Masonry Magazine June 1997 Page. 15
Profit is not a Dirty Word
Business Planning
Risk vs. Reward. One of the underlying tenants of the free enterprise system is that risk is compensated by opportunity for reward. The implication is that the riskiest business should, on average, provide the largest reward over time.
Does this apply to the construction industry? All would agree that construction is one of the riskiest industries in the U.S. The characteristics that create risk for contractors are numerous: weather, soil conditions, labor unrest, new work force at every project, uniqueness of every project, fixed priced contracts based on estimated (but unknown) costs, new customer on every project, poor quality of plans and specifications, etc., etc. The ultimate measure of risk for an industry is the failure rate. According to Dun & Bradstreet Corporation, construction had 9,158 bankruptcies in 1995, a 9.8 percent increase from 1994.
Since construction is one of the riskiest businesses around, how are we doing on the reward side of the equation? Profitability and return on equity invested are two accepted measures of success in business. Those figures for construction are as follows:
1. According to a survey co-sponsored by AGC in 1994, 20 percent of the responding contractors reported a net operating loss of greater than 1.0 percent in the previous year. Another 10.0 percent either had a small loss or made less than 1.0 percent profit as a percentage of revenue.
2. The 1995 survey conducted by the Construction Financial Management Association reported that the average net income after tax of the responding 975 construction firms was 1.5 percent of revenue, up from 1994. The average return on equity increased from 8.9 percent in 1994 to 12.5 percent in 1995, and 14.7 percent of the respondents reported a loss in the year, down from 19.0 percent in 1993.
3. Forbes magazine's 1995 Annual Report on American Industry reported that the publicly traded construction companies had a median net income of 2.5 percent of sales and a median return on equity of 12.0 percent for the latest 12 months. The construction industry ranked 19th out of 20 industries on a level of return on equity.
Are these returns adequate to offset the risk being incurred? How do these returns compare to other industries? For a broad-base comparison, the public companies making up the Standard & Poors' 500, a cross section of American industry, earned net income of 5.1 percent of sales in 1995 and the return on equity was 15 percent. The previously mentioned Forbes list of 1,309 firms earned net income of 4.9 percent and a return on equity of 13.9 percent. Only 10.1 percent of the companies lost money-an increase from 1994.
Profit is not a Dirty Word
By: Hugh L. Rice
MASONRY-MAY/JUNE, 1997 15