As the owner or manager of an HVAC, plumbing or construction subcontractor, your backlog is a crucial indicator of your business's health and future prospects. A healthy backlog ensures a steady flow of work and revenue, allowing you to plan and allocate resources effectively. However, when you notice a drop in your upcoming or planned projects, it's essential to pay attention and take action to prevent a potential downturn in your business. Let’s examine the key financial statistics and markers that can help you identify when it's time to start worrying about your backlog and what steps you can take to mitigate the risks.
1. Declining Backlog Ratio
The backlog ratio is a key metric that compares your current backlog to your annual revenue. A healthy backlog ratio typically ranges between 6 and 12 months, depending on your industry and the size of your projects.
If you notice a consistent decline in your backlog ratio, falling below 6 months, it's a clear indication that you need to start worrying about your future projects. A low backlog ratio means that you may not have enough work lined up to sustain your business in the coming months, which can lead to financial strain and potential layoffs.
2. Increasing Bid-Hit Ratio
The bid-hit ratio represents the number of projects you've won compared to the total number of projects you've bid on. A high bid-hit ratio indicates that you're consistently winning projects and maintaining a healthy backlog. However, if you notice a significant increase in your bid-hit ratio, it could be a sign that you're not being selective enough in your bidding process. Taking on too many projects without proper planning and resources can lead to delays, quality issues, and ultimately, a decrease in your backlog as clients lose confidence in your ability to deliver.
3. Rising Days Sales Outstanding (DSO)
Days Sales Outstanding (DSO) is a measure of how long it takes your clients to pay their invoices. An increasing DSO can be a red flag for your backlog, as it indicates that your clients are taking longer to pay, which can impact your cash flow and ability to take on new projects. If your DSO rises above 60 days, it's time to start worrying and take action to improve your collections process. Implement stricter payment terms, follow up on overdue invoices, and consider offering discounts for early payments to encourage clients to pay on time.
4. Decreasing Market Share
Keep a close eye on your market share and compare it to your competitors. If you notice a consistent decrease in your market share, it could be a sign that you're losing ground to your competitors and may struggle to maintain a healthy backlog in the future.
Analyze your competitors' strategies, pricing, and marketing efforts to identify areas where you can improve and regain your market share. Consider diversifying your services, targeting new markets, or forming strategic partnerships to expand your reach and secure new projects.
5. Economic Indicators
In addition to internal metrics, it's crucial to monitor external economic indicators that can impact your backlog. Keep an eye on interest rates, inflation, and government spending on infrastructure projects. Rising interest rates can make it more expensive for clients to finance new projects, while inflation can increase the cost of materials and labor, making it harder to win bids. On the other hand, increased government spending on infrastructure can create new opportunities for construction companies. Stay informed about economic trends and adjust your strategies accordingly to maintain a healthy backlog.
Maintaining a healthy backlog is essential for the long-term success of your construction company. By monitoring key financial statistics and markers, such as your backlog ratio, bid-hit ratio, DSO, market share, and economic indicators, you can identify potential issues early on and take proactive steps to mitigate the risks. If you notice a consistent decline in your backlog, don't wait until it's too late to take action. Analyze your operations, identify areas for improvement, and implement strategies to win new projects and maintain a steady flow of work. By staying vigilant and adapting to changing market conditions, you can ensure the long-term sustainability and growth of your construction business.
Derrick Rebello and Brad Carlson are Partners in the Construction Practice Group at Gray, Gray & Gray, LLP, a business consulting and accounting firm that serves the AED and construction industries. They can be reached at (781) 407-0300 or [email protected]