Measure and Manage Months in Backlog

IIn this month’s Off the Mat article, we will discuss how the highest performing paving contractors use the months-in-backlog analytic to drive the decision of procuring new project opportunities. Evaluating how much work you have on the books at a given point in time is critical to a paving company being able to accurately predict and project its next few months of operating results.

Backlog is an ever-changing calculation. As new work comes in, backlog increases, and as work is performed, backlog decreases. For paving companies that have long-term projects, the months in backlog analysis will be easier to calculate as there are typically fewer projects to have to consider. It is also customarily easier to schedule, coordinate and mobilize on a few larger projects as compared to a multitude of smaller projects.

Backlog is considered uncompleted work that is awarded via executed contract. Pipeline open bids, which are open proposals, are not included in the actual backlog figure, because these are not “hard” contracts. Pipeline open bids are important in understanding the historical win rate the contractor has when determining how close the contractor is to its targeted backlog figure.

In a previous Off the Mat article—Mitigate Contractor Risk— we discussed contractor failure and contractors who do not understand the relationship of man hours available to work compared to actual contracted man hours to be completed in a given season. This can create significant operational challenges for a contractor to be profitable. For instance, too much work at a low margin may cause the contractor to not hit its profitability goals.

Months in backlog can have multiple definitions; let’s review three of those formulas now.

Sales months in backlog is the number of months of backlog a paving company can perform based on the total gross sales (revenue) prior to any expenses deducted.

Backlog Months Sales Dollars X Gross Profit Percentage (Avg. annual fixed cost + budgeted net profit)/12

One primary positive of the sales months in backlog calculation is it is the simplest of the three formulas. When communicating goals and expectations with the sales team, sales dollars is often the easiest term for employees to understand. When using sales as the driver for this analysis, it does not factor in the profitability of the backlog.

Gross profit months in backlog is the number of months of backlog a paving company can perform based on the total gross profit (revenue less direct costs of construction). Backlog Months X Gross Profit Dollars (Avg. annual fixed cost + budgeted net profit)/12

The advantage of this analysis, compared to the sales approach, is it focuses on the actual dollars the paving contractor has left over after performing the work.

Challenges in using this method broadly are having to educate the team on the definition of direct costs and the results of the direct costs are not in control of the sales team member. This method is better served to convey to those charged with estimating work and not actually selling the work.

Labor hours months in backlog is the number of months of work on the books a paving company has based on the total field labor man hours available.

Backlog Months Labor Hours X Avg. Gross Profit Per Labor Hour (Avg. Annual fixed cost + budgeted net profit)/12

In our industry, skilled labor availability continues to be a challenge. When evaluating months in backlog, the analysis that yields the most accurate results uses labor hour months in backlog. This analysis does require the most attention to detail and understanding how accurate the estimates are on a job-by-job basis. The sales figure and estimated cost dollars need to be correct to give the projected gross profit on the project and the estimated number of labor hours needs to be correct for this analysis to be accurate.

The main downfall with this analysis is the detailed level of information required is so much greater than the previous two, that it creates additional opportunity for inaccurate information to be used in the analysis. That, in turn, would give an inaccurate projection of the months in backlog.

This method is best used to communicate with the operations team tasked with scheduling the projects.

BACKLOG IN PRACTICE

As a case study, using the five variables below and the three scenarios above, these would yield approximately 12 months in backlog. • 30,000 crew hours for the upcoming paving season • Backlog sales of $14,000,000 • An average gross margin of 18% • Fixed costs of $1,200,000 • Net profit budget of $1,300,000

When evaluating months in backlog, it is important to know this is a theoretical formula. An important factor to consider is the timing of the work. Just because the contractor has 12 months backlog of work doesn’t mean the projects will be spread evenly throughout the next 12 months.

The next step after determining the theoretical months in backlog would be to take the projects and allocate them over the next several months. This will allow the paving contractor to identify potential

Months in Backlog

Months in BacklogTable 1. Case Study with Labor Variable 50,000

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ABC and ELFA See Different Levels of Confidence

BY SANDY LENDER

The Associated Builders and Contractors (ABC) reported in September that its Construction Backlog Indicator fell sharply in August 2021 to 7.7 months, according to an ABC member survey conducted Aug. 19 to Sept. 1. The reading is down 0.8 months from July 2021. It’s down 0.3 months from August 2020.

ABC’s Construction Confidence Index readings for sales, profit margins and staffing levels all fell modestly in August but remained above the threshold of 50, indicating expectations of growth going into 2022.

“Both contractor backlog and confidence have begun to fade,” ABC Chief Economist Anirban Basu said. “Higher materials prices and labor costs have conspired to put more projects on hold. In many instances, expanding costs have rendered projects infeasible.

“That said, it is still the case that contractors collectively anticipate sales, staffing levels and margins to rise over the next six months,” Basu said. “The expected pace of improvement has softened, however. With so much liquidity continuing to be injected into financial systems, investors have considerable sums to deploy in new investments. Real estate valuations and construction volumes benefit from such dynamics. Recent dips in commodity prices and more normal labor market functioning should help translate into slower cost escalations and rebounding backlog during the months ahead, ultimately reversing the backlog decline sustained in August.”

This sense of confidence returning has its roots in more than sales and margins rising. The Equipment Leasing and Financing Association (ELFA) released its Monthly Leasing and Finance Index (MLFI-25) for the month of August 2021 showing strength in the year-over-year activity. The Index, “which reports economic activity from 25 companies representing a cross section of the $900 billion equipment finance sector, showed their overall new business volume for August was $8.5 billion, up 21 percent year-over-year from new business volume in August 2020.”

ELFA showed that the August 2021 volume of new business was down 14 percent month-to-month from $9.9 billion in July, but year-to-date, cumulative new business volume was up 10 percent compared to 2020.

At the time of ELFA’s MLFI-25 report, the association was seeing in its September Equipment Leasing & Finance Foundation’s Monthly Confidence Index (MCI-EFI) a result of 60.5. While that’s an aboveaverage number, it’s a decrease from the August index of 66.6. As ABC suggests, we’ve got a few more months to watch it curve back upward.

ELFA’s president and CEO, Ralph Petta, shared words of explanation and hope: “August data show some softness in equipment demand resulting from a mix of summer doldrums, continued supply chain disruptions and lingering pandemic-related woes. Business optimism, which peaked earlier in the summer, also has waned somewhat. However, when compared to where the economy and equipment finance business were a year ago, with the COVID-19 virus raging throughout the country, August new business volume is wholly acceptable.”

Jeffrey Hilzinger, the president and CEO of Marlin Capital Solutions, said, “2021, while much better than 2020, continues to be a challenging period for the equipment finance industry. While demand for equipment remains strong, August was the second consecutive month of reduced origination volume for the industry. Supply chain issues continue to be a key driver underlying this trend and seem to have worsened in recent months. On the positive side, approval rates have remained at pre-COVID levels and portfolio delinquencies and chargeoffs remain at historically low levels.”

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Months in Backlog Another scenario to analyze would be if the average gross profit percentage would increase and all other variables would remain constant. 30%

Gross Profit Percentage 21% 24% 27% 18% - 5 10 15 20 25 Months in Backlog holes or shortfalls in the schedule as there is always a limiting conThis tool should be utilized as one of the key metrics management reports on a regular basis to ownership, straint to how much work can get done in a month. sales, operations and estimating as the contractor evaluates its desired net profitability goals, workforce The months backlog analysis is a fluid formula and adjusting availability and new sales opportunities. variables can have a significant impact on the results of the analysis, which is why we recommend performing a sensitivity analysis when evaluating months in backlog. For instance, if the above case study adjusted the number of man hours available and all other variables remained constant, Table 1 represents the impact that would have on the number of months in backlog.

Another scenario to analyze would be if the average gross profit percentage would increase and all other variables would remain constant. See that result in Table 2.

This tool should be used as one of the key metrics management reports on a regular basis to ownership, sales, operations and estimating as the contractor evaluates its desired net profitability goals, workforce availability and new sales opportunities.

– BY SEAN RIZER

Sean Rizer is the CFO for Harding Group, Indianapolis, Indiana, which performs asphalt services, supplies hot-mix asphalt and provides dump truck transportation. Prior to joining Harding Group, Rizer spent over 10 years in public accounting, providing operational and transactional consulting. He graduated from Valparaiso University with a bachelor’s degree in both accounting and finance.

Another scenario to analyze would be if the average gross profit percentage would increase and all other In this table, you can see the effect available man hours has on backlog. variables would remain constant. 30% Months in Backlog

Gross Profit Percentage 21% 24% 27% 18% - 5 10 15 20 25 Months in Backlog This tool should be utilized as one of the key metrics management reports on a regular basis to ownership, sales, operations and estimating as the contractor evaluates its desired net profitability goals, workforce availability and new sales opportunities.

Months in Backlog Table 2. Case Study with Gross Profit Percentage Variable In this table, you can see the effect gross profit percentage has on backlog.