Contractor profitability: how daily activities can have a big impact.

IN THIS ENVIRONMENT of tough competition and demanding customers, profits are sometimes hard to come by. Admittedly, it's not easy to balance all the competing forces and come out on top every time. But the best thing you can do to increase your net income is to understand how your operations, policies and business practices can affect your bottom line.

Increase contract revenue. Let's start at the top: Contract revenue. There are a number of things you can do to bring more money through the door, but the most effective is often the simplest--focus on what you do best. By finding your niche (either in type of construction, size of job or geographic area) you're able to focus your resources on a specific target market helping you develop experience, relationships, trust and name recognition more quickly.

Now that you have established yourself, market your expertise to architects and owners but bid selectively. And when you do, make sure you have a solid understanding of your indirect costs. This includes all those soft costs you incur to be in business, many of which are often overlooked, especially in billing rates for T&M contracts. Make sure your estimates include an appropriate overhead rate for your business.

So you win the work and proceed to finish ahead of schedule. But wait. The owner or architect decides to make changes to the schedule or design. Sound familiar? How you handle change orders can make or break your business. Understand the scope of every project and be quick to recognize changes to that scope. Proper documentation, authorization and cost capture are essential for you to be able to recover those costs from the owner.

Decrease cost of construction. Perhaps the most significant reduction to costs can come from increasing productivity. It also can be the toughest. Certainly new technology over the past five to 10 years has made a huge impact on workforce productivity across all industries, including construction. Could you imagine a job site today without cell phones and most recently the trusty Nextel walkie-talkie?

Proper well-maintained equipment is also essential. And, always weigh the option of short-term leasing against purchasing equipment, especially in limited-use situations. The cost of owning equipment is often more than just the purchase price. You'll need to insure it, store it, transport it and maintain it.

Staying current with technology and using the right tools for the job are definitely important aspects to being productive. But, most companies have found their greatest increases in productivity come from having well-trained employees and quality subcontractors who are conscientious and motivated to get it done right the first time.

Workplace safety is a cost all its own. Insurance premiums to contractors have skyrocketed in recent years. But that's not the only cost you need to worry about. If something were to happen on a job site, you'll be facing legal costs, damage to your reputation, lost productivity, higher workers' compensation rates and the list goes on. Maintaining an effective safety program and investing in proper training and added safety measures can significantly reduce your costs of construction.

Decrease selling, general and administrative expenses. No doubt, having an effective back office can be an important ingredient for success. But your back office should be the "right size" for your business. To determine that, compare your organization against industry benchmarking data, such as RMA and CFMA financial surveys or PAS compensation surveys. Your professional service providers can help you with this. For example, as part of our audit services, we benchmark our construction clients annually and provide that analysis along with our audit opinion.

And, if you haven't already, consider implementing an incentive compensation plan. Don't make it too complicated. The best plans are simple and are tied in some way to the profitability of the company. The goal should be to get everyone in the company moving in the same direction.

Increase other income, decrease expense. Although this may be an oversimplification, interest income and interest expense are the primary drivers behind these numbers, and that means cash flow. Cash is king in construction. One of the best ways to improve your cash flow is to defer income and accelerate deductions--in essence, an interest-free loan from Uncle Sam.

Other ways to improve cash flow include developing good billing practices and negotiating front-end-loaded schedules of values or lower retainages as jobs progress, i.e., 10 percent retention up to 80 percent complete, 5 percent retention over 80 percent complete. Another effective tactic is to work with your bank to help put your cash to work (lock box and other banking services).

Managing profitability is an ongoing process that requires constant attention. Things change. And as those things change, they affect your profits. In addition, all contractors are different, as are their profit drivers. The most successful contractors we work with understand their formula for profitability and tweak it every day as they ran their businesses.

George Gabor is partner at BKD in Indianapolis who works with construction clients and serves on BKD's firmwide Construction and Real Estate Committee.