Return on Investment or ROI is the new business model of construction contracting. No longer is it “backlog and margin”. If your ROI for your projects is high, your company should be also. This is a “one way street” in construction contracting. Project results determine your corporate results i.e. Project / Loss Statement and Balance Sheet health.
The return on investment calculation is relatively simple. This a best practice when considering bid strategy or pricing for a project. Additionally, using it as one of the metrics in the post mortem phase of a job serves an equally valuable discussion point.
One component is the average amount of capital invested in a project – this many times is your average working capital investment into the job.
This number is projected by the person estimating the project or the Senior Executive overseeing the project. So for illustration’s sake, we will use $1 million dollars. Also, let’s make this a one year project. This one year horizon allows us to easily calculate it on an annualized basis. This is important when comparing project to project.
This working capital number is fully loaded with overhead and retention costs. See our overhead and retention calculation work in my book, Managing a Construction on Just 24 Hours a Day (McGraw Hill, 2007).
Then, use expected (or actual) profit as the numerator with the working capital demand average as the dominator.
Obviously, after a project is completed would more accurate. Using actual records leaves little room for argument.
If your profit is $400,000 and working capital investment is $1,000,000 then the annualized ROI is 40%. As an aside, financially “best of class” contractors achieve annualized ROIs at this level. A good return for the second riskiest business in the United States.
For more information on this critical subject, purchase a copy of my McGraw-Hill book, Managing a Construction Firm on Just 24 Hours a Day. We offer a bundle with Excel templates that are featured in the book and 5 on-line courses to help teach construction business concepts. Go to www.stevensci.com and click on the book link
Our workbook companion with 10 case studies is titled, The Business Managment Workbook for Construction with Case Studies is now available.This text is focused as an assist for Colleges, Associations and Contractor Training Programs that teach the business of construction.
My next book, The New Business Model of Construction Contracting is planned for December 2007. Its focus concerns the changing construction environment and what processes address those changes.
Matt Stevens is President of Stevens Construction Institute, Inc. A management consulting firm which works only with construction contractors. Learn more at www.stevensci.com. Take a free course at www.constructioncbt.com and sign in as a new student.