Back in December, I attended the American Institute of Certified Public Accountants’ annual two-day Construction and Real Estate Conference in Las Vegas. At the event, I attended nearly 20 individual sessions, many of which focused on the construction industry, but some were on broader topic such as what causes businesses, specifically contractors to fail. Although this seems like a negative topic, there were plenty of valuable takeaways about effective approaches for executives to keep their businesses positioned for success in good times and in bad.
The presenter, Ryan Howsam of FMI, had done a quite a bit of research on the topic and dispelled a common myth immediately in his talk. His study indicated that general economic conditions are not often the root cause of a company’s failure, but that declining markets are one of many factors in a downfall.
In fact, Howsam said that contractors are three times as likely to fail in good times as in bad. For one, when the economy is booming, contractors may be less inclined to turn down a project. Consequently, contractors in general have almost nine months of backlog right now, compared to six months back in 2009. Having a healthy flow of committed work is important, but it also requires executives to carefully manage the increased level of work.
There were three major reasons that Howsam identified for why contractors fail, although they are also applicable to many types of businesses.
The tone at the top of an organization has far-reaching effects throughout the company and it goes a long way in determining how stable the business will be. Executives who are driven to grow regardless of the quality of additional customers or the profitability of new work will struggle to thrive despite higher top-line revenues.
Management also needs to be sensitive to risk. When things are going well, some leaders will become less sensitive to risk than usual. Specifically for construction entities, one bad job can cause long-lasting harm to the company and potentially cause it to fail. Being aware of the risks in each transaction are important regardless of the economic conditions.
Amount of Change
Companies need to be nimble and prepared to adapt to technological advances, changes in business climate and workforce trends. However, too much change can be detrimental to business. Simultaneously adding volume, markets, stockholders, geographical areas and vendors, suppliers or subcontractors puts a great burden on the company to keep up with all of those changes at once. A strategic plan that addresses adding a business sector or expanding geographical footprint will better allow the company to overcome the challenges that come with major changes in the business.
Although there can be many factors, overall, a company fails because it does not have enough money. Having a plan to keep a certain amount of money in the business during good years and continuing to be diligent with costs will help a company through bad stretches. Overpaying for acquisitions are a common pitfall of highly-successful companies that become a little too confident. Similarly, companies that are highly leveraged are in danger of not having sufficient funds to handle anything greater than a minor blip on the radar.
Many industries have enjoyed great achievements in recent years, but the attentiveness and care that went into putting a business into a strong position need to be maintained to ensure the continuity of this success.
By Dan Massey, CPA, Manager