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Importance of Using Key Performance Indicators in Construction

12/29/2016 at 12:44 pm by

I recently visited with a client about the importance of forecasting, and the client displayed for me on a computer screen the daily key performance indicators (KPIs) they monitor. The client commented that the company can use the daily KPIs to predict monthly profits within a small variance and any significant balance sheet effect. This discussion was a powerful example of how a company can use its system’s data to accurately predict financial results and make management decisions that avoid negative trends.

Construction companies continue to implement new and advanced technologies that capture financial and nonfinancial data related to their operations and strategies. Due to the number of processes that construction companies utilize—sales; marketing; estimating; bidding on projects; executing the contract; using labor, materials, equipment, and subcontractors to construct the project; billing and collecting for work performed, and closing out the projects—construction companies need to identify the KPI of each process. In addition, construction companies should develop goals and benchmarks and understand the interconnectivity of certain KPIs (e.g., a negative labor variance results in lower gross margin on the project). Companies should have the discipline to use the KPIs to make operational and management-level decisions.

Can you name five performance indicators that drive profitability and cash flow for your construction company? Some examples might include:

  • Daily labor hours
  • Purchase orders requested
  • Rolling two-week billings on contracts
  • Daily cash collections on a rolling two-week basis
  • Accounts payable invoices processed
  • Number of new contracts secured
  • Average value of new contracts secured on a rolling thirty-day time frame
  • Forecasted labor hours for next 30 days

There are many other KPIs that have been developed—the key is finding the small group (less than 10) that truly drive performance in your construction company. KPIs can be broken down into two major categories: financial and nonfinancial. Construction companies, by the nature of their business, need to have KPIs in both categories.

Financial KPIs

Examples of construction company financial KPIs include:

  • Liquidity: current ratio, quick ratio, days of cash, working capital turnover
  • Profitability: return on assets, return on equity, times interest earned
  • Leverage: debt, under-billings, backlog and revenue to equity, asset turnover, fixed asset ratio, equity to selling, general and administrative expense
  • Efficiency: backlog to working capital, months in backlog, days in accounts receivable, inventory, accounts payable, operating cycle

Many of these financial KPIs may already exist within the company financial accounting system in various standard reports. I’m a huge proponent of using existing systems to capture and analyze the data around KPIs. Spreadsheets that contain complex calculations or data analysis can result in errors that are difficult to detect, which ultimately can lead to bad decisions based on bad data and cause suspicion around the future use of KPIs.

Nonfinancial KPIs

Nonfinancial KPIs can be identified to truly understand what drives the financial results.  Simply measuring total contract revenue, gross margin, or net income will often miss the underlying driver of the result.

  • Cost codes approaching or over budget (actual and committed)
  • Labor hours or cost exceeding budget
  • Productivity below estimate
  • Change requests overdue
  • Defects found
  • Safety incidents

I’ve seen robust KPIs used in construction companies, yet performance on an individual project or at the company level doesn’t improve. Many times, this is a result of data overload. Identifying and calculating the KPI is only the beginning. Effective KPI use requires involvement from each level of the company:  senior leadership must set the tone, midlevel management must execute the strategy, and the remainder must understand their contribution to reaching KPI goals. For example, if the senior vice president of engineering sets a KPI goal of 4,000 direct construction labor hours per week for the next six weeks, the project managers and schedulers should look at the forecasted work and break it down to the individual project level, then the job superintendent needs to monitor and measure the direct labor hours directly under his or her supervision. Any variance in the KPI needs to be evaluated and corrective action taken (e.g., increased head count, scheduling of additional work/projects, etc).  The best of intentions with KPIs can result in negative consequences—lack of action, analysis by paralysis, ignoring what the data tells you, making excuses/rationalizing.

Occasionally, I’m asked if a construction company can truly affect growth and profitability with KPIs.  I usually answer with a simple example of using three goals that can drive growth and profitability, measured with KPIs:

Goal one

  • Increase working capital in the next quarter by $500,000
  • KPI – current ratio, acid ratio, contract margin, revenue per day
  • Owner of goal – CFO

Goal two

  • Increase average margin on contract revenue by 2 percent in the next quarter
  • KPI – average margin by customer, by contract, and on new bids
  • Owner of goal – vice president of sales/operations (or similar position)

Goal three

  • Reduce the average labor hours on rework by 10 percent in the next quarter
  • KPI – rework labor hours per dollar of contract revenue, rework dollars as a percent of total contract costs
  • Owner of goal – vice president of engineering/lead project manager

Now that you’re convinced about the benefits of KPIs, how do you get started?  Some of the key steps and questions include:

  • Where is the data stored?
    • Use existing systems if possible.
    • Data must be standardized.
    • Don’t allow for manipulation—be wary of spreadsheets!
  • Share the information.
    • Set routines to collect the data and report.
    • Don’t have too many metrics.
    • Internal comparisons across divisions and departments.

KPIs in a construction company have been proven to assist in operational and financial improvements.  If you’re currently using KPIs, continue to internally challenge the metrics you’re using and look for ways to improve your process. If you’re not using KPIs, it’s never too late to start. Your technology platform may change over the years, but your company will always need data and the ability to analyze it.

Editor’s note: This article is for general information purposes only and is not to be considered as legal advice. This information was written by qualified, experienced BKD professionals, but applying this information to your particular situation requires careful consideration of your specific facts and circumstances. Consult your BKD advisor or legal counsel before acting on any matter covered in this update.

Article reprinted with permission from BKD, LLP, bkd.com.  All rights reserved.

 

About the Author

Tim Wilson, CPA, CCIFP, is a National Industry Partner for Construction & Real Estate at BKD, LLP

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