1. Aleš Tomek Faculty of Civil Engineering Department of Construction Engineering and Management CZECH TECHNICAL UNIVERSITY IN PRAGUE Nature of Construction Business

2. 126YMCC Construction Business Management Introductory Lesson Aleš Tomek 2014

3. WHAT IS CONSTRUCTION Construction involves the marshaling of materials, people, and equipment on a project site and assembling the materials in the proper sequence to construct a project that meets the customer's requirements. These projects may range from an individual home to a sophisticated infrastructure project, such as a regional airport or a major transportation system

4. CHALLENGES OF BUSINESS MANAGEMENT The business management challenges in construction are to ensure that : the revenue generated by the construction activity exceeds the cost of doing the work, the company has adequate demand for its services, the company has adequate financial resources to finance construction projects until reimbursed by its customers, the company has a skilled, motivated workforce of sufficient size to meet anticipated requirements, and the cost of the company overhead is affordable based on the projected workload.

5. Construction : competitive business Construction is an intensely competitive industry, with companies ranging in size from less than ten employees to over tens of thousands of employees. Because of the great diversity in the types and sizes of projects as well as the variety in the expertise and size of companies, most firms tend to specialize in distinct segments of the market, such as : highway, commercial, industrial, residential, electrical, mechanical, site and utility, marine, and underground.

6. Business problems of every contractor The following business responsibilities are similar for every contractor: acquisition of work, performance of the work, and management of the financial, capital, and human resources of the firm.

7. Working capital - necessary condition The construction industry annually accounts for about from 5 to 12 percent of the gross domestic product (e.g. 10% in the United States). It is a fragmented industry with a large number of firms. Unlike manufacturing, construction does not require large capital investments to establish a business. Construction does require sufficient cash resources to meet financial obligations.

8. PRIMARY CAUSES OF BUSINESS FAILURE Few construction firms fail from a single cause or from a sudden, catastrophic event. One cause may predominate, but inadequate response to several interrelated factors is the typical cause of business failure. The primary causes of failure can be grouped into two categories: external influences and internal problems. External Influences prolonged economic recession, loss of a major customer, new competition, and shortage of skilled labor.

9. Internal problems as main cause of failure Strategic Planning Issues Pursuit of volume To many people in the construction industry, business volume is a measure of success. While it may indicate the significance of a firm in its relevant market, profitability is a more important measure of success. The pursuit of volume without a corresponding increase in profitability places the economic viability of the construction firm at risk. Lack of comprehensive business plan Construction companies often do not have business plans that guide their business decisions. They simply react to the market. Business planning requires an understanding of the market, procurement, the competitive advantages, services to be offered, the selection of market area, the selection of people and equipment required.

10. Diversifying into unfamiliar types of projects There is high risk, because appropriate suppliers and subcontractors may not be known, and the technical requirements may exceed the expertise of the company's project management staff. Costs may be underestimated, resulting in unprofitable projects. Unfamiliar contracting approaches, such as design-build, results in significant financial risk Diversifying into unfamiliar geographic areas New market poses great risk to a construction firm. Potential customers, suppliers, and subcontractors are unknown. If the location of the new market is a significant distance from the company's normal area of operation, there will be little ability to augment project management staff with other company resources; placing greater stress on the project management team. Keywords: staff expertise,design-build, risk

11. End of Strategic planning issues Lack of managerial maturity Construction firms often are founded by one or two people. As a firm grows, its management system must cope with increased scope of work. Additional managers are needed, and the founders must delegate some authority for making business decisions to others. Continuing to centralize all decision making in one or two people does not provide the responsiveness needed to react to changing business conditions. The only solution is to delegate power and responsibilities Keywords: delegation,centralized and decentralized model of decision making

12. Strategic Implementation/Control Increase in project size Unrealistic increase in project size may lead to financial difficulties. The size of the project in relation to the capabilities of the firm may lead to significant financial problems. One large unprofitable project will have a greater adverse impact than will a small unprofitable project. Large projects may stress managerial expertise, subject the firm to greater risk, and require more capital to finance cash flow requirements. Unplanned loss of key personnel It can severely stress construction firms, particularly small ones. The loss can be due to death, to illness, or to resignation. Unplanned loss of management or technical expertise may take considerable time to overcome and places small firms at great risk. Keywords: project size, cashflow requirements

13. Poor cost-estimating skills To ensure that a company remains a profitable business enterprise, construction firm managers must understand the anticipated costs and risks of each project and price the work at a level to cover all costs and provide a profit. Construction company managers should not pursue volume at the expense of profitability. This means that bids and cost proposals should not be reduced just to increase the company workload, because with greater work volume the company incurs more risk. Keywords: Overestimating, Underestimating,Turnover versus Profitability

14. Lack of equipment control The cost of owning and operating equipment is a significant part of the construction business. Controlling equipment costs is controlling the amount of equipment owned, leased, or rented. Investing too much of a company's financial resources (EQUITY) in equipment may degrade the firm's ability to finance its cash flow requirements. Idle equipment represents an overhead cost that should be avoided. Equipment should either be used and be able to pay for itself, or returned to the rental or leasing company or sold. Keywords: equity, overhead, lack of control, building yard

15. Poor internal communications Poor internal communications between project sites and the home office plague many construction companies. Consequently, there may be little warning of project execution problems or financial difficulties. In most instances, it only takes one or two disastrous projects to bring down a company. Early warning is essential if corrective action is to be taken on time. Keywords: home office, project office, reporting system, early warning End of Strategic implementation and Control

16. Poor use of accounting system A number of contractor failures are caused by poor accounting practices or by a failure to review accounting records to determine the financial status of projects. A delayed customer payment often results in inadequate cash flow. By not using the current balance sheet, income statement, and job cost reports, managers may be unable to identify financial difficulties until it is too late to take corrective action. Keywords: cost control, accrual accounting, cost accounting Financial management issues

17. Excessive debt Cash flow requirements must be met either from internal resources or from debt. Some contractors rely on debt to compensate for the lack of business capitalization or equity. Excessive debt may cause such a drain on income that the capital resources of the firm do not grow or may even decline. The cost of borrowing should be included in company overhead margins. Too high margins may make the construction company noncompetitive in tight markets. Keywords: debt, business capitalization, overhead margin, mark-up, contigency, profit

18. BUSINESS STRATEGIES TO MINIMIZE THE RISK OF BUSINESS FAILURE HOW TO PLAN STRATEGIES? BS1.Develop comprehensive business plans and communicate company goals and objectives to all employees. The business plan provides a tool for assessing the company's current position and for establishing a vision of what the company aspires to become. In addition to containing goals to be accomplished, the plan should identify specific action plans that are to be undertaken by different segments of the company to assist in meeting the business goals. See separate lecture. Keywords: business plan, goals

19. BS2.Test a new geographic area with a small project or a repeat customer. Develop a withdrawal plan if the project is not successful. Moving into a new geographic area presents significant risk, in that the customers, the suppliers, and the subcontractors generally are unknown. To reduce the risk, either undertake a series of small projects to learn the environment or enter the market with a customer with whom the company is familiar. Keywords: pilot project, international projects, withdrawal plan

20. BS3. Carefully monitor company management capabilities during periods of growth. Learn to recognize signs of inadequate management, and delegate. Adequate company management systems and staff need to be available to manage the work of the company. Management capabilities need to be expanded prior to increasing the volume of work undertaken, so that the increased work can be planned and managed effectively. Sometimes companies increase their work volume without adequately increasing the management capabilities. In such instances, company managers become overworked. Also, the lack of adequate management capability may result in poor project performance and an unhappy customer Keywords: management system, standard procedures and checklists, management capabilities

21. HOW TO PLAN AND IMPLEMENT STRATEGIES PI1: Develop internal management systems that monitor the status of all projects and provide early warning of problem areas. Good communications need to be established between all project offices and the company leadership. In addition, company leaders need to visit project sites frequently to keep abreast of any issues. Frequent project cost and project status reports are needed to closely monitor project execution. Keywords: project status, project execution monitoring

22. PI2: Form long-term relationships with industry professionals who can serve as sounding boards and listen to them. Among these specialists are bankers, bonding agents, insurance agents, accountants, and construction attorneys. These individuals should be selected based on their industry experience and understanding of the type of projects undertaken by the construction company. Because they have industry experience, they can provide advice regarding project risk mitigation and business processes. Keywords: risk mitigation, business development, construction professionals

23. PI3: Increase project size gradually. Take on only one larger project at a time. Finish the first larger project and evaluate before taking on the next one. The amount of risk associated with a project generally relates to its size and its complexity. Care must be exercised when pursuing projects that are larger than those historically constructed by the firm. If the typical project size has been $5 million, it is better to pursue a project valued at $7 million than one at $15 million. This is to ensure that the company's management expertise and systems are enhanced to meet the demands of larger projects. Undertaking too large a project usually requires more cash flow than the company should risk on a single project. Keywords: project complexity, working capital, expertise

24. PI4: Select project size based on the size of the construction company and its financial and human resources. Do not have more than 30 percent of a company's resources involved in a single project. Diversify among several projects to minimize risk 1.Success in the construction business depends on understanding the risk faced on each project and mitigating it. 2.Not all projects are successful.Sometimes things do not work out as anticipated, and the construction firm incurs a loss. To minimize the potential for financial failure if a project is not profitable, the construction firm should undertake multiple projects, as long as it has sufficient managerial talent to supervise the projects effectively. Keywords: diversification of projects, loss projects, failure potential

25. WHAT FINANCIAL STRATEGIES ? FS1: Understand the cost of doing business, and price services appropriately. It is essential that company leaders understand their cost of doing business to include all company overhead costs. Services must be priced adequately to cover all anticipated costs and provide a reasonable profit. If the company does not adequately price its services, it will soon find that it is out of cash and in financial difficulty. Keywords: reasonable profit, overhead costst, anticipated costs ( i.e budgeted or estimated), construction services, service provider

26. FS2: Prepare month-to-month cash flow budgets each year, and track results monthly. 1.Company leaders need to understand their financial needs to ensure that they have the ability to meet financial obligations. 2.In most cases, construction work is initially financed by a construction company, and a bill or invoice is submitted to the project owner for payment. This request for payment typically is submitted on each project on a monthly basis. 3.A cash flow analysis to develop a cash flow budget for the construction company is needed for each project. If external financing is needed, the cost of the financing needs to be included as an overhead cost while calculating project budgets. 4.Actual income and expenditures need to be tracked to monitor the cash flow status of the company. Keywords: liquidity, CF budget, income, expenditures

27. FS3 : Carefully manage company overhead, and reduce it during periods of declining workload. 1.Company overhead budgets need to be set at the beginning of each year based on what is perceived as affordable for a projected volume of work. 2. If the volume of work does not materialize, the overhead budget needs to be reduced proportionately so that the company does not get into financial difficulty because company earnings were insufficient to cover overhead costs. Keywords: company overhead budget, earnings, volume of work, backlog

28. FS4 Finance equipment purchases with debt to preserve capital to finance cash flow requirements. 1.Capital equipment should be purchased using either a lease-to-own strategy or by the use of equipment loans. 2.The concept is for each item of equipment to earn more each year than it would cost to make a loan payment or a lease payment. This will preserve the construction company's financial resources to fund its cash flow requirements. 3.If the cash is used to purchase equipment, the company could become cash-starved relative to meeting its cash flow requirements and forced to go out of business. Keywords: capital equipment, loan, lease-to-own, going out of business

29. FS5 : Purchase a line of credit as a contingency to cover unexpected negative cash flows. 1. Rather than waiting until there is a need to borrow funds, a company should purchase a line of credit from a financial institution. 2. Credit line is similar to a credit card, in that expenses can be charged to the line of credit when needed, and the amount of credit can be repaid as soon as sufficient income is received. 3.There is a small fee for having the line of credit, but interest is only paid on the unpaid balance at the end of each month, similar to the situation with a personal credit card. Keywords: contingency, line of credit, fee, interest, balance