A Comprehensive Guide to Financial Ratios in Construction

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Ratios are the key indicators of the financial health and status of the construction business. When other financial statements and documents fail to elaborate on the financial performance, these ratios are a lifesaver by accurately indicating the business’s performance regarding leverage, liquidity, financial efficiency, and profitability.

Financial ratios also help find various growth opportunities by predicting future outcomes. Ratios are calculated using information from a company’s income statements and balance sheets. Thanks to these ratios, contractors can sort out their business and understand the real meaning behind the numbers on financial statements.

24hr Bookkeeper understands the importance of ratios for financial management. Thus, they offer various accounting and financial management services for construction companies. With the help of their expert bookkeeping services, you can accurately determine the financial performance of your construction company. Owing to their brilliant services, many businesses also rely on them for efficient workflow management and accounting software integration.

Continue reading because this post will discuss which financial ratios are used in construction and delve deeper into their importance.

Importance of Financial Ratios In The Construction Business

Financial ratios serve as powerful tools that can guide decision-making, improve financial management, and ensure long-term prosperity.

Let's learn about the importance of calculating financial ratios for a construction business.

Help In Assessing Profitability

Financial ratios like the gross profit margin and net profit margin tell about the profitability of the construction company. They provide a clear picture of how much profit the business is generating from its construction projects after deducting costs. Understanding profitability ratios helps the business identify areas where cost efficiency can be improved, leading to higher profits.

Evaluating Efficiency and Productivity

Efficiency ratios, such as the asset turnover ratio and revenue per employee ratio, empower the business to gauge how effectively it utilizes its assets and workforce. These insights can help identify opportunities for improving productivity and resource utilization, leading to optimized project management and cost control.

Ensuring Liquidity and Cash Flow Management

Liquidity ratios, such as the Current Ratio, act as a protective shield against financial troubles. They measure the business's ability to cover short-term financial obligations and manage cash flow effectively.

Maintaining healthy liquidity ratios ensures that the construction company can pay its suppliers, subcontractors, and employees on time, avoiding disruptions in project execution.

Managing Debt and Financial Stability

Debt ratios, like the debt-to-equity ratio and interest coverage ratio, reveal the level of financial leverage and the company's ability to fulfill interest obligations. Monitoring these ratios helps the business maintain a balanced debt structure and avoid excessive debt burdens that could strain its financial stability.

Planning for Future Projects

Backlog ratios provide the foresight to plan for the future. They indicate the value of projects yet to be completed, offering insight into the company's pipeline and workload. A healthy backlog ratio indicates a promising future for the business and potential opportunities for expansion.

Helpful Financial Ratios For Construction Industry

We all know the importance of financial ratios. Let’s look at some important financial ratios in construction.

Profitability Ratios

Profitability ratios showcase the enchanting ability of your construction business to generate profits from its operations. Two essential ratios in this category are:

• Gross Profit Margin: The ratio reveals the revenue that remains after deducting COGS. It’s calculated as (Gross Profit / Revenue) x 100. A higher GP ratio shows that your construction projects are profitable after considering direct expenses like labor and materials.
• Net Profit Margin: The net profit margin showcases the percentage of revenue that remains after accounting for all expenses, including operating costs, interest, and taxes. It’s calculated as (Net Profit / Revenue) x 100. A healthy net profit margin indicates overall financial health and effective cost management.

Liquidity Ratios

Liquidity ratios measure your construction company's ability to cover short-term financial obligations with ease. The crucial ratio in this category is:

• Current Ratio: The ratio assesses the company's current assets relative to its current liabilities. It’s calculated as (Current Assets / Current Liabilities). A current ratio above 1 shows that your company possesses sufficient current assets to cover its immediate financial obligations.

Debt Ratios

Debt ratios reveal the level of debt enchanting your construction business. The two prominent ratios in this category are:

• Debt-to-Equity Ratio: It compares the total debts to shareholders' equity. It’s calculated as (Total Debt / Shareholders' Equity). A lower debt-to-equity ratio indicates a lower reliance on borrowed funds, representing a stronger financial position.
• Interest Coverage Ratio: The interest coverage ratio measures your ability to fulfill interest payments on debts. It’s calculated as (Operating Income / Interest). A higher ratio suggests your company can comfortably handle its interest obligations.

Efficiency Ratios

Efficiency ratios showcase how skillfully you wield your construction resources. Two key ratios in this category are:

• Asset Turnover Ratio: The ratio measures how efficiently your construction assets generate revenue. It’s calculated as (Revenue / Total Assets). A higher asset turnover ratio implies better asset utilization to generate revenue.
• Days Sales Outstanding (DSO) Ratio: The ratio reveals the average time it takes to collect outstanding payments from clients. It’s calculated as (Accounts Receivable / Average Daily Sales). A lower DSO indicates a faster collection of payments and healthier cash flow.

Productivity Ratios:

Productivity ratios showcase how efficiently your construction business utilizes its workforce and resources. The primary ratio in this category is:

• Revenue per Employee Ratio: The ratio measures the revenue generated per employee. It’s calculated as (Revenue / Total Number of Employees). A higher revenue per employee suggests a more productive workforce.

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About The Author:

Jane Peters is a seasoned financial expert with over a decade of experience working with various construction companies. Jane guides entrepreneurs through her expert insights and strategic guidance. She’s also a dog mom who loves to spend her free time with her family.

The author of this post has been writing for the official website of Wembley Solicitors for a decade. He offers legal solutions to his clients for issues related to family law.