The Profit Paradox: Why Growing Your Construction Business Can Hurt Your Bottom Line

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ℹ ABOUT THIS EPISODE

Wade and Stephen delve into the paradox of growth in the construction industry. They explore why landing bigger jobs and expanding your business may not always translate into higher profits. The discussion covers common pitfalls such as increased overhead, cash flow challenges, and bidding mistakes.They also offer practical advice on managing growth sustainably, understanding overhead allocation, and maintaining profitability. 

Whether you're a contractor facing these challenges or looking to grow your business wisely, this episode provides valuable insights and actionable strategies. 

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⌚️ In this episode:

• 00:32 Common Mistakes in Expanding Construction Businesses 
• 01:39 The Overhead and Cash Flow Dilemma 
• 03:43 The Risks of Rapid Growth
• 07:40 Bidding Practices and Financial Management 
• 12:54 Strategies for Sustainable Growth 
• 19:12 Conclusion: Ensuring Profitable Growth

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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com

Transcript

Wade Carpenter: [00:00:00] You ever land that huge project you've been chasing, only to find your bank account emptier than before? In construction, bigger jobs can mean smaller profits. It's like digging a deeper hole just to build a taller building. Today we're tackling the strange reality that growing your construction business can actually make you less profitable, and it happens everywhere.

More revenue coming in, but somehow less money in your pocket at the end of the day. This is the Contractor Success Forum. I'm Wade Carpenter, Carpenter Company CPAs alongside Stephen Brown with McDaniel Whitley Bonding and Insurance. Stephen what's the most common mistake contractors make when they start trying to expand and land bigger jobs?

Stephen Brown: Well, it's just the whole perception of profit. They think for sure that this is a unit price type contract. So if I was gonna make $20,000 profit on this hundred thousand dollars job, on a million dollars job, I'll earn a hundred thousand dollars, guaranteed. And it's whole perception that [00:01:00] if the revenues are higher, then I'm gonna make more profit.

And the problem with that is you call it a paradox. I think that's a great word. It sounds good. It makes perfect sense. But in reality, there are things that absolutely gut that profit. There's risk, there's how long the job's gonna take. There's so many factors involved, and there's overhead that changes because of the needs to do a job that's larger.

We're gonna dive into that today, right?

Wade Carpenter: Yeah. And a lot of people think they'll make it up on the margin. And sometimes that doesn't translate. We'll get into the overhead part, but the other realization is profit doesn't equal cash flow. And too often we see people, as I was saying, digging a deeper hole.

Some of the signs that, you try to grow and maybe it's hurting, not helping. If you got all the work you can do right now, but less cash. I've seen many contractors with a full workload, full job calendar. The bank [00:02:00] balance is empty while the job calendar is full.

Stephen Brown: Yeah, we talked about that in the last episode that we did. It was just regarding, cash flow nightmares. Looking for a bag to breathe into because you just, you're slammed. Things should be good, things should be great. Again, more sales solve all your problems. That's the mentality.

When it's not the case, something's wrong, and then your plate's full and you gotta try to figure out how to, turn your ship around. You know How long it takes to change the course of a barge pushing five fully loaded, separate barges of just grain alone, just the weight of that, or concrete. It takes a lot of effort.

So here you are, you got a full barge and you're going down the river licket y split and you gotta change course. And there's just a lot that you need to do. Yet again, Wade, there's another analogy for you.

Wade Carpenter: Memphis [00:03:00] analogy.

Stephen Brown: It's a Memphis. Okay, there we go. But.

Wade Carpenter: We don't have those in Atlanta.

Stephen Brown: Yeah. But I guess the point I was trying to make Wade is just that, sometimes, having a full list of jobs in progress, growing your business, adding more work than you can possibly do. I'll just make more margins and we can deal with it. I'm gonna be finished with this job in time to get going on this one, to get going on this one. And so you think, the timing's right to grow, but then you don't really know behind the scenes what's gonna eat into your profit.

And, I've seen that happen over and over again, Wade.

Wade Carpenter: Yeah. There's several factors for this and the one thing you've already mentioned, the overhead growing faster than revenue. It's very common to see that. And a lot of times contractors don't understand that you gotta have more infrastructure. Maybe you need to hire more people, more trucks, you need to buy more software and get another desk or whatever.

Say you got pizza dough or something like [00:04:00] that and you're trying to stretch that working capital as thin as possible, because what's really happening, you go from half a million dollars of annual revenue to a million. If your revenue doubles, your accounts receivable is doubling.

So if your average accounts receivable was, say $50,000, it's now a hundred thousand dollars that's sitting out there waiting for 30, 60, 90 days to collect, plus retainage. It's just like that stretched pizza dough is getting thinner and thinner, and pretty soon you got holes in your pizza.

Stephen Brown: Yeah, then everything's just falling into the bottom of your pizza. You've stretched it too thin.

Wade Carpenter: Yeah.

Stephen Brown: Maybe we could do analogy of a pizza on a barge on the Mississippi River. I don't know. But, I love that analogy too. You're spreading your crust too thin.

Wade Carpenter: Yeah. I guess the other thing that happens, like I said, your receivables are gonna be growing, so what we often see is, we're gonna see this additional revenue coming in, or we think we are. So we just go ahead and hire up or [00:05:00] whatever, but then more bills come in.

We gotta cover the materials, the subs. And what we often see is your debt starts climbing. So whether your credit cards are building, in spite of these higher sales, the debt keeps going up and up. And so that's another one of these signs that you're chasing revenue and not margin.

You ever see that?

Stephen Brown: Absolutely. And like, any debt, as you get into it, you just never realize how fast you're getting into it until you are already into it.

Wade Carpenter: Yeah. I guess going back to the math behind all this, you would think that, okay, your overhead is going to shrink as a percentage of your revenue. So you know, if you're got a half million dollars, this This is the mentality and I get it, is, you got a half million dollars in annual revenue and you jump to a million, but your overhead was say, a hundred thousand.

That was 20% overhead. Okay, we grow it to a million dollars. That should drop to maybe [00:06:00] 10% overhead. That's the thinking. You're gonna make more profit. But too often that percentage of overhead has to grow faster than the top line revenue just to support it. That's part of the math that's sabotaging these contractors.

I guess another thing, sticking with that, everybody thinks the bigger is better and we always say that. But They tend to give away margin. It's like, okay, well I'm gonna get a bigger job. I'm just gonna make it up on the margin. And often that means we bid it lower just so we can get in the door, or, we forget the fact that, if we got even more materials up front, we're gonna have more sitting in our receivables.

A lot of times these bigger jobs are gonna take longer to do. So you got more retainage sitting out there for half a year, sometimes two years.

This is that strain on working capital we've been talking about.

Stephen Brown: Yeah. Strain on working capital. A strain on your workforce.

Wade Carpenter: Yeah. But I guess the whole thing is, just you need more [00:07:00] fuel to run a bigger machine. And that's where people don't realize that bigger doesn't always mean better. So if you're in a growth mode, then you really need to watch some of these things like the overhead , and put some kind of parameters around it.

But, if you're going into growth mode and your tank wasn't full to begin with, you're going to stall out on this.

Sometimes the bidding practices deteriorate during growth. You start getting too busy, becomes chaos. You're trying to deal with more people and more jobs and so you end up getting sloppier. Maybe you don't really put as much effort into the bids.

Just Hey, we're just going to, just wing it here. Stop tracking actual job costs and you end up underbidding your future.

Stephen Brown: You're right. You're more prone to make mistakes as you grow too, because you're venturing into a new territory. Where you make less mistakes on the things that you do over and over again that you can repeat. So a lot of times you say, this particular project is something that's just something I do all the [00:08:00] time, that's just a little bit bigger than I'm used to doing.

That may be perfect sense, and we're not saying growing your revenues is bad, but growing your revenues and thinking that's gonna solve your problems without knowing every detail of how that growth is gonna affect your profit, is what we're talking about here.

Wade Carpenter: Yeah. I can't tell you how many times we've said on here. I know you've said it. I've said it. I've seen contractors grow themselves right outta business. And it's just like trying to fill a leaky bucket. You keep pouring in more revenue and more revenue when you hadn't fixed these holes. It becomes a cycle.

You're too busy, bad pricing, I guess I would say under billing your work sometimes, not chasing change orders and those kind of things. These are several of the warning signs that maybe you're growing a little too fast. You need to really pay attention when you are in growth mode, ' cause the cash flow can run out pretty quick.

Stephen Brown: Okay, we talked about, maybe slowing your vessel down, so you can stop or [00:09:00] turn easier when you're carrying a big load. We talked about spreading your working capital, your cash, thin as if it was a pizza dough that just gets stretched and stretched until it won't even hold the pizza.

What other fallacy would you say needs to be observed by our listeners as they're contemplating growth that we see all the time? And I'll just go ahead and start that by saying, I see all the time, chasing jobs that a contractor really doesn't need to chase.

You gotta consider the risk involved and you're chasing a job that's not something you do all the time, and it's a lot bigger than you've done in the past, you're gonna have a hard time getting a bond for that particular project for a reason. There's a reason for that. It may be a new territory, it may be undertaking something new. In an ideal world, the bonding companies wanna see you just bite off a job that's no more than twice your [00:10:00] biggest job you've completed in the past.

That's a kind of a rule of thumb there.

Wade Carpenter: Again, we said it before, it's like, are you running short? And being able to keep your, paying your power bill. credit card balance is increasing. Are you losing people? Are you hiring too fast? Are you having things like quality issues where you're having to do rework or callbacks, back charges, those kind of things.

Are you stretching your vendors out? Those are all signs that. Maybe you are growing a little too fast and you know there are some things we can do about it, but the main thing to be aware of is that there are gonna be some changes as you grow.

Stephen Brown: Okay, what is some of the, the chaos of growth? What's some of the math behind, these situations that you go through as you grow your revenue?

Wade Carpenter: How do you make sure that the math works? You know I'm a huge proponent of the Profit First mentality, especially since my book's coming out in the next few weeks.

How are you gonna scale? You're operating expenses or [00:11:00] your overhead, call it what you will, contractors never know that number. And when you can dial it in from a cashflow standpoint, that's where you can begin to realize, hey, this is my number and I've always used 10%, but it's really running 17%. I need to put that into my bid.

 When you realize this, you start allocating percentages, say, to your overhead. If nothing else, as you grow, you're going to have some kind of artificial guardrail. You start running outta money in your operating account, that bucket starts drying up. That's a little bit of a sign that growth isn't necessarily working for you, or you need to maybe tamp down worrying about going to get that nice new F250.

Stephen Brown: Yeah, you're right. It's a bummer to think about, but you can always get that nice new F250. We're not saying that. We're saying look at your overhead. As you grow, your overhead changes, whether you want it to or not. With increased sales. Your overhead changes. [00:12:00] What does that mean? Maybe you can dial it down and streamline it and get it more functional than it's ever been before. And it's not that big of an impact, but it's something that can be a huge swing to the profit margins you actually think you're gonna make. Yeah.

Wade Carpenter: I guess I would also say too, if your plan is to grow you, you gotta realize that you're gonna need more working capital. So maybe you need to build your cash before you start building the business even higher.

Stephen Brown: This particular job I'm looking at, everything's fine. Don't worry. It's gonna cash flow like a champ. We get paid on the 20th of every month. We're gonna get paid like clockwork. Don't worry about that. I hear that sort of thing all the time, and I can just tell you again, cash flow and cash doesn't mean anything until you need to buy something. And you gotta buy something in order to complete a project.

So the flow of that cash, paying your bills, juggling credit and you still got the owner that is expecting you to finance everything. How frustrating [00:13:00] is that?

So you got that going on and then, you mentioned earlier just bidding practices that could fall apart as you get busier. You have your set rules and procedures for bidding projects. All of a sudden you get busy, or you decide because you want that higher valued project that you're gonna disregard some of the things that have always been important part of your business strategy, to go after that.

I see that happen a lot, Wade.

Wade Carpenter: Yeah, and if you know you're going into growth mode, you need to start putting money aside. Maybe you should build some cash before you build your business. Just going back to the Profit First mentality, if you start putting profit aside, the idea is, maybe we don't take it all at the end of the quarter. We put half of it back to fund some kind of growth reserve.

Or, just actually start putting away a vault account or something like that. Realize the fact that you're going to need more working capital and don't just go ahead and [00:14:00] buy that new truck or move to a bigger office anticipating the growth.

You gotta really only scale when your systems can handle it.

Stephen Brown: It's easy to let the tail start wagging the dog, isn't it?

Wade Carpenter: it is, and, if you start putting out all these fires, you're not really ready to throw gasoline on your business.

Don't chase revenue thinking that, hey, I can just cut my margin. Maybe you need to set some profit benchmarks before you bid. You need to know what that target market is, and don't assume that it's gonna show up at the end of the project, because it usually doesn't.

Stephen Brown: Sure. And Wade, you're exactly right in that. And I've also seen, contractors say I gotta get into a different revenue scale in order to get away from my competitors that are just bidding things too low. There may be some wisdom to that, but then again, there's no wisdom in it if you're not bidding it properly, and you're not addressing it prudently.

Is it a big [00:15:00] deal to discuss what you wanna do with your financial board of directors? Your attorney, your banker, your bonding agent, your insurance agent, and your CPA. These are all people on your board of directors that are gonna look at things from a different angle and give you advice on that,

Wade Carpenter: I guess the other thing I would add on to that is, say no to bad growth. If it's not profitable, it's not worth doing just to feel like you're doing more.

And we understand sometimes people get in those in situations, it's gonna happen. But the fact is you gotta be aware of what you're doing, because it becomes a spiral. And really, should you actually be cutting your staff back when you run into a situation like that?

Nobody wants to do that. But, what can we practically do to, basically plan for profitable growth? I got a few thoughts. You want to throw anything out?

Stephen Brown: No, go ahead Wade.

Wade Carpenter: Really understanding your overhead allocation as you grow, and tracking it and [00:16:00] watching it . And making sure it's not growing outta your-- do you need to adjust your pricing, your bids on to reflect the true costs? Are prices increasing or whatever?

Do you need to build your systems like that pizza dough? Maybe it's designed to support so much of revenue, but you need to really build the system to scale it effectively. Or is it like you kept it all in your head, but now you hired a project manager and they do it their own way, and then you got a new bookkeeper that does it their way, do the system need to follow all that?

Again, the idea is let's measure our profit, not just revenue. That revenue top line. You also gotta think about the role of your debt. Your debt is probably going to be growing as you scale up. And you probably sometimes have to rely on some of that.

But you gotta realize that, hey, okay, I'm scaling up, and maybe just big wave of cash or retainage comes in all of a sudden, can you really afford to go buy that new [00:17:00] excavator or whatever you're trying to get?

Stephen Brown: Yeah, you might say, the bigger jobs will help pay for that excavator. And then I've got an excavator that I own at the end of the project.

Wade Carpenter: Well, the bank owns it, and then you've got seven more years of payments on it.

Stephen Brown: Yeah, that's right. You're just raining on everybody's parade for buying equipment and tripling their business and doing great things, and buying airplanes and things like that. This is all, a downer, you can do everything you wanna do if you just do it the right way, and you can do it with a whole lot less stress and you can grow your business, you can grow your revenues, but more importantly, you're growing your profits.

So when we're talking about the tail wagging the dog Wade the tail should be the profit that is wagging the dog. You talk in profit first about taking that profit and sticking it in a separate account, the estimated profit on a job, and just working around it from an expense standpoint. [00:18:00] So whatever your sales are, if you're doing that and you're aware of your operating expenses and job expenses, you are gonna be doing better than i f you didn't do that, it's like inevitable, isn't it?

Wade Carpenter: Yeah. I guess the main point of today for the contractors out there, maybe you're sitting at a point where, hey, I've actually gotten to this next level and I still don't see it in my pocket. I'm actually working harder, spending more hours, and I don't have any more to show for it.

 What I hope you take from this is that you may have to change some things the way you're doing it. Maybe put some parameters around like, I'll preach Profit first all day long, because it really does work. The fact that just you're constraining your cash, so you're naturally going to work very differently when you got one big bank account and you think, hey, a big check comes in and you've got, you're on top of the world, and then the next Friday you're broke again. The world's coming to an end. That's my thoughts on [00:19:00] it.

Stephen Brown: As we mentioned at the beginning of the podcast, the whole paradox of growing your sales is it's not necessarily answer all your problems or all your desires. You remember me telling you about the coach I was listening to on the podcast. He was saying, you can't tell a five star recruit that their problems in life do not revolve around money. They're absolutely positive, no, no, no, no. I have enough money, that's gonna solve all my problems. If you have enough profit in construction, that's gonna solve a lot of your problems. It's gonna give you more options, right? It's gonna just give you more options.

And, a lot of things that are tried and true in the surety bonding business way, are there for a reason. For example, bonding companies generally don't want you to do a job over twice as big as your biggest project.

Then if you are going after that, you need to really give that bonding company a sales pitch of exactly how you're gonna pull it off.

And they're more [00:20:00] inclined to let you do that bigger job if you have enough cash. 'cause that's your prop. That's your cash. If it costs you cash to finish the job, they're not gonna have a claim. So they, some of them look at it that way. But then, taking on a big job that's something new you're not used to doing, or in a new territory that you're not used to working in that territory is creates risk that you just don't know about. And construction is risk management, right? It's your management of the risk. And we're talking about managing overhead as well. And as you're bidding jobs and you're growing that overhead changes per job. And that's what a lot of contractors don't seem to get. They just plug in a percent over there and say, this is more than enough to handle what I need.

But again, it's your expenses you can tie down. Your materials you can tie down. Your labor costs you can tie down. Can you tie down whether you're gonna keep the labor? No. And, can you tie down your overhead? You can do as best as you can, but [00:21:00] you need to get it as close as possible.

Wade Carpenter: The point today is as you grow, your foundation is probably gonna be shifting a little bit. And just like you wouldn't build the foundation on quicksand, if building a building. Whatever spot you're in right now, you may be slipping and just make sure you're on solid footing is all I would say.

Let's go ahead and wrap this one up. We appreciate you being here. If you have any thoughts or comments, we'd love to hear them in the show notes below. And if you enjoyed this episode, we appreciate if you like, share, subscribe, do all that stuff. It really helps us out.

We do this every single week and we haven't missed a week in four plus years now. So we're happy about that. But, we appreciate you being here and we will see you on the next show. Thanks.