A construction backlog can be an indicator of a company’s financial health, and some very important players might use it to determine the risk you pose for them.
When you struck out on your own, you probably received a lot of advice. Undoubtedly, you heard the term “feast or famine” from all of your friends and family, whether you wanted to listen to it or not. Remember the old saying about free advice?
While famine is obviously a terrible sign for a construction business, feast can be almost as challenging to handle. Famine means there’s no money coming in, but feast creates management challenges that you might not be ready (or able) to handle.
What you actually need is balance, and managing your backlog is how you’ll get it. Yes, you always need work in the pipeline — but ensuring that you’re profitable and that your customers are happy is equally as important. It’s essential to keep your backlog in tip-top shape. This guide will show you how.
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What is a construction backlog?
Defining “construction backlog” is far easier than managing one. Essentially, a company’s backlog is the amount or value of projects that they have in the pipeline on which work has not yet started.
In essence, future projects that you won the bids for — but have not yet broken ground on — are your backlog.
There are two ways to represent your backlog: time and cash value. A backlog represented in time describes how far out you have worked scheduled. The cash value is helpful in determining profitability and financials.
When you bid for a new project, the customer will often ask about your schedule: They’re unknowingly referring to your backlog. Choosing the right answer is a dicey business — but we’ll discuss that in the next section.
As a caveat, you should know that sometimes the word “backlog” is sometimes used to describe collections or outstanding accounts receivables. For this article’s purposes, we’re focusing on the definition relating to your work pipeline.
Is a backlog good or bad for contractors?
Let’s get one thing out of the way: Your business needs some degree of a backlog to keep the lights on and pay the rent. Having a backlog is good — whether what’s in the backlog is good or not is another question.
Remember that balance we spoke about earlier? If your backlog is balanced, it’s good. If unbalanced on either side, it can be an indicator of impending troubles that you’ll need to deal with.
Having no backlog means big problems
A short or non-existent backlog is bad. Sure, it can make your business look punchy, allowing you to take projects at the drop of a hat, but it also means you’re merely treading water. If you’re treading water, you can’t grow. You might not even be able to survive.
It also means you can’t be selective about the projects you take, which means profitability is an afterthought — a major no-no.
New customers might like that you can jump right on their projects. But showing that you’re too eager to tackle their job might call your credibility or worth as a contractor into question. After all, good contractors are hard to find, so the ideal prospective customers expect to wait at least a little while.
A long construction backlog can spell trouble, too
Having a long backlog can be an issue as well. If you’re telling prospective customers that you can’t start their project for nine months, it’s going to be hard to win new jobs. This will often balance itself out over time, but it’s a dangerous trap to dig your way out from.
Again, customers might question your ability if you have a long backlog. Yes, you have customers, but a long backlog could mean that you’re behind and can’t manage your projects effectively. Absolutely nobody wants to enter into a contract with someone who they suspect can’t hold a deadline.
A long backlog can be a problem for your financials, as well. Many contractors that end up with excessively long backlogs do so because they’re grabbing every contract they can get. This is often the result of undercutting everyone else’s prices, and it usually comes at the cost of their own profitability.
Very often, contractors take a full backlog as the opportunity to grow and expand. However, biting off more than you can chew with the intention of expanding to handle it can be a bad decision if you aren’t ready. Growing too quickly comes with its own pains and risks. Overextension and cash flow issues thrive during periods of growth, and many companies struggle to recover from their effects.
Your backlog represents your risk level
When it comes to taking great projects, sureties can make or break you. You might need to secure a payment or performance bond to take the project. A bid bond might be a requirement just to submit a bid.
Before a surety issues a bond on your behalf, it will most likely want to look at your financials, work in progress, and your backlog. They’ll use these values to determine if you’re profitable, on track, or overextended. If the risks are too high, you might not be able to secure a bond for the project.
How to calculate a construction backlog
While you probably have a decent idea of how long it’ll take you to get to your projects in your head, you need to get it on paper. You need an accurate and trackable system for determining your backlog effectively. Also, a surety needs hard numbers to assess risk — not handshakes and loose scheduling.
The easiest way to calculate your backlog is to use a standard WIP (Work in Progress) report. By including the contract value and information for upcoming awarded projects in your WIP report, a surety can establish where your business stands on the current projects using the Percentage of Completion Method. The surety can also get a clearer picture of the health of your financials and when you’ll likely get to the future projects.
Software options for contractor backlog management
There are several software programs that you can use to track your WIP, removing guesswork and errors from the equation. These programs can also help you organize many of your other project management tasks, including job costing, AR/AP, and change orders.
- PlanSwift: A Windows-based program that integrates with Excel
- Knowify: A GPS-enabled, cloud-based program optimized for tablets to allow job-site integration
- Clear Estimates: A cloud-based program aimed at small to mid-sized builders and home remodelers
- Jonas Premier: A cloud-based program ideal for general contractors and project managers
If you’re not already using a software program to track your work in progress and backlog, you could be leaving too much of your company’s welfare to chance.
Strategies for managing a construction backlog
If you’re looking for help striking that ideal backlog balance, these tips should help.
1. Measure your backlog accurately
We’ve already established that a backlog is much more than a schedule in your head or written on the back of a sheet in your clipboard. Use construction-specific accounting and management software to maintain an accurate WIP and backlog.
2. Communicate clearly with your clients
Like previously mentioned, talking about your backlog the wrong way can throw some red flags to your customers. Explain the process of getting their project’s ducks in a row so they know you’re experienced and reliable. Only after they trust you and understand the process should you discuss their timeline.d
3. Make workforce decisions that fit your backlog
Whether you’re flush or struggling, your manpower needs to align to maintain profitability. If you’re flush with work and financially able, you should expand your workforce. If you’re barely above water and struggling to keep the lights on, you might have to reduce the size of your staff or hire ace salespeople.
4. Keep an eye on the economy and adjust accordingly
You have to know your market to determine the health of your backlog. The Associated Builders and Contractors (ABC) sends confidential questionnaires to contractors to help determine the backlog of the commercial construction industry as a whole.
The ABC uses the information to establish the Construction Backlog Indicator. Track it. Drastic changes up or down could indicate an impending bust or boom. The CBI is an excellent benchmark to try to match —as long as you’re staying profitable.
5. Know your limits, but don’t sell yourself short
Being busy may be a “good problem to have” in other industries, but the construction industry’s cash-hungry nature can cause massive cash flow issues if you aren’t ready. Don’t bite off more work than you can chew.
At the same time, if growth is your goal, don’t sell yourself short. Take a systematic approach to avoid construction growing pains.
6. Protect your payments
Healthy cash flow is the only way to transition from job to job seamlessly, and it’s crucial for handling growth safely. Mechanics liens are the best tools for collecting faster on your accounts receivables. Knowing, protecting, and leveraging your mechanics lien rights will help keep the money coming in when you need it.