Evaluating a subcontractor’s health before awarding work has become more important than ever for general contractors. For one thing, circumstances can change quickly in today’s uncertain construction industry. For another, work delays from 2021 are likely to impact the risk of subcontractor default in 2022 and beyond.
The following standard financial ratios can help risk management teams evaluate potential trade partners during the subcontractor qualification process. Extracting key ratios from financial statements and safety metrics from OSHA filings allows builders to gauge a subcontractor’s short-term and long-term health — and empower estimators with the data they need to make more informed bidding decisions.
A very common liquidity metric, the Quick Ratio is also known as the “Acid Test” ratio. A higher ratio indicates a stronger cash position.
Formula: (Cash and Cash Equivalents + Marketable Securities + Accounts Receivables) / Current Liabilities
Like the Quick Ratio, Current Ratio measures a company’s ability to pay off its short-term liabilities with its current assets. A higher ratio indicates a strong working capital position.
Formula: Current Assets / Liabilities
Days of Cash on Hand is the number of days that a company can continue to pay its operating expenses, given the amount of cash available and assuming there is no additional revenue. A high value indicates a strong cash position and ability to withstand cash flow constraints.
Formula: Cash on Hand / (Operating Expenses – Depreciation) / 365 Days
Underbillings to Working Capital indicates the percentage of a company’s working capital that is composed of work performed but not yet billed. Underbillings may be unreliable assets, therefore a lower ratio is preferred.
Formula: Underbillings / Working Capital
Accounts Receivable Turnover is an activity ratio that measures how efficiently a firm uses its assets. A higher ratio indicates a stronger ability to collect on Accounts Receivable.
Formula: Revenue / Accounts Receivable
Working Capital Turnover compares the depletion of working capital to the generation of sales over a given period. This provides some insight as to how effectively a company is using its working capital to generate new sales.
Formula: Revenue / Working Capital
Asset Turnover Ratio indicates the efficiency with which a company is deploying its assets in order to generate revenue.
Formula: Revenue / Total Assets
Debt Ratio measures the extent of a company’s leverage. It can be used to determine the proportion of a company’s assets that are financed by debt. A high ratio indicates a heavily leveraged company, and is less preferrable.
Formula: Total Liabilities / Total Assets
Debt-to-Equity measures how much suppliers, lenders, creditors and obligors have committed to the company versus what the shareholders have committed. A lower ratio is preferred.
Formula: Total Liabilities / Total Shareholders’ Equity
This is like the Debt-to-Equity ratio but adjusts to the strengths or weaknesses of a company’s cash position. Cash is excluded from liabilities in this ratio because cash can be used to retire a liability at any point in time. In some cases, this may be a better indicator of how leveraged the company is.
Formula: (Total Liabilities – Cash & Cash Equivalents) / Total Shareholders’ Equity
Cash to Overbillings is the percentage of a company’s cash that is composed of work not yet performed but already billed. This ratio is used to identify whether the cash from billings has been collected/ spent or saved as cash.
Formula: Cash & Cash Equivalents / Overbillings
Working Capital Compression is used to measure compression in the current portion of the balance sheet. A low ratio indicates that the company is financing a substantial portion of its current assets to create a relatively small working capital position.
Formula: Working Capital / Current Assets
Gross Profit Margin indicates the gross profit (revenue less cost of sales) as a percentage of overall revenue.
Formula: (Total Revenue – Cost of Goods Sold) / Total Revenue
Return on Assets measures how effectively assets are being used to generate net profit.
Formula: Net Income / Total Assets
Net Profit Margin indicates the net profit (revenue less cost of sales plus all operating expenses, interest, taxes and dividends) as a percentage of overall revenue.
Formula: Net Income / Total Revenue
EMR is a value calculated by insurance carriers and is an indication of Worker’s Compensation claims history. EMR indicates the ratio of actual losses to expected losses, though it can be an imperfect metric that sometimes hurts smaller companies disproportionally more than larger.
RIR describes the rate of employees per 100 full-time employees that have been involved in a recordable injury or illness.
Formula: (Number of Incidents x 200,000) / Total Hours Worked
The rate of recordable incidents per 100 full-time employees that resulted in lost or restricted days or job transfer due to work related injuries or illnesses.
Formula: (Number of OSHA Recordable Injuries and Illnesses that Resulted in Days Away; Restricted; Transferred X 200,000) / Total Hours Worked
TradeTapp, Autodesk’s subcontractor qualification solution, helps risk managers quickly collect and evaluate this financial and safety data. Automated email reminders ensure subcontractors provide the necessary information without the chase, and TradeTapp’s risk evaluation engine provides concrete risk mitigation recommendations based on the results.