How to increase your construction company business profitability and business value

My friend Victoria Downing at Remodeler’s Advantage recently posted a video on a simple tool that improves business profitability and business value when used by construction contractors, subcontractors, material suppliers, engineering firms and re-modelers.  The tool is an annual budget.  While Victoria specializes in residential remodelers the principle applies to all construction contractors (really all businesses).  Click here to watch this short video now.

Want to know more about building value and selling your construction company – Click here to download a 20+ page e-book. 

Gregory Caruso, JD, CPA, CVA
Harvest Business Advisors
Business Brokers, Business Valuations, Succession Planning
gcaruso@harvestbusiness.com
609-664-7955

 

A Business Broker’s Tip to Improving Your Business Value – Determine Your Most Profitable Customers and Fire the Rest

Yes, I am a business broker, I also have 10 years experience owning a home building company and am an JD, CPA, and CVA.   This is good stuff when followed.

Every contracting business and engineering firm has profitable and unprofitable customers.  If you have not analyzed this, you should.  In most cases owners are shocked when they perform this analysis.  Take each customer (or product type or market group) and deduct the cost of goods sold to them.  Fairly allocate overhead costs either by a simple blanket allocation of all overhead or by breaking out different overhead costs as they apply to different customers.

Considering Selling Your Business? Please click here for a downloadable e-book, “ 10 Ways to Increase the Value of Your Business“.

New Construction Blues

Take a look at this small mechanical contractor’s books.  Simplified, they look like this: 

Sales Revenue of $5,000,000 broken down as:

New construction        $2,000,000
Residential service     $500,000
Commercial service    $2,500,000

Cost of Goods Sold $2,675,000 broken down as:

New construction        $1,500,000
Residential service     $175,000
Commercial service     $1,000,000

Overhead totaled $2,000,000, broken up as:

Indirect labor (including owner’s salary)       $750,000
Other overhead                                         $1,250,000
Total profit                                                $325,000

The simplest analysis to determine profitability is:

Customer Profitability Chart

Sales –            COGS –          Allocated Overhead = Profit

New Construction       $2,000,000      1,500,000        $800,000                 -$300,000
Residential Service     $500,000          175,000            200,000                   125,000
Commercial Service   $2,500,000      1,000,000        $1,000,000                  500,000

The overhead was allocated based on the percentage of sales of the customer type to total sales. 

The next level of analysis might be to allocate indirect labor by the amount of time spent on each customer type.  Track or, if you must, estimate payroll allocation to the hours spent direct marketing, supervising, meeting, getting paid etc.  With new construction the profitability might decrease more. 

As you can clearly see, this business is performing new construction services at a loss.  Unless there is a really strong business reason, this business owner should either raise prices for new construction or focus on selling more residential and commercial service.  Sales for the sake of sales is ego, (expensive ego) not a valid business reason.

You can make the argument that $100,000 of overhead is paid from new construction projects but that can be equaled with additional sales of under $200,000 of commercial services.  Transition to the higher paying customers.  The most profitable companies consistently perform this type of analysis and focus on their most profitable customers.  Over time this is how exceptional profits are generated.

Greg’s Tip:  Improving sustainable cash flow and profitability is the most effective way to increase the value of your business.  This is by far the most important factor in determining business value.  Sell when profits will be improving right through settlement.

Gregory R. Caruso, JD, CPA, CVA
Harvest Business Advisors
Business Brokers, Business Valuations, Business Transactions
609-664-7955
gcaruso@harvestbusiness.com
www.harvestbusiness.com

Baltimore Business Broker to Speak at American Subcontractor Association Conference in New Orleans

Gregory Caruso, Esquire, CPA, CVA a principal at Harvest Business Advisors will be speaking at the National Subcontractor Association Meeting, Sub-Excel, Saturday March 8th 2014 in New Orleans.  Greg will cover the topic Family Transition and Family Business Succession in Subcontracting Businesses.   The presentation will focus on how to avoid pitfalls that destroy family businesses and sometimes the families themselves.  Greg has been involved in 100’s of business transitions as a principal, attorney, broker, and valuation professional.  Before becoming an advisor on succession matters for sub-contractors, suppliers, and engineers he grew up in a family contracting company and later co-owned another family construction company.

Want to know more about building value and selling your construction company – Click here to download a 20+ page e-book. 

Gregory Caruso, JD, CPA, CVA
Harvest Business Advisors
Business Brokers, Business Valuations, Business Succession for
Sub-Contractors, Construction Contractors, Suppliers, and Engineering Firms
www.harvestbusiness.com
609-664-7955

Business Valuation for Business Sale Price Estimates – More Detail on Calculating a Valuation Multiplier

Small business valuation for selling your business, or business merger and acquisition purposes is tricky and depends on many factors.  In this article I summarize how a valuation multiplier for a small business could be calculated.  The calculated value should also be checked against the business sales comps available from one or more databases such as Pratt’s Stats, www.bvmarketdata.com  and BizComps, www.bizcomps.comYou can also look in The Business Reference Guide by Tom West, available at www.bbpinc.com  .  Also, get a check from a reputable experienced business broker or valuation professional in all cases before entering into contracts or even negotiations.

Want to know more?  Please click here for the downloadable e-book. “7 Things You Must Know Before You Order a Business Valuation” 

This methodology is most effective for businesses with a value between $150,000 and $1,500,000.  Below $150,000 in value in my experience it is hard to reasonably calculate value although in many cases it does exist.  If the value is low enough you must also look at what the liquidation value of the assets may bring.  Sometimes this is the highest value.  Once a company grows larger than $1,500,000 there are other methods that may be more accurate which should be used to estimate value. We will post another article or articles on valuing larger businesses in the near future.

This methodology works for estimating the business value or business sales value of most types of companies including subcontractors, electrical companies, HVAC, plumbing, engineering firms, service firms such as CPA’s and consultants, manufacturers, government contractors, retailers, restaurants, etc. 

Generally, the multiplier is calculated by looking at risk and how the business will continue to generate cash flow for the new owner and the perceived desirability and growth prospects of the firm.  This is similar to the concept behind bonds or bank accounts.  Junk bonds pay more interest than government insured savings accounts in order to attract your investment dollar.  Of course, you will never lose principal on the government insured savings account.  Small businesses are very risky and carry a large discount usually in the 20% to 50% range.  The safer the business the higher the multiplier.  The higher the multiplier the higher the value and price when it comes time to sell.

Typical factors in the calculation:

  • Ease of entry into business
  • Location of business
  • Competition in Market Area
  • Historical profit trend
  • Industry trend
  • Size of business
  • Management systems in place
  • No one customer providing more than 10% or 20% of sales revenues
  • No major suppliers that would be hard to replace
  • Availability of financing
  • Condition of Books and Records

 One way to do the analysis is to rate each factor above from 1 to 4, with four being the most favorable, then divide by the number of applicable factors.   In all likelihood your business multiple will be between 2 and 3.  The average is between 2.3 and 2.7 depending on who is collecting the data.  Businesses that tend to be owner intensive such as auto shops and small independent restaurants tend to sell around 2 or less.  Highly efficient larger service firms with contracts may sell for 3 to 3.5.  Again, only proven rapid growth companies or unusually hot businesses (think BMW auto dealerships) reach above 4. 

 Example of Calculating a Multiplier:

 Sam’s Auto Repair factors     

Ease of entry into business                                                              1 easy to enter

Location of business                                                                          3 Sam’s is in an urban area where auto related land usage is discouraged

Competition in Market Area                                                          3  Same as above – few competitors, hard to get a nearby location

Historical profit trend                                                                      3 Sam is profitable

Industry trend                                                                                     2 Too many new cars

Size of business                                                                                   2  Sam’s is still small

Management systems in place                                                   2  Has great receptionist / scheduler

No one customer exceeding 10% or 20%                             4  Few large commercial acc.

No major suppliers that would be hard to replace          4  Many parts stores and suppliers

Availability of financing                                                              2  Hard to finance Auto related

Condition of books and records                                                3  Easy to follow, accurate books and records and tax returns

 

That totals 11 factors with a sum of 29 creating a multiplier of 2.6 which is high for an auto repair but the assumptions make this look like a pretty good small business.  Give him poor financial books, low profitability, and a neighborhood with car repair on every corner and you quickly have a 2  multiplier.                         

Now you just multiply your discretionary cash flow by your multiplier and you get an estimate of value.  ($150,000 discretionary cash flow times 2.6 equals $390,000 estimated value).  If done accurately (experience helps!) this can produce a very good indication of value.  It is also useful for internal purposes just as a check to see how you are doing as good businesses are valuable businesses.

DISCLAIMER:  Please note that this is a useful formula for preliminary planning or tracking your progress but is not a substitute for a proper valuation when selling your business.  NEVER go to market or enter into important negotiations or legal proceedings based on a rule of thumb formula such as this.  Get proper valuation assistance.  Call us.

Gregory R. Caruso, JD, CPA, CVA
Harvest Business Advisors
609-664-7955

gcaruso@harvestbusiness.com
www.harvestbusiness.com

 

How Types of Customer Contracts effect Business Value

The types of contracts you have with your customers and the terms in those contracts will affect your business value.  This is particularly true of construction contractors, engineers, and subcontractors who often have long term projects.  The highest value goes to a long term, non-cancelable, highly profitable contract (this elusive contract is almost mythical I might add).  Clearly they exist but they can be fairly rare.  Below is the list of contract types.  The higher on the list, in general the more value created.

  • ·         Long term fixed price contracts (with profits)
  • ·         Long term T & M contracts
  • ·         Short term fixed price or T & M contracts with repeat customers
  • ·         New customers on negotiated jobs
  • ·         Repeat customers on competitively bid jobs
  • ·         New customers on competitively bid jobs

Time to Sell Your Construction Business? Please click here to download the e-book, “A Contractor’s Guide to Succession Planning”.

In general “repeat contract service work” has the highest value.  The lowest value is one time bid work for new clients.   

Who you work for impacts value too.  A contractor doing negotiated work for defense contractors and medical companies is going to be perceived as more stable than one building speculative office buildings.

What does your mix look like?  How can you improve your mix to get Your highest possible business value?

Gregory R. Caruso, JD, CPA, CVA
Harvest Business Advisors
609-664-7955

gcaruso@harvestbusiness.com
www.harvestbusiness.com