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Ratio Analysis. The fun stuff! (Part 1)

Updated: Aug 23, 2022

There are tons of ratios you can use when evaluating your performance. I've put together some of the ones that I felt were the most useful. Download the attachment and we can begin! This is the first part of the lesson so I will address the other ratios in a separately so your brain doesn't fry like the picture above!

Whether your projects are bonded or not, it's a good idea to use ratio analysis over multiple periods to evaluate your operations. Analysis paralysis is real, so hopefully the following ratios won't be too overwhelming.

WARNING: GARBAGE IN, GARBAGE OUT. Like the old cliche says, compare yourself to yourself before others. You can make sense of your numbers and why they are the way they are because you know the operations behind it! Then compare against the crowd! Please bear that in mind when reading through the following explanations. I could spew out some detailed expectations but in the end it may not really mean anything because I don't know how you operate.

Working Capital: Current Assets minus Current Liabilities. Do you have enough assets in the short-term to cover your short-term obligations? The answer should always be yes. What will be satisfying these short-term obligations is important, as you would hope cash and AR aged 1-3o days makes up most of your current assets.

Underbillings to Working Capital: Underbillings divided by Working Capital. Underbillings are driven by management's estimates and we all know how estimates can change in the blink of an eye. If your underbillings have a history of turning into losses your surety will likely discount them in their calculation of working capital. So depending on your historic performance, underbillings may not carry too much weight in your favor for bonding.

Cash as % of CA: Cash and Cash Equivalents divided by Current Assets. Remember "cash is king" so under ideal circumstances, cash makes up a large portion of your current assets. How much exactly? Look over this ratio during the "good years" and compare it across periods. There's more to ratios than just numbers!

A/R as % of CA: Accounts Receivable divided by Current Assets. How much of your receivables are current or likely to be collected? That's something you'll want to ask yourself when calculating this because significantly aged receivables are often discounted by sureties.

61-90 days as % of A/R: Take your receivables aged from 61 to-90 days from your accounting software and divide by total Accounts Receivable. Hopefully, it's not a large percentage but maybe it is and has historically been that way! That will offer some great insight into your cash flows. While your receivables are collecting dust, your paying out payroll, subcontractors, material, etc. Do your best to let the project owner finance the project!

Over 90 days as of % of AR: Take your receivables aged from 90 days and greater from your accounting software and divide by total Accounts Receivable. These receivables don't carry too much from my understanding from the sureties perspective. Just make sure everyone in your organization is aware of these balances so you can collect them ASAP!

Collection Period: Accounts Receivable multiplied by 365 days, with the total being divided by Contract Revenues. This will show you how long it takes for you to convert your AR into cash in days. Hopefully it's within a month or a month and a half. The sooner you collect AR the quicker you meet your obligations and work towards project completion. It's best to exclude retainage here as it will skew your calculation since collection can take a year or longer.

Overbillings as % of Cash: Overbillings divided by Cash. This one is pretty big time. You're familiar with overbillings as you've mastered the previous lessons so this part should be a breeze. You've billed ahead of your expected gross profit! That's great right?! Depends on who you ask. Those overbillings will need to pay project costs soon so where is that money? Is it in cash or accounts receivable. You hope your overbillings don't exceed your cash balance, but hey it happens. If it is, then your next best friend is current AR. It's got to be living somewhere on your balance sheet and hopefully not as a distribution! You've got to fund the project!

Overbillings as % of A/R: Accounts Receivable divided by AR. Same idea as above. When it comes to overbillings living in AR, you'll want to make sure the receivables are collectible. All everyone wants to know is that money you'll collect from the project will be used to collect the project!

Average age of fixed assets: Accumulated Depreciation divided by Depreciation Expense. How old are your assets? Is it time to prepare for some big purchases? This ratio can offer some guidance on when you may anticipate significant cash outflows.

Fixed Asset Turnover: Contract Revenue divided by Net Fixed Assets (Fixed Assets less Accumulated Depreciation). This will apply more to those of you with heavy equipment that's essential to your projects. How efficient are you at using your equipment in producing revenue?

Revenue to Working Capital: Contract Revenue divided by Working Capital. How well are you leveraging your working capital to generate revenue? This is about financing operations and staying ahead of your projects. The higher the ratio the better.

Quick Ratio: Cash plus AR divided by current liabilities. Cash and AR are the most liquid assets you have. This measures how well positioned you are to satisfy your current obligations with cash and AR. The higher the ratio the better.

Current Ratio: Current Assets divided by Current Liabilities. Same as above but now you're factoring in total current assets, which could include other items like inventory. Once again, the higher the ratio the better.

Contract Revenue to Equity: Contract Revenue divided by Equity. This measures how well you're leveraging your equity, or what you have free and clear, to operate your business and generate revenue. Look over this ratio across multiple periods to give yourself an idea of the what a good benchmark looks like. Then compare to an outside average.

Total Debt to Equity: Liabilities (less Overbillings) divided by Equity. How much of your operations is funded by debt? As you could imagine, you would like this ratio to be small or decrease over time.

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Done...for now!

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