, back in the days it was like, okay, go pour a bunch of slabs. We need some cash from the bank. Go put 20 slabs in. We’ll be just abundant with cash.
[00:24:09] Wade Carpenter: Don’t get me wrong, front end loading is not a bad thing. We need some mobilization money, but that ratio is basically looking to say, hey, we got this money up front, but now we’re outta cash. Are we like digging a hole?
[00:24:23] Rob Williams: Yeah, exactly. What are you doing with that money when you get it? Are you using it wisely? You can be front end loaded to not have as much debt or something. That would be great as long as you’re not spending it on something else.
[00:24:34] Wade Carpenter: If you’re paying for the last job and not paying for the job you’re working on, that’s a problem. So.
[00:24:42] Stephen Brown: I wish we had changed the name of this podcast to Ratios Can Be Fun.
[00:24:46] Rob Williams: They are so much fun.
[00:24:47] Stephen Brown: But that would make everybody insane that saw that.
[00:24:50] Rob Williams: Well, we gotta talk about profitability ratios, because some contractors, those are the only ratios they understand.
[00:24:57] Stephen Brown: Gross profit. Net income after taxes. What are your general and administration, G&A expenses? What are your return on assets and what are your return on equity? That’s what Liberty Mutual says are the important.
[00:25:13] Wade Carpenter: Pick your favorite
Net income after taxes
[00:25:15] Stephen Brown: Well, everybody wants to know, you know, what did you make after taxes at the end of the year. And bonding company standpoint, they love it if you show more net income after taxes, because that’s real money that goes back in to working capital and equity.
[00:25:34] Rob Williams: Yeah, there’s your supposed to be your profit depending on how you define profit, but it’s not cash flow necessarily, but that’s what people judge themselves as how they did, is their net income after taxes.
[00:25:47] Stephen Brown: Yeah.
You might say, bite me bonding company. That’s my money. I’m taking it all. But at some point you gotta build up your cash reserves to be the best contractor you can be.
[00:25:59] Rob Williams: Yeah.
Return on Assets
[00:26:00] Wade Carpenter: As far as profitability ratios, the number one I would throw out there, return on assets. Why? Because number one, it’s looking at profitability. Things like gross profit margin, well, if you’re not consistent, if you have two different CPAs and one puts all their direct costs in their gross margin versus another one that actually does it by GAP and allocates all the things properly to gross margin, that can be manipulated quite a bit.
Return on assets is a true look of, hey, we made some profit based on the capital that we got employed on this. So to me that is more of a true look at hey, you know, how did we really do?
[00:26:43] Rob Williams: Yeah. And I love that return on assets because I think some people make a real big deal about it, and some people don’t. Well, it really depends on the business. There are some businesses that really, the assets are determining, they need those assets to make that profit. You need these things, you need equipment, you need money. There are other businesses that I’ve run into that just not as return on asset oriented because maybe they have some proprietary knowledge that they know and it doesn’t take as much equipment and capital to do a job. But I think of the heavy equipment guys, Stephen, I know you’ve got a lot of those guys, they need a lot of big machinery and money into those to make that money. Or maybe the road construction guys. Wade may know some better examples.
[00:27:30] Wade Carpenter: Absolutely. Looking at it from industry to industry or different types of construction, that’s not really always comparable. But if you’re looking at return on assets year over year and compared to the actual industry you’re in, I mean, maybe we can do an episode on this, but the CFMA the Construction Financial Management Association, does a great job of breaking these things out by the industry.
They actually break it out by, geographic, of the country. So that’s a great way to look at how are we actually doing, how do we stack up?
[00:28:03] Stephen Brown: Right. They call that benchmarking, right?
[00:28:06] Rob Williams: Yeah, great point. And comparing apples to apples on this is so important because you might have a company that has long receivables, so they’re gonna need a lot of assets to be able to be in business. It takes money to make money. But then there’s some of them, well, we’re just talking about like receivable lines and things like that, but there’s some companies that they get paid faster than they have to pay their materials and things like that. So that’s where I’m seeing that the assets may not be as important for those type of companies. And if you don’t have any assets, know these things so you know where to focus your business and maybe the type of customer that you have, also.
Because I know when I went into, Stephen with you, some of those big, long receivables, man. I had to have some assets and stuff and I didn’t realize how long it was gonna take to get my money sometimes. That was a very asset intensive business, where when I was doing the residential stuff, man, I got paid every week. We were able to really turn assets over. So I actually, I probably did get paid faster than I was paying my bills out. So I didn’t have to have a lot of core capital for that model until they didn’t pay me.
[00:29:16] Stephen Brown: Well, well, listeners, if you wanna know how to calculate your ratios, they have a name and you can Google it and you can learn how to calculate it yourself based on your financial information. And Wade said, you go to the CFMA website and maybe get some data to benchmark your type of company.
But you know, we weren’t really arguing a lot, guys ,about our favorite ratios. I, I thought we would fight a little bit more to, you know, Quick Ratio. Wade said Working Capital Ratio. Okay, well we both agree those are important.
Debt to equity ratio. Rob, what was yours?
[00:29:49] Rob Williams: I said Days of Cash on the, on those–
[00:29:51] Stephen Brown: –cash, Rob, liked that one. that got Rob going.
And then we talked about profitability ratios. That’s the one, we’re all about cash flow and we’re about Profit First. And then we talked about the cash flow ratios, the efficiency ratios being a category. We haven’t really gotten into that.
Backlog Gross Profit
[00:30:10] Stephen Brown: I wanted to throw out a backlog ratio. Backlog ratio, that’s important to bonding companies. It’s just something to think about. Cause of course, in my opinion, if it’s important to a bonding company, it’s important to everyone. But you know, that’s me, Mr. Vegas, that’s just the way I feel about it. But, Backlog gross profit is the work that you have left to do, the jobs in progress at a certain period in time, and your estimated profit on those jobs divided by your G&A expenses for the year.
So if you’ve got 50% backlog gross profit to G&A expenses, that’s considered good. 50% or higher.
Now do you get bonding credit for Backlog Gross Profit? Yes. Yes you do. It’s beautiful. You do they look at it and they say, Man this is good, man. They’ve got a lot of Backlog Gross Profit, they got this, they’re running this work off. It’s not all negative in the bonding world. We’re happy when you’re happy. As a general rule. Now, of course you’re not happy paying taxes and sometimes that throws the numbers off. But as a general rule, if you’re making money, we’re making money and everybody here is making money.
So that’s what we’re all about here.
[00:31:25] Rob Williams: On that one and Wade, with the CPA and the controllers, I didn’t look at that as a ratio. I looked it as a cash flow projection. I guess the bonding companies may look at it that I never really calculated. I’m actually listening to Stephen and actually getting a lesson on this, at the moment, because it was all my spreadsheets and what I had as a 12 month cash flow projection and maybe even a two and three year, which is the same numbers that we’re looking at, it was a different format.
So I think some of these guys may actually be calculating a backlog ratio as a cash flow, but I didn’t really look at that. Wade, what do y’all do?
[00:32:03] Wade Carpenter: We need to wrap it up. Maybe we can continue this, but the backlog ratios were the next one that I had on the list. Because they are very important to–
[00:32:12] Stephen Brown: Hey, no fighting here.
[00:32:14] Wade Carpenter: — to the bonding company. The bank wouldn’t have a clue. But it does mean hey, how much work do I have going into next year? And am I gonna have something to fill up my pipeline?
[00:32:25] Rob Williams: I think people will be really surprised that we didn’t say gross profit. Because I think that’s the first thing people say, okay, what’s my margin? What’s my markup? That’s the first thing that a lot of my contractors talk about.
The reason that I don’t say that is because the apples to oranges thing. I think people, what they’re counting in their job cost and their margin is just different from one person to the other. We used to call them sticks and bricks, so it was just the material. And we didn’t actually apply the expenses to the jobs, but we had the breakdown. We knew take out 4% for sales, take out 4% for overhead. And we knew those, but we didn’t actually make the entries.
[00:33:10] Stephen Brown: Well, maybe we should do a podcast on gross profits because it’s huge. It is the most interesting thing, I would think, to all our of our listeners. How much gross profit do I make? How much is great gross profit, and what do I need to break even? If I’m doing more than breaking even, what are my competitors doing? It’s an obsession.
[00:33:32] Rob Williams: Yeah, and I think it’s very important. I remember when you and I were talking to that underwriter, it seems like one of the biggest problems in his mind was, what was the estimation of the job, and then what did they actually make on it? And I did have a hard time figuring out whether he believed whether it was the gross profit on the job, or whether it was the allocation of these overhead expenses to the job.
Again, we’re talking about what are we talking about when we say gross profit.
[00:33:59] Stephen Brown: That’s something all three of us could talk about all day and all night. So you’re right, Rob, to throw that in. That’s huge. Wade if, have we jumped over you on a ratio that we haven’t gotten into?
[00:34:08] Wade Carpenter: No, I know we originally said five and I don’t know, we even got to five today.
[00:34:13] Stephen Brown: No, we got five and we may get, we may have gotten
[00:34:16] Wade Carpenter: Threw out plenty, but.
[00:34:17] Stephen Brown: We did get at five or more. Go back and count them, guys. We’ve got five or more. I promise. We’ve–
[00:34:24] Rob Williams: We’ve– got more. got more
[00:34:27] Stephen Brown: right.
[00:34:28] Rob Williams: That’s right. We’re about more.
[00:34:30] Stephen Brown: More profit. At the Contractor Success Forum.
[00:34:34] Rob Williams: All right. Well, this has been a great, very long, very popular episode.
[00:34:40] Stephen Brown: Well, at least to us.
[00:34:40] Wade Carpenter: We’ll see.
[00:34:42] Rob Williams: we’ve enjoyed it because we make ratios fun on the Contractor Success Forum.
[00:34:49] Stephen Brown: Yes. Yes.
[00:34:51] Rob Williams: And if this is the only episode you guys have listened to out there, we have Wade Carpenter, Carpenter and Company, CPAs and Stephen Brown with McDaniel-Whitley bonding and insurance agency, and Rob Williams with IronGate Entrepreneurial Support Systems.
[00:35:07] Stephen Brown: Get your MBA through the Contractor Success Forum.
[00:35:10] Rob Williams: That’s right. By you listening to this, that is your MBA in construction. You don’t need to go to those fancy schools and see those high escalating college costs because you got it right here.
[00:35:21] Stephen Brown: Yeah, if–
[00:35:22] Rob Williams: On your download or your–
[00:35:24] Wade Carpenter: Give you a diploma. Or if–
[00:35:26] Stephen Brown: If wanna be educated and bored silly, we’re your guys.
[00:35:30] Rob Williams: Now that we’re losing them here and they’re hanging up on us, so, we’ll sign out from the Contractor Success Forum them today, and listen to the next episode to continue your MBA.