How to Conduct a Financial Stress Test on Your Construction Business

As a construction business owner, you spend every minute of your workday looking for and completing projects. Your business is something you’re passionate about and you want it to flourish. But what if you encounter unexpected setbacks that hurt your ability to succeed? Just like any other well-managed company, construction businesses need to dive into the question of “what if?” and get a better understanding of how various outside elements could impact their viability. It’s not easy to keep things going if you are unsure what the future holds.

What Is a Financial Stress Test and Why Is It So Important?

Imagine a board used in the construction process. The goal of a financial stress test is to see what will happen when the business, or the board, is put under various types of strain. It provides information about how the business will react and if it can survive. The construction industry is not immune to risks, and for companies that have been around for 10 years or more, it is quite clear why this type of testing is so important.

The construction industry took a significant hit when the Great Recession occurred. Between 2000-2006, the housing bubble was at its highest peak. More than 900,000 jobs were added to the construction industry to keep up with the demands. Then, the Great Recession occurred. From 2007 through 2010, the construction industry lost 2.1 million jobs, which amounted to about 25% of the nation’s net job losses, according to the Washington Post. Now, we are watching a rebound take place and, while that is encouraging, numerous factors could further impact the industry, putting your business at risk. When you decide to conduct a financial stress test, you can better address the risks you face, and hopefully work to prevent those risks from occurring.

The Questions to Ask

Some critical questions you need to ask about your business are listed below. After you gather this information, you can use software programs from investment professionals or advisors to help you to play out the actual scenarios, and better estimate the amount of impact these risks could have on your business. For the sake of this article, though, we’ll get you ready to ask the important questions.

Who Is Your Primary Customer?

Some construction firms are very specialized (foundation work, for example) whereas others provide a large range of services to commercial, residential, retail, and other sectors. You need to outline who your customer is as a first step.

What Are the Risk Factors That Impact a Construction Business?

Next, think about all of the risk factors that could impact your construction business. These should be as specific as possible to your business. Here are some that impact most businesses in the industry:

  • Real estate construction could begin to fall off due to a drop in the real estate market
  • Industry standards may tighten or regulations may occur to influence building methods, costs, and requirements
  • Protocol for workplace safety — something that continues to evolve within this industry — could change.
  • The economy could falter. How would that impact your business?
  • Interest rates could rise, which is something that’s likely to occur when the Fed makes changes this year. How will this impact your business and the availability of construction loans?
  • Green and environmentally friendly standards are changing, with some cities even requiring new construction to implement energy efficiency. How would you need to prepare to implement these new expectations?

What Critical Performance Variables Are You Tracking?

Next, ask yourself what variables you should be tracking so you can pinpoint specific risks like these? Are you tracking year-over-year revenue? Are you monitoring inspections and OSHA violations? Are you tracking efficiency improvements within your organization? The cost of labor, economic conditions, and overall local construction market factors need to be tracked.

What Are Your Business Needs?

Finally, you need to know the details of your business needs in order to keep the doors open. Conduct a financial accounting of your income and expenses. Determine what your projected expenses will be over the next year, five years, and ten years, based on inflationary measures. Then, calculate specific needs.

  • How much cash do you need on hand?
  • How much liability insurance do you need to have in place?
  • How much reserve do you need to ensure payroll can be met?
  • How many projects do you need each month to break even?

By working through this financial stress test, your business will have a plan in place to identify what your risk factors are, what steps you need to take to prevent them, and what to do if they do occur.