How the Balance Sheet Drives Better Management for Contractors
- Cost Construction Accounting
- Oct 22
- 5 min read
Updated: Oct 23
Your profit and loss statement shows a healthy profit for the year. But when it's time to make payroll or pay your suppliers, the cash isn't there. Sound familiar?
This disconnect between profit and cash flow frustrates contractors every day. You're profitable on paper, but constantly stressed about money. The problem isn't your job costing or your estimating. The problem is you're not using your balance sheet to manage your business.
Most contractors focus intensely on job costing and P&L statements while treating the balance sheet as something they barely glance at. But here's the truth: your balance sheet controls your bonding capacity, your banking relationships, and your ability to grow. Let's look at how understanding three key numbers on your balance sheet can transform how you manage your contracting business.
Table of Content:
Why Your Balance Sheet Matters More Than You Think
It Controls Your Bonding Capacity
When you need bonding for your next project, the surety company looks at one number first: your working capital. Working capital is simply your current assets minus your current liabilities. It tells the surety whether you have the financial cushion to handle project risks.
As a general rule, contractors can bond for 10-15 times their working capital. So if you have $500,000 in working capital, you might qualify for $5-7 million in bonding capacity. Want to bid bigger projects? You need to build working capital, and that means understanding your balance sheet.
It Determines Your Banking Relationship
Banks use your balance sheet to decide whether to extend or increase your line of credit. They look at your current ratio and debt-to-equity ratio to assess risk. A strong balance sheet means better loan terms, higher credit limits, and faster approvals when you need equipment financing. A weak balance sheet means declined applications or expensive terms that eat into your margins.
It Reveals Your True Financial Health
Here's why contractors can be profitable yet broke: profit measures whether you made money on jobs, but your balance sheet shows whether you have cash to operate. You might show $200,000 profit, but if that money is tied up in accounts receivable, retainage, or equipment, you can't pay today's bills with it.
Even worse, many contractors fall into the overbilling trap. You bill 40% upfront, spend that cash on overhead or equipment, then realize you still have 60% of the work to complete with no cash left to do it. Your balance sheet would have warned you overbillings are a liability, not profit.
The 3 Numbers Every Contractor Must Track
1. Working Capital: Your Growth Fuel
Working Capital = Current Assets - Current Liabilities |
This single number determines your bonding capacity and ability to bid new work. It's your financial cushion when projects run long or clients pay late. Target: 10-15% of annual revenue. A $5M company should maintain $500K-$750K in working capital.
Example: $900K in current assets (cash, AR, underbillings) minus $600K in current liabilities (AP, overbillings, short-term debt) equals $300K working capital. That supports roughly $3-4.5M in bonding capacity.
Red flag: Negative or shrinking working capital means you can't bid new work and current projects are at risk.
2. Current Ratio: Your Safety Margin
Current Ratio = Current Assets ÷ Current Liabilities |
This ratio answers one question: can you pay your bills over the next 12 months? Industry benchmark for contractors: 1.3-1.5. A ratio of 1.5 means you have $1.50 in assets for every $1.00 of liabilities.
Example: $800K assets ÷ $500K liabilities = 1.6 (healthy). If those assets dropped to $550K, your ratio falls to 1.1 (dangerously tight).
Red flag: Below 1.2 means one slow-paying client or unexpected cost creates a cash crisis. Surety companies and banks watch this number closely.
3. Debt-to-Equity Ratio: Your Leverage Level
Debt-to-Equity Ratio = Total Liabilities ÷ Total Equity |
This shows the balance between borrowed money and owner's investment. Healthy range for contractors: 2.0-3.0. A ratio of 2.5 means you're using $2.50 of borrowed money for every $1.00 of owner equity normal for contractors who need equipment and working capital.
Red flag: Above 4.0 means you're overleveraged. You'll struggle to get bonding and banks will see you as high risk. Below 1.0 might mean you're too conservative and missing growth opportunities.
Quick Action: Pull last month's balance sheet right now and calculate these three numbers. Write them down. These are your baseline.
How to Use Your Balance Sheet to Make Better Decisions
Decision 1: Should I Bid This Project?
Before you bid, check your balance sheet and ask:
Do I have working capital to cover mobilization and early costs before the first payment?
Will this project require bonding capacity I don't have?
Can I handle 30-60 day payment cycles without creating cash flow problems?
Real scenario: A contractor with $200,000 in working capital bid a $2 million project requiring 10% ($200,000) in upfront costs for mobilization, materials, and early labor. By month two, he couldn't pay subcontractors. The project descended into chaos, relationships were damaged, and he had to use his personal credit to finish the work. His P&L looked great. His balance sheet screamed "don't bid this job."
Decision 2: Managing Overbillings and Underbillings
Your WIP (Work in Progress) schedule connects directly to your balance sheet. Underbillings mean you've completed work but haven't billed for it yet, that's a cash drain. Overbillings mean you've billed more than the work you've completed, that's an obligation to perform future work, not profit.
Many contractors see a large overbilling and think "great, we're ahead!" Then they spend that cash. But overbillings are liabilities on your balance sheet. You've borrowed from your future cash flow. Watch your WIP schedule monthly and keep overbillings below 10-15% of contract value.
Decision 3: When to Expand Equipment or Crews
Don't just look at your P&L profit when deciding whether to buy equipment or hire crews. Check your balance sheet:
Is your working capital strong enough to handle the additional overhead?
Will taking on debt for equipment drop your current ratio below 1.3?
Can your balance sheet support a 20% increase in revenue?
Rule of thumb: If a growth decision would drop your current ratio below 1.3 or push your debt-to-equity above 3.5, wait until you've built more equity or working capital.
The Biggest Balance Sheet Mistake Contractors Make
The most dangerous mistake is spending overbilled cash like it's profit. Here's how it happens:
You bill 40% upfront on a $500,000 project ($200,000 received)
Actual work completed: only 20% ($100,000 in costs incurred)
Your balance sheet shows $100,000 in overbillings (a liability)
You spend that $200,000 on new equipment, overhead, or owner draws
You're now 60% through the project, cash is gone, but work remains
You can't finish the project, can't pay subcontractors, and the company faces a crisis
This scenario plays out constantly. The contractor was "profitable" but broke because they misunderstood what overbillings represent. Your balance sheet would have shown the danger immediately.
Treat overbillings as obligations, not income. Don't spend cash that belongs to future work. Keep overbillings in check and review your WIP schedule monthly. That simple discipline prevents most contractor failures.
Your balance sheet isn't just for tax time or bank loans. It's your business dashboard. The most successful contractors we work with review their balance sheet monthly, not annually. They use it to decide which projects to bid, when to buy equipment, and how fast to grow.
Your profit and loss statement tells you if you made money. Your balance sheet tells you if you can survive and grow. One looks backward, the other looks forward. You need both.
Need help understanding your balance sheet? We specialize in construction accounting and can review your financials with you to identify opportunities and risks. Contact us at Construction Cost Accounting to get started.
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