By Steve Scoggan

When starting a business, one of the first recommended steps is creating an overall financial budget for the company. And perhaps you did that when you established your construction company. But in the hustle and bustle of moving from one project to the next, you may have let your budget slip onto the back burner or out of sight completely.

If so, now is a good time to start rebuilding your budget from the ground up. Why? Because today's fragile economy has made managing revenue and cash flow more important than ever.

Look at your income

To get started, first look at your income statement to analyze your sales, margins, operating expenses, and profits or losses. If times have been tough, you may not even want to know how little income you're pulling in, but it's important to look at the specific numbers.

Once you do look at the income statement, however, your natural tendency may be to get hung up on it — particularly if your construction company is showing a profit. Yet bear in mind that this part of your budget doesn't reflect cash-related activities such as buying new equipment or borrowing money from the bank. Just because your business appears profitable now doesn't mean it's out of the woods, because the cash you've earned may be dangerously tied up in other financial assets or obligations.

An important number to focus on from an overall budgetary standpoint is your gross profit margin. If your margin is declining, you may need to adjust or increase your contract revenues or try to lower your contract costs.

Check your cash flow

In today's cash-conscious economy, the center point of your budget is surely the cash flow statement. It begins where the income statement leaves off — with your net income. From there, the cash flow statement is typically divided into three subsections:

1.      Operating (activities associated with running the business),

2.      Investing (activities associated with growing the business), and

3.      Financing (activities associated with obtaining money).

Cash flow is important for any business, but construction companies can all too easily be undone by a lack of available dollars at critical times. So your budget needs to account for cash flow at the time you re-establish your budget as well as your projected cash flow for the coming year.

To integrate a cash flow projection into your budget, take your current and anticipated projects and estimate your expected revenue by month. Naturally, predicting exactly when cash will come in is tricky — especially if you're working with an unfamiliar project owner or undertaking a spec job. But you can use your historical payment data to calculate an average for planning purposes.

Bring in your balance sheet

With your income and cash flow down on paper, a third critical aspect of your budget is the balance sheet. Think of it as a snapshot of your construction company's financial condition on a given date. The balance sheet usually lists assets, liabilities and shareholders' equity. Elements such as these can help you realistically shape your budget going forward.

For instance, if your balance sheet shows a substantial amount of debt, you'll likely need to curtail discretionary expenses (such as company parties) in your budget. You can also use your balance sheet to calculate your debt-to-asset ratio. It can tell you how many of your assets (heavy equipment, office technology) are owned by your lender(s) and how this could impede your budget for the year.

Lay the foundation

Think of the three elements discussed above — income statement, cash flow statement and balance sheet — as the foundation of your budget. Work with your CPA to generate these documents and you'll have the basis for a solid plan of attack for the coming year (or whatever time frame to which you'd like to apply your budget).

Of course, there are other elements you might include in your budget, such as your mission statement and an executive summary. But if, like many contractors, you've gotten away from budgeting in recent years, it's probably best to start with the basics and work up from there.

An idea for staying within budget: Pay-for-performance

It's one thing to create a budget (see main article), another to stay within its parameters. One expense that often drives up a contractor's budget is labor costs. If your workers are leaving the job site early or working inefficiently while they're there, even the soundest budget can become unattainable.

One way to keep your labor costs in line is to switch to a pay-for-performance model for some or all of your employees. Under this compensation paradigm, a worker's pay comprises a base component set by what the competitive market pays for a comparable position (factoring in skills and experience) and a variable component determined by whether and how well he or she meets specific goals.

For construction companies, pay-for-performance can motivate workers to keep up with ambitious job schedules while creating clear accountability for what you're trying to accomplish on each project. It can also help weed out unmotivated workers who hang around job sites putting in a bare minimum of work and looking for ways to cut corners.

Of course, there are risks to consider. Some workers may feel that the pay-for-performance model pits team members against each other. This may foster unrest and poor morale on job sites. In addition, employees may work more sloppily to beat deadlines and, thereby, qualify for incentives.

To mitigate these dangers, you'll need to design variable components that trigger performance pay specifically to each project role or phase based on reasonable scheduling and including quality checks. In addition, you might provide some performance pay on a team basis, rather than just on an individual basis.