How to prepare your construction business for a recession – your guide to surviving and thriving through uncertainty
How to prepare your construction business for a recession – your guide to surviving and thriving through uncertainty
Headlines are being dominated by talks of a recession. Find out what your construction business can do to prepare for any challenges ahead.
With inflation hitting almost 40-year highs in Canada, many observers worry a recession is increasingly probable. While the future is not set in stone, construction businesses need to start planning to ensure they can navigate a potential economic slowdown from a competitive and confident position.
The longer you have to plan ahead, the better prepared you will ultimately be. This article outlines the key factors and steps to consider so you can successfully address challenges and seize opportunities.
Focus your time on major priorities
As soon as possible, make time to revisit your business models and any assumptions you have made about the economy. Set aside at least a half day with your top decision makers to scenario plan how a recession could negatively impact your business. Areas you’ll want to study include your gross margins, net margins, sales, various channels, and markets you operate in — as well as risk in your customer base.
A six to seven percent inflation rate will erode earnings regardless of your performance over the last year. Take, for example, a healthy and profitable company that generates a 10-percent earnings before interest, taxes, depreciation, and amortization (EBITDA) — or an average of $3 million of profit on $30 million of revenue. With inflation at present levels, its entire profitability will be wiped out within 18 to 24 months.
With that in mind, the first step is to determine what’s driving your costs and margins. Inflation is impacting everyone and everything — influenced in large part by soaring fuel prices, surging demand, and geopolitical uncertainty. As China reopens from COVID lockdowns, rising industrial demand will likely put even more pressure on supply, demand, and prices.
Think about how you might incorporate higher transportation and raw material costs into your pricing, especially given the dramatic shift for petroleum-based products. Are your models still relevant? Keep in mind, that there’s a straight line between your predicted costs and your predicted profits.
Another factor to be mindful of is there will be a delay between any change you make today and its eventual impact. The longer your cycle times, the faster you need to react.
Finally, dedicate time to thinking about the labour shortage in Canada. The country’s aging population and accelerated retirements through the pandemic have caught many organizations unprepared for the staffing challenges. How could this impact your organization? There isn’t a simple solution. It will require different strategies than you’ve used in the past.
Review of suppliers and costs
- Review all costs and contracts with suppliers. For medium to long-term construction projects, which of these costs are locked in, and which of these could increase. How well do you know your suppliers and their ability to provide the services / inventory under the contract? Will the shortage in labour supply hinder their ability under the service contract? Will rising interest rates and a challenging environment affect their ability to stay in business?
- Is there an ability to fix the prices under these contracts for supply that will be needed in 2+ years or are suppliers pushing to have contracts that allow for variable pricing?
- Is there an ability to pre-purchase certain supplies/inputs? Consideration needs to be given to financing these purchases and storage as warehouse/industrial space to store these supplies is in short supply
Cash flow planning will be critical moving forward. Construction businesses with cash can pay off more debt as interest rates climb. You might also consider paying off your highest interest rate loans now before rates increase again.
Some blue skies
There are opportunities to be found during times of recession. Namely, a prepared construction business may find itself in a position to capture market share and grow through consolidation. You can also enjoy competitive advantages if you can predict what projects will take off, focus on higher margins, and improve cash conversion.
As businesses emerge from recessions or periods of economic uncertainty, there are often opportunities for those seeking to grow through acquisitions and those looking to exit. Those that are struggling because they couldn’t make changes, cut costs and manage cash flow may provide strategic merger opportunities at a discounted price.
Similarly, knowing other firms may be looking to acquire, this is a good time for those considering an exit to conduct a readiness study. The assessment will identify and inform a stepwise plan to eliminate any value inhibitors prior to putting the business on the market. You’ve worked hard to build your business. This or a similarly structured process will help you “stage it for sale” and maximize the return on your investment.
Inventory Management Health Check
Be self-aware
Many businesses have enjoyed great returns over the past several years and are managing their entire business based on their current financials and what's in the bank account. They're not looking ahead and scenario planning — they’re not asking “what if…?”
What if input costs soar? What if sales drop? What if key employees retire or quit?
You need to be proactive as concerns of a recession continue to grow. Engage in an enterprise-wide organizational review with an independent performance improvement team. They can provide unbiased insights into which products and services provide the best returns, where your prices could and should be, and where your opportunities lie.
Remember, if inflation is expected to be six to seven percent over the next two years, you’ll need to find the same percent in cost or price improvements just to preserve the status quo.
Conclusion
- Take time to plan; this includes:
- Reviewing your business models with senior staff
- Assessing your priorities, risks, and impacts on your business
- Incorporating inflation into your pricing models
- Paying down debt
- Have a rainy-day fund to ensure your construction business has enough cash to ride out a recession.
- Focus on returns: Look at your inventory, cash conversion, margin, and overhead and be prepared to let go of burdensome products / services. If you haven’t already, switch from a just-in-time to a just-in-case approach to inventory (NTD – inventory comment needs to be removed or edited as construction companies don’t sell inventory).
Finally, always look ahead. Many businesses have had their best financial years recently, but world economies are still volatile. A construction business that anticipates and gauges challenges is more likely to overcome them — and outperform its competitors.
Contact us
For more information, contact:
Yohaan Thommy
National Performance Improvement Lead
[email protected]
Alex Levin, CPA, CA, Partner
Real Estate and Construction Services
[email protected]
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