"The best way to predict the future is to create it." – Peter Drucke
Good financial performance in a construction company depends on three factors:
1. The terms of financing arrangements are adequate in regards to the amounts, interest rates, and payments. (I.e. Your line of credit isn’t locking up purchases for completing a job)
2. Overhead and non-job related costs are monitored, planned, and controlled.
3. Jobs are performed at appropriate margins.
The third is what I consider to be both the most important and most difficult. It’s not enough to just perform jobs, you must perform them profitably, at margins that consistently returns cash back into the company. Profitably performing jobs would be much easier if the managers and owners had a crystal ball to consider. So, here’s your crystal ball.
The ultimate profitability of a job is tied to behaviors. Tracking those behaviors and teasing out those behaviors in a format in which they can be monitored, predicted, and changed in advance is of the most valuable tools in a business owner's toolbox. It’s also true that most business owners and managers feel like it’s impossible to gather that type of information, but the information may already be in your software if you’re using many enterprise solutions like Sage.
Predictive or Performance?
The best tool in the toolbox for predicting the future is a frequent Key Performance/Predictive Indicator (KPI) review. A performance indicator is a number, usually monitored over time, which tells us how a specific business function is performing currently and historically. It helps us know if we’re on track and doing what we planned to do. A predictive indicator is a number, also usually monitored over time, which tells us how we’re likely to be performing in the future. We believe the information with the highest value is information about events and transactions that haven’t occurred yet, here we focus on predictive indicators as opposed to indicators of current or past performance.
The best example of indicators being predictive vs. performance related is the difference between the temperature gauge and the speedometer on a car. One tells us the engine’s temperature, which is predictive of the engine’s short term performance. A car that’s overheating will perform poorly or not at all. A speedometer is a current statistic telling us a lot about how the car is currently doing but does little in terms of predicting the car’s future.
How do we get good KPIs?
Around September of 2015, Phillip E Tetlock (a university professor) and Dan Gardner (a journalist and author) released a book called Superforecasting: The Art and Science of Prediction. In this book, they claimed the key to making good forecasts depends on carefully considering relationships between events and predictions and constantly reviewing your results and how close you were after the event occurs.
This is also true of KPIs. We need to first, find a relationship between a dataset such as job performance in certain phases or certain labor patterns. Then, as we make small incremental changes in company decisions, behaviors, and habits, we need to monitor whether they truly impact our business in the way we predict.
In short, good KPIs, and even good business management rely on a completed feedback loop. There should always be feedback to evaluate how our intentional and documented changes impact performance, while also constantly judging our ability to predict results.
KPIs must be monitored frequently. Sometimes it’s not practical to have every KPI available weekly, but you need to set a cadence that makes sense. Some reviewed by management weekly, some monthly, some quarterly. This takes discipline, but it’s worth it.
Good KPIs generally come from one of three areas: marketing, operations, or finance. Here are some ideas for places to look for good KPIs (these in themselves are not KPIs, but instead things to improve through using KPIs):
o Sales pipeline size and speed
o Accurate estimates
o Appropriate pricing
· Performance of business operations
o Successfully completing contracts
o Minimize safety concerns for employees
o Minimize rework/errors in the field
o Jobs costs match estimated costs
o Job tasks/phases match estimated tasks/phases exactly
o Capacity constraints and surplus
o Appropriate return on investment
o Cash flow sufficient to fund job completion and cover overhead in foreseeable future.
o No unnecessary risk from over/under capitalization.
o Velocity of Cash
Good KPIs are usually:
• Tied directly to specific behaviors
• Accepted as a relative truth by all individuals involved
• Communicated throughout the organization
• Compared to a specific goa
Good First Steps
Some good advice to follow for creating or improving KPIs is to start small. Make small changes until you find the right KPIs. If you have no KPIs, just try to find the one KPI to monitor at first that will make the biggest difference in your organization. Develop the feedback loop on that one KPI before moving on to having more. This can take time, so have patience.
Make sure the KPIs are in line with the vision of your company. Are you a vision-driven company? Check out my colleague Todd Williams post on being a vision-driven company here. If you’re using Traction, these KPIs are your scorecard and this needs to be in line with your VT/O.
Just like any other muscle you build in business, predicting takes practice. To become better at choosing, analyzing, and acting upon KPIs, you need to constantly be doing so and reviewing your results.
Feel free to reach out to us on LinkedIn or on the website for more on how a KPIs are helping construction companies predict the future and making better businesses.
James H Johnson, CPA.CITP, CGMA, MBA