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What are the Key Financial Ratios and KPIs for Construction and Trade Businesses?

Updated: Apr 26

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At our regular meetings we will help you understand your business’s financial performance by keeping track of important financial ratios and Key Performance Indicators (KPI). These ratios and KPIs are relevant to all businesses, including the construction and trade businesses. We have also created this short guide with calculations, interpretations, and examples for you to keep on hand to help you grow your business.


These simple calculations will provide valuable insights into your profitability, liquidity, leverage, efficiency, and productivity. This information will allow you to identify your strengths and weaknesses, benchmark your business against your competitors and industry standards, and make informed decisions and plans.


If you are a Queensland Building and Construction Commission (QBCC) License holder, you may also like our article on demystifying QBCC phrases and calculations.


The below formulas are all based around a few terms. Not sure what these terms and mean or just want to brush up? Read our handy index of accounting terms and definitions.


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Profitability Ratios


Profitability ratios measure how well your business generates profit from its revenue, assets, and equity. These ratios indicate the ability of the business to create value for the owners and reflect your competitive advantage and market position.


Some of the most common profitability ratios for construction and trade businesses are:


 

Gross Profit Margin


The Gross Profit (GP) Margin ratio is the most common margin we use. This shows the percentage of revenue that is left after deducting the variable costs in a business. Also called cost of goods sold (COGS), which includes the direct costs of materials, labour, and subcontractors. It measures how efficiently your business manages its production costs and pricing strategy.


Gross Profit Margin = (Revenue - COGS) / Revenue


For example, if your business has a revenue of $1,000,000 and a COGS of $700,00, your gross profit margin is:


Gross Profit Margin = ($1,000,000 - $700,000) / $1,000,000

Gross Profit Margin = 0.3 or 30%


A higher gross profit margin means that your business requires a lower volume of sales to achieve your targets because you either have a higher markup on your products or services, or a lower production cost. A lower gross profit margin means that your business will require a higher volume of sales because it has a lower markup or a higher production cost. The ATO provides a small business benchmark for gross profit across various industries.


 

Net Profit Margin


The Net Profit Margin shows the percentage of revenue that is left after deducting all the business expenses like rent, interest, tax, etc. as well as COGS. It measures how effectively your business manages its total operating costs and financial obligations.


Net Profit Margin = (Revenue - Expenses) / Revenue


For example, if your business has a revenue of $1,000,000 and total expenses of $800,000, your net profit margin is:


Net Profit Margin = ($1,000,000 - $800,000) / $1,000,000

Net Profit Margin = 0.2 or 20%


A higher net profit margin means that your business has a higher net income and lower expenses. A lower net profit margin means that your business has either a lower net income or higher total expenses.


 

Return on Assets


The Return on Assets (ROA) ratio shows how much profit your business generates for every dollar of assets it owns. Assets include equipment, inventory, cash, accounts receivable, and other resources that your business uses to operate and generate revenue. It measures how efficiently your business utilises its assets to create value.


Return on Assets = Net Income / Total Assets


For example, if your business has a net income of $200,000 and a total asset of $1,000,000, your ROA is:


Return on Assets = $200,000 / $1,000,000

Return on Assets = 0.2 or 20%


This means that for every dollar of asset your business has invested in, it returns 20 cents in net profit. A higher ROA means that your business has a higher profit or a lower asset value. A lower ROA means that your business has a lower profit or a higher asset value.


 

Return on Equity


The Return on Equity (ROE) ratio indicates how much profit your business generates for every dollar of equity it has. It measures how effectively your business uses its equity to create value. (Equity is calculated by the sum of your total assets less your total liabilities, which represents the owners' investment in the business.)


Return on Equity = Net Income / Total Equity


For example, if your business has a net income of $200,000 and a total equity of $500,000, your ROE is:


Return on Equity = $200,000 / $500,000

Return on Equity = 0.4 or 40%


A higher ROE means that your business has a higher profit and a lower equity. A lower ROE means that your business has a lower profit or a higher equity.



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Cash Flow


Cash flow is the movement of money in an out of your business and is not the same as profit. Cash flow shows how well your business is managing its operating expenses and pay its debts. It’s essential for understanding how liquid the business is and able to maintain business growth.


A positive cash flow means your business is receiving more money than it is spending. Therefore, the business can cover its expenses and invest in business growth. Cash flow takes into consideration the purchase of materials and equipment, paying staff and contractors, and other expenses like utilities in each period. Along with the receipt of payments for invoiced work.


A negative cash flow show that the business has more money leaving the business than it is receiving in a set period.


There are two methods to calculate cash flow:


Direct Method Cash Flow Statement


The Direct Method looks at all the transactions that impacted cash during the reporting period.


Cash Flow Statement =

Cash collected from operating activities – cash paid from operating activities


 

Indirect Method Cash Flow Statement


The Indirect Method is based on the accrual accounting method and records expenses and revenue at a time other than when cash was received or paid out. Your accountant will make adjustments in light of the non-cash accruals that were made during the reporting period.



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Liquidity Ratios


Liquidity ratios measure how well your business can pay off its short-term debts and obligations using its current assets. Current assets include cash, accounts receivable, inventory, and other resources that can be easily converted into cash within a year. Current liabilities include accounts payable, accrued expenses, short-term loans, and other obligations that are due within a year. Liquidity ratios indicate your business's solvency and cash flow.


Some of the most common liquidity ratios for construction and trade businesses are:


Current Ratio


The Current Ratio shows the proportion of current assets to current liabilities. It measures your business's ability to meet its short-term financial obligations with its current resources.


Current Ratio = Current Assets / Current Liabilities


For example, if your business has a current asset of $500,000 and a current liability of $300,000, your current ratio is:


Current Ratio = $500,000 / $300,000

Current Ratio = 1.66666


A current ratio of greater than 1 means that your business can pay off short-term debts using its assets. This shows that your business has more current assets than current liabilities. A current ratio of less than 1 means that your business has fewer current assets than the current liabilities and may struggle to pay any debts that become due.


 

Quick Ratio


The Quick Ratio (Acid Test) shows the proportion of current assets that can be quickly converted into cash, such as cash, accounts receivable, and marketable securities, in relation to current liabilities. It measures your business's ability to meet its immediate financial obligations with its most liquid resources.


The Quick Ratio is considered a more conservative measure than the Current Ratio.


Quick Ratio = (Current Assets - Inventory) / Current Liabilities


For example, if your business has a current asset of $500,000, an inventory of $100,000, and a current liability of $300,000, your quick ratio is:


Quick Ratio = ($500,000 - $100,000) / $300,000

Quick Ratio = 1.33


A higher quick ratio means that your business has more liquid assets than current liabilities and is therefore more liquid. A lower quick ratio means that your business has fewer liquid assets than current liabilities and may therefore find it harder to pay off debts.



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Leverage Ratios


Leverage ratios measure how much debt your business has in relation to its assets, equity, and income. Debt includes short-term and long-term loans, bonds, leases, and other obligations that your business owes to others. Leverage ratios indicate your business's financial risk and leverage.


Some of the most common leverage ratios for construction and trade businesses are:


Debt to Equity Ratio


The Debt-to-Equity Ratio shows the proportion of debt in relation to the equity in your business. It measures how much your business relies on external financing versus internal financing to fund its assets and operations.


Debt-to-Equity Ratio = Total Debt / Total Equity


For example, if your business has a total debt of $400,000 and a total equity of $500,000, your debt-to-equity ratio is:


Debt-to-Equity Ratio = $400,000 / $500,000

Debt-to-Equity Ratio = 0.8


A higher debt-to-equity ratio means that your business has more debt than equity and may suggest a greater risk to potential investors in your business. A lower debt-to-equity ratio means that your business has more equity than debt and thus less reliance on debt. However, it could also mean your business is not taking enough advantage of finance through debt to grow.


 

Times Interest Earned Ratio


The Times Interest Earned (TIE) Ratio shows how many times your business can cover its interest expenses with its operating income. It measures your business's ability to service its debt and pay the interest on the debt.


Times Interest Earned Ratio = Operating Income / Interest Expense


For example, if your business has an operating income of $300,000 and an interest expense of $80,000, your TIE ratio is:


Times Interest Earned Ratio = $300,000 / $80,000

Times Interest Earned Ratio = 3.75


A higher TIE ratio means that your business has more operating income than the interest expense, and therefore the ability to pay its debts and continue to invest in growing the business. While a lower TIE ratio means that your business has less operating income in relation to your interest expense.



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Efficiency Ratios


The Efficiency ratios measure how well your business uses its assets and liabilities to generate revenue and profit. It measures current or short-term performance and is an indicator of your business's operational efficiency and productivity.


Some of the most common efficiency ratios for construction and trade businesses is the Equity Turnover Ratio



Equity Turnover Ratio


The Equity Turnover Ratio shows how much revenue your business generates for every dollar of equity it has. It measures current or short-term performance and how effectively your business uses its assets and liabilities to create sales.


Equity Turnover Ratio = Revenue / Total Equity


For example, if your business has a revenue of $1,000,000 and a Total Equity of $400,000, your Equity Turnover Ratio is:


Equity Turnover Ratio = $1,000,000 / $400,000

Equity Turnover Ratio = 2.5


The Equity Turnover Ratio should be well below 15.



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How we help you master the Key Financial Ratios and KPIs


We hope this handy list of the Key Financial Ratios and KPIs for Construction and Trade Businesses (as well as other small businesses) will make it easy for you to access the calculations when you need them. Regular monitoring of these key financial ratios is also important to ensure you identify and solve any problems before you lodge your annual report to the QBCC. Regular meetings are included in our Guide and Grow, and Proactive Partner Service Packages, where we help you master these ratios and KPI’s to help your business grow. Get in touch with your ABA Client Advisor if you would like to discuss any of these calculations in more detail.


Not in the construction and trades industry? No problem. At ABA. Advice Beyond Accounting we work with small and medium businesses across a wide range of industries. Our clients include real estate, hospitality, tourism, manufacturing, and many more diverse businesses. If you’d like to find out more about how our expert team of accountants can help you master your finances and increase your profit, simply book your free discovery meeting today to get started.








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