The 2018 CLA Electrical and Mechanical Construction Benchmark Report
Owners of privately held electrical and mechanical construction companies and their management teams face daily challenges, both operationally and financially. They need to know how their company stacks up against their competition and if there is anything they can do better to improve their operating results.
The 2018 Electrical and Mechanical Construction Benchmark Report summarizes three years of data from 150 privately held, owner-operated electrical and mechanical contractors. This report provides succinct analysis of national trends and offers key financial and non-financial information to assist electrical and mechanical contractors in comparing themselves to their peers. Contractors included in the survey are privately held companies engaged in construction related to plumbing, heating and cooling, refrigeration, piping, mechanical service, and electrical projects for private and public projects.
Overview and Executive Summary
Industry challenges and opportunities
Across the electrical and mechanical construction industry, gross margins were up almost 2 percent in 2017, but overall profitability decreased by 1 percent to 4.1 percent of revenue. This reduction in profitability was largely due to increased general and administrative costs. However, electrical and mechanical contractors were able to maintain strong working capital positions even with the reduction in profitability.
Though the outlook for 2018 is positive, there are challenges electrical and mechanical contractors face to maintain or improve results. Several issues are at work in the industry that will impact contractors and their ability to improve profitability levels:
- The skilled labor pool is aging. Contractors continue to have difficulty hiring sufficient numbers of skilled laborers. Similarly, as leaders near retirement age, few in the next generation are prepared to take their places.
- Tariffs could change the prices on supplies and impact current suppliers.
- Recent national and worldwide natural disasters will further impact the construction labor market and put upward pressures on material prices.
- Without succession plans in place, many owners of electrical and mechanical construction companies are uncertain of how they will fund their retirement.
Key ratios and trends
Months in backlog ― This ratio has increased an entire month compared to 2016. Industry wide, the backlog now sits at 4.5 months. Electrical and mechanical contractors had a great year in 2017, and if the increase in backlog is any indication, 2018 could be just as strong.
Return on equity ― Corresponding to decreased profitability, owners’ return on investment fell in 2017. The greatest decrease was with union contractors who experienced a 2.5 percent decrease in their return on equity investment. Contractors with revenues of $50 million or more were able to overcome the industry trend and increase their return on equity by 6.1 percent.
General and administrative expenses ― Executive and management compensation was one of the only costs in 2017 in general and administrative expenses that remained stable. General and administrative costs increased across the board for all other categories. Across the industry, general and administrative costs jumped up 1.7 percent as a percentage of revenue in 2017.
2017 backlog ― Electrical and mechanical contractors expect their backlog in 2018 to be less profitable than the work completed in 2017. Industry wide, gross profit on 2017 work was 21.5 percent, and estimated gross profit on 2017 backlog (which will be completed in 2018), is only 15 percent across the industry. The largest decreases in expected gross profit are with contractors whose revenues are below $50 million. The main cause of the fading of gross profit is due to expected increases in equipment and labor costs. The current labor shortage is expected to drive up the costs of employment via higher base-wage rates, overtime pay, and benefits that newer hires are demanding.
Financial ratios and key performance indicators have been computed using information obtained primarily from audited and reviewed financial statements of our construction contractor clients. Participation in the study is voluntary, and data gathered have been analyzed by representatives from our construction industry practice. This report summarizes data from 150 electrical and mechanical construction companies with operations conducted throughout the United States.
Financial ratios and key performance indicators
Analysis of financial ratios and key performance indicators can assist in the assessment of a contractor’s financial health, operating efficiency, and profitability. A critical element in the review of a contractor’s financial well-being is understanding the magnitude of a variance compared to similar organizations, and then taking the initiative to investigate and understand the reason for the variance. Ultimately, understanding the cause of variances may lead to a series of operational changes that may both improve profitability and create efficiencies.
Consistently monitoring key financial and operational indicators can help management improve profitability and operations, and provide key information for developing competitive bids and maintaining healthy financial statements for bonding. Some of the advantages and limitations of using comparative indicators are outlined below.
- Benchmarks provide comparisons to contractors with similar operations.
- The data help identify unusual operating results and trends.
- Performance indicators highlight areas of strength and areas that may need improvement.
- Variances alone do not necessarily reflect an opportunity or a challenge.
- Potential for inconsistency in data collection can reduce the usefulness of comparisons.
- Benchmarks should be used in conjunction with other analyses of a contractor’s operations.
- In a highly specialized market segment, companies may face a broad spectrum of competition.
Ultimately, no single ratio or financial analysis should be evaluated on its own to assess a contractor’s financial condition. Variances from benchmarks should be investigated and considered in the context of the company’s specific operating structure, sub-industry, and the region in which it operates. In many cases, the most useful information is a combination of benchmarking data and the company’s own numbers.
Electrical and Mechanical Contractors’ To-Do List
- Assess your company’s information technology system’s vulnerability to worldwide hacking threats, and invest in information security solutions and employee awareness programs.
- Consider working with school districts to encourage building trades as an alternative to college.
- Meet with your financial institution to discuss the impacts of the new revenue recognition and lease standards on financial covenants.
- Review your tax accounting methods, and consult with your tax advisor regarding tax incentives for electrical and mechanical contractors, such as research and development credits, the work opportunity tax credit, fuel tax credits, and energy efficiency incentives.
- Dedicate resources to equipment and fleet management to better understand your equipment needs and maximize the utilization of your fleet.
- Have discussions with your tax professional on succession planning and how to structure your retirement strategy.
- Discuss your enterprise resource planning system with your entire team. Determine if it’s time to consider another option to help you lower the cost and improve your software’s capabilities.
Ratio analysis and key performance indicators
The following graphs present median results for each key performance indicator (KPI). The median values for each KPI were computed independently and represent the mid-point of the data set. Since median calculations are being used, mathematical relationships do not exist between the various KPIs reported.
Margin on self-performed revenue
This ratio represents the percent of self-performed contract revenue the company retains after incurring direct costs associated with completing the contract.
Subcontractor expenses for electrical and mechanical contractors can be a significant portion of the overall cost associated with a project. Often, subcontracted work yields little or no profit margin to the prime contractor and can result in total gross profit percentages becoming skewed based on the amount of work a company subcontracts to others. Analyzing a company’s margin on self-performed revenue often provides a better indication of the company’s ability to generate profit on the work it performs.
Most industry segments had a consistent or slightly higher margin on self-performed work when compared to 2016. The segment with the highest increase in this ratio was contactors over $50 million in revenue, who saw a 3.4 percent increase over prior year. Most contractors noted only a modest increase on gross margin for 2017 due to high levels of competition.
Pre-tax income as a percentage of revenue
This is the ratio of earnings before income tax as percentage of total construction revenue.
The higher the percentage, the more potential return can be provided to owners or re-invested into the business. For nearly all contractors, 2017 was a challenging year. Pre-tax income as a percentage of revenue decreased in some segments, such as the non-union electrical and mechanical contractors and those whose revenue is between $0 – 15 million. Union contractors and contractors with $15 – 50 million in revenues had slight increases in the income generated per sales dollar.
Fixed assets to net worth
This ratio measures the amount of an owner’s equity that is tied up in fixed assets. A lower ratio generally indicates better solvency and usually translates into a greater percentage of assets available to meet current obligations.
Electrical and mechanical contractors continued to invest in their equipment and vehicle fleets in 2017, but at a slower pace. With strong income throughout the industry for the past few years, contractors had replaced a significant portion of their fleets to lower their taxable incomes. Also, some companies planned on lower volume in 2017 due to increased competition, and therefore budgeted for lower equipment acquisitions in 2017. This ratio reflected improvement in 2017 for the electrical and mechanical industry as a whole and in all segments, except contractors with revenue between $15 and $50 million.
Working capital turnover
Working capital turnover indicates the amount of construction revenue generated by each dollar of working capital. The higher the ratio, the more efficient a company is in using working capital to generate revenue. However, very high working capital turnover can indicate the need for additional working capital to support revenue goals.
Working capital turnover varied throughout the industry segments. Larger, more established union contractors’ working capital produced greater levels of revenue in 2017 than in 2016. Contractors with $50 million or more in revenue saw significant increases in this ratio. Contractors with revenue between $15 and $50 million had a small decline in their efficiency. With the increased competition in the non-union marketplace, companies were not as efficient in putting their working capital to use as they have in the past. High profits in the industry in recent years have generated additional competition for smaller contractors, who, as a result, saw a decrease in their working capital turnover.
Days in accounts receivable
Days in accounts receivable (AR) calculates the average number of days that receivables are outstanding or how quickly a contractor converts its receivables to cash. Fewer days in accounts receivable is desirable, as this suggests a company takes less time to covert its receivables to cash.
Overall, it is taking electrical and mechanical contractors longer to collect on their receivables than it did in 2016. This was mainly caused by customers pushing for the longer timeframe for payment terms. Due to heavy competition in the industry, contractors have been willing to extend terms to keep customers happy. Even with the higher days in accounts receivable in 2017, electrical and mechanical contractors have maintained strong working capital in their companies.
Days in accounts payable
Accounts payable (AP) calculates the average number of days it takes a company to pay its outstanding payables to trade creditors, such as subcontractors and suppliers. More days in accounts payable are desirable, as this suggests a company is stretching out its payments to improve cash flow. Care needs to be taken to maintain compliance with applicable prompt payment requirements and to avoid damaging relationships with subcontractors and suppliers when delaying payment.
Results varied by industry segment in their payables cycles. Larger union-based companies were able to increase this ratio to combat the increased aging of receivables. Non-union shops paid their payables faster in 2017, causing strains on their cash flow. In all industry segments, electrical and mechanical contractors were paying their payables faster than they were being paid by their customers, which strains cash flow and requires short-term financing during the peak construction season.
Balance sheet compositions
Below is the weighted average composition of the balance sheets and income statements of all the survey participants. This information is important to assess a contractor’s overall financial position and results of operations in relation to its peers.
The asset composition of electrical and mechanical contractors did not change significantly compared to 2016. With the strong financial performance and less investment in equipment, cash increased approximately 4 percent as a component of total assets. Fixed assets are a smaller component of total assets in 2017 due to reduced spending in this area. Part of the decrease in fixed assets can also be traced to contractors renting equipment, rather than buying it, and using operating leases.
Underbillings are one area that decreased in composition percentage for 2017 due to electrical and mechanical contractors front-loading more contracts. Inventory and other assets have similar composition year over year, and receivables in 2017 are a greater percent of total assets than they were in 2016. The details above led to slight increases in bonding capacity, depending on how much receivables are being discounted by sureties. Similar to 2016 though, receivables remain the largest portion of total assets in the industry.
Also note that a company’s asset composition may differ above due to location and seasonality. Typically, seasonal contractors in the northern United States see a higher percentage of cash and lower percentage of receivables due to a few months with minimal billings.
Similar to asset composition, a contractor’s location and seasonality has an effect on its liability and equity composition. Seasonal contractors typically have lower accounts payable balances, and contractors operating 12 months of the year may have higher amounts of long-term debt.
With decreased investment in equipment in the electrical and mechanical construction industry and less favorable financing terms, long-term debt as a percent of total liabilities and equity decreased 1.3 percent compared to 2016. With days in accounts payable decreasing, accounts payable as a percentage of total liabilities and equity also decreased. Equity continues to be the largest component of total liabilities and equity by a significant margin. During 2017, the percentage of equity to the total liabilities and equity increased another 1.4 percent up to 54.8 percent. The strong profitability of electrical and mechanical contractors over the past few years has continued to drive up this percentage. As a company approaches and surpasses the 55 percent equity mark, it may want to consider diversifying risk by pulling out some equity and investing elsewhere. Overall, electrical and mechanical contractors continue to report healthy net worth to finance operations and support bonding capacity.
Income statement compositions
This chart shows the weighted average composition of direct contract costs compared to total revenue for electrical and mechanical contractors surveyed in 2017. These comparisons vary depending on whether a contractor self-performs or subcontracts most of its work. Seasonality, location, and a company’s overall business strategy also impact these percentages. Therefore, the composition for a particular contractor will depend on operating capabilities, strategies, and the nature of the projects under contract over the reporting period.
This chart shows the weighted average composition of general and administrative (G and A) expenses compared to total revenue for electrical and mechanical contractors surveyed in 2017. These comparisons may differ depending upon a variety of factors, including the company’s size, complexity, corporate structure, and culture. A related performance indicator is a company’s general and administrative expenses as a percent of its revenues. This provides a gauge of overall overhead expenses relative to how well those costs are generating revenues. This can offer insight into a company’s cost structure compared to its peers.
Additional key performance indicators
Below are some additional key performance indicators that may be helpful in assessing your a company’s overall financial health and performance.
|Year||All E&M||Union contractors||Non-union contractors||Contractors $0-15M||Contractors $15-50M||Contractors $50+M|
|Gross profit percentage||2017||21.5%||20.1%||23.6%||22.6%||20.1%||18.6%|
|General and administrative expense as a percentage of revenue||2017||14.7%||13.6%||16.5%||16.6%||14.5%||11.7%|
|Earnings before interest and taxes as a percentage of revenue||2017||4.2%||3.8%||5.5%||4.1%||4.2%||5.4%|
|Pre-tax return on equity||2017||23.8%||21.7%||28.4%||20.3%||28.5%||30.6%|
|Days in cash||2017||16.9%||15.7%||19.3%||21.3%||9.2%||19.7%|
|Debt to equity||2017||1.0%||0.9%||0.8%||0.8%||1.6%||2.2%|
|Equipment purchases as a percentage of depreciation expense||2017||89%||99%||76%||56%||124%||100%|
|Months in backlog||2017||4.4%||4.4%||3.9%||3.5%||6.9%||7.6%|
|Distributions as a percentage of pre-tax income||2017||26.1%||27.1%||15.5%||0.1%||29.8%||63.7%|
How we can help
CLA offers this publication as a resource for companies in the construction industry. It is intended to assist management by providing comparable data, industry trends, and other information to help them make strong financial decisions.
A more detailed comparison of financial results is available through the CLA Benchmark Analysis. This analysis provides a comprehensive comparison of a company’s financial results to a defined group of similar contractors that are selected using a number of factors, including geographic operating region, company size, union or non-union labor force, public or private work focus, and many other considerations. The analysis provides for easy comparison between different-sized companies and combines balance sheet and income statement analysis, along with a graphical comparison of approximately 40 key performance indicators.
The information presented in a benchmark analysis has assisted many construction companies in identifying areas for improvement and highlighting aspects of their business that need further attention. A company’s decisions-makers can use the analysis on an ongoing basis for strategic planning, risk mitigation, internal budgeting, and to help define and track financial and operating goals.