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ASC Proceedings of the 41st Annual Conference
University of Cincinnati - Cincinnati, Ohio
April 6 - 9, 2005         
 
A Comparative Analysis of Financial Statements of General Contractors
 
Syed M. Ahmed, Ph.D., Weihua Mao, Aarti Pandit, and Juan Zheng
Florida International University
Miami, FL
 
Construction companies are shown by noted agencies to have an alarming rate of business failures and bankruptcies. As most construction companies are involved in large amounts of investments, there are huge financial risks involved in these projects. The importance of sound financial management of these mega-scale projects and the companies executing such projects should not be under-estimated. In order to stress the importance of financial management in the construction industry, two companies were selected for this study. Certain relevant ratios were then selected for carrying out a detailed ratio analysis. In addition, weights were assigned to selected ratios, depending on their importance, to arrive at a single final value for each company through simple mathematical calculations.  Final conclusions are then drawn accordingly.
 
Key Words: ratio analysis, financial statements, construction companies, general contractors, financial risks.
 
 
Introduction
 
Data from noted agencies like Dun & Bradstreet, the Surety Information Office and the Centre to Protect Worker's Rights, have shown that construction companies have an alarming rate of failure, perhaps more so than companies belonging to other industrial sectors. The basic function of these construction companies is to execute and manage construction projects, a majority of which are on mega-scales, involving capital investments in millions and billions of dollars, and requiring several years for completion and return of investment. Hence, the financial risks involved with these projects, which get transferred to the companies working on them and from them onto the financial institutions or private parties funding them, are tremendous. The overall management, planning, design and construction aspects of these projects become critical, wherein even small mistakes can lead to heavy losses. Hence, the importance of sound financial management of these projects should never be under-estimated.
 
Construction projects range from infrastructure projects (e.g. water supply, electricity and sanitation networks, dams, electric and thermal power plants, nuclear reactors, etc.) and transportation projects (e.g. road, waterway and railway networks, tunnels, bridges, harbors and airports) to residential and commercial construction projects. Good financial management, implications of the related decisions and the skills required to successfully complete projects on time, within budget and with sufficient profit, can be best understood from the financial statements of companies dealing with especially large projects, in which small differences in financial ratios can translate into extremely large variations in the actual amounts pertaining to any account. Hence, it was deemed beneficial to select the financial statements of two of the bigger general contractors in the country, in order to carry out the financial analysis.
 
A comparison can be made between, the financial statements of a given company and the industrial averages for companies in the same industrial sector or for all companies in general, the same company for two different fiscal years, two companies in the same fiscal year, etc. The objective of this paper is to compare the financial statements of two general contractors for the same fiscal year. The value of a financial ratio will reflect the concerned company’s performance in a given market and other external conditions. By selecting financial statements of two companies for the same fiscal year, the authors can assume that the market and other external conditions faced by these two companies are similar and can therefore interpret these ratios as a result of the companies' performances in response to these external conditions. The companies selected by the authors for this analysis belong to the same industry i.e. the Construction Industry. However, they do belong to different industrial sectors. The authors are, therefore, also able to ascertain that the way a company handles its assets and liabilities to generate profit, is based on the characteristics of the industrial sector that the company belongs to.
 
 
Background of the Companies
 
Granite Construction Company – GC
 
Granite Construction Incorporated is the parent company of Granite Construction Company, one of the nation's largest heavy civil contractors and construction materials producers. Incorporated in 1922 and publicly traded since 1990, it is a member of the S&P 400 Index. Granite Construction Company serves both public and private sector clients and is comprised of many well-coordinated, highly professional teams of Builders located across the nation. GC are best known for transportation infrastructure projects including roads, highways, tunnels, bridges, mass transit facilities and airports. The company also produces sand, gravel, ready-mix and asphalt concrete and other construction materials. Unusual among large contractors, GC is equally effective at building through its two operating divisions, the Branch Division (BD) and the Heavy Construction Division (HCD). HCD is a major user of construction equipment and has developed substantial expertise with large, complex projects. The branches draw on these resources, which are generally not available to smaller, local competitors. Conversely, the BD offices have greater knowledge of local markets and provide HCD with valuable information regarding larger projects in their respective areas, as well as providing a source of aggregates.
 
Centex Corporation – CC
 
Centex Corporation is the nation's premier company in building and related services: Home Building, Home Services, Financial Services and Construction Services. Established in 1950 in Dallas, Texas, with revenues exceeding $10 billion, Centex is a Fortune 250 company traded on the New York Stock Exchange under the symbol "CTX." Centex consistently ranks among "America's Most Admired Companies" in its industry, according to FORTUNE magazine. The company has approximately 17,500 employees located in more than 1,500 offices and construction job sites across the nation and in the United Kingdom.
 
Both these companies are very big and comprehensive construction companies. However, both focus on different types of construction projects. GC has more emphasis on heavy infrastructure projects and construction materials production. Comparatively, CC has more experiences on home building and construction services. This difference will be considered in analysis and conclusions.
 
 
Methodology
 
Instead of selecting the Financial Statements of small-scale General Contractors, two premier construction companies Granite Construction Incorporated (GC) and Centex Corporation (CC) are selected to find out what results can be expected as normal, for companies in the construction industry, who are financially sound or doing well. These companies are well-reputed and work on mega-projects. Hence, their Financial Statements would be similar to what can be considered as normal financial statements of companies in the construction industry and hence will not give skewed results in the financial analysis.
 
The Annual Reports of the two selected companies, both in the same Form 10-K format, as required by the United States Securities and Exchange Commission are used for easy comparisons. These reports include the following financial statements, Consolidated Balance Sheets, Consolidated Statements of Income/Revenues/Earnings, Consolidated Statements of Stockholder’s Equity, and Consolidated Statements of Cash Flows.
 
The ratios used for financial analysis are ratios specific to the construction industry. The source for these ratios is Dun & Bradstreet, Inc., Industrial Norms and Key Business Ratios One Year - Desk Top Edition. A financial analysis for a specified fiscal year (GC-December 31, 2002 to December 31, 2003 and CC- March 31, 2003 to March 31, 2004) is carried out. There is a 3 - month lag between the selected fiscal years of the two companies, due to a difference in their financial policies. Since three-month escalation will not affect a company’s ratio except the absolute value, this minor difference will be ignored for convenience in comparison of the two companies, thus assuming that the two sets of data correspond to the same fiscal year.
 
If two reports from two different time periods were selected, it would be difficult to compare them, as the values recorded in these reports could have been the result of very different market conditions. Using the financial reports of two companies for the same time period, the results of their ratio analysis can be used to indicate the companies’ performances in response to these external conditions for the sake of comparison between them. All values, including those from the balance sheet, have to be taken for a certain period and since the balance sheet corresponds to an instant in time, the value from a balance sheet entered into this ratio must be the average of the corresponding values on two balance sheets i.e. that for the Start of the concerned Fiscal Year (GC-  December 31, 2002 and CC-   March  31, 2003) and that for the End of the concerned Fiscal Year (GC- December 31, 2003 and CC- 31st  March 2004). The values from the income Statement correspond to the same period as the selected fiscal year (GC- December 31, 2002 to   December 31, 2003 and CC- March 31, 2003 to March 31, 2004).   
 
 
Financial Ratios
 
Financial ratios are used to analyze the financial statements of the two companies. A financial ratio is a ratio obtained by dividing one category or group of categories on the given company's financial statement by another category or group of categories on the same company's financial statement (Peterson, 2005). The ratio is expressed as a ratio to 1 (e.g. 0.2:1) or as a percentage (e.g. 20%) or as the number of times an event occurs during a certain period (e.g. number of times a company turns over its working capital). The financial statements most commonly used for this analysis are the company’s balance sheet and income statement. Although for some analysis, Statements of Stockholder’s Equity and Statements of Cash Flows are used as well.
 
Over a period of several years, data collected from the financial statements of several companies from each industrial sector has been analyzed in order to prepare target ratios for each industrial sector. Corresponding to each sector, statistical data analysis has also provided a median value and a range for each ratio. This ratio enables the interpretation of the relationship between the various values shown on the financial statement and to draw appropriate conclusions from the same. The authors compared different ratios for these two companies, obtained from calculations from its financial statement, with the standard value for that ratio for the corresponding industrial sector. From this comparison, several conclusions regarding the company's financial health were drawn.
 
Financial ratio analysis will help the financial manager of the company to identify a potential financial problem in the company before it becomes a crisis. It can help handle simple planning issues, for example, setting aside funds to account for the depreciation of a company asset, such as equipment, in order to enable purchase of its replacement at the end of the life span of that asset. It can also provide insight into the company's ability to pay bills, efficiency in utilizing its financial resources, profitability, capital structure of the company, as well as assist in analysis of other basic business/financial functions.          
 
 
Analysis of Data
 
Financial ratios measure different aspects of a firm’s financial status. For better comparison, ratios are analyzed in four major categories, liquidity ratios, capital structure analysis, activity ratios, and profitability ratios. Liquidity ratio measures the ability of the firm to pay its obligations as they come due. Capital structure analysis measures a company’s ability to manage debt and demonstrates the way a company has chosen to finance its operations. Activity ratios measure how effectively a firm is using its assets. Profitability ratios measure the ability of the firm to generate income from operations and thus increase the equity (Jackson, 2002).
 
Liquidity Ratio
 
Quick Ratio & Current Ratio [See Appendix “Ratio Analysis Table”]
 
The quick ratio and current ratio reflect the company’s ability to pay current (short-term) liabilities, i.e. its short term liquidity. In 2003 and 2002, GC’s Quick Ratio was 1.03 and 0.97 respectively, while CC’s was 0.75 and 0.72. GC’s Current Ratios was 1.77 and 1.67 in 2003 and 2002 respectively, while CC’s was 1.19 and 1.12.
 
Fig. 1 shows that both GC’s and CC’s quick ratios are slightly below the corresponding medians for their respective industrial sectors. The quick ratios of GC in 2002 and CC in 2003 and 2002 were lower than 1:00 to 1, which means they were both not liquid enough. Nevertheless, their quick ratios were well within the range.  Fig. 2 shows that both companies have the ability to pay current liabilities because their current ratios are higher than 1.00 to 1. Furthermore, GC’s current ratios in 2003 and 2002 were almost the same as the typical current ratio for heavy and highway companies. It increased from 1.67 in 2002 to 1.77 in 2003. CC’s current ratios were lower than those for a typical single-family residential company not only in 2002, but also in 2003, but within the range. Although CC did some improvement from 2002 to 2003 for its short term liquidity, its current ratio was still not very good. According to their current ratios, GC performed better than CC. CC was probably undercapitalized and could have run into financial problems during the next year as its ratios were below 1.50 to 1.
 
Figure 1: Quick Ratio.                                                        Figure 2: Current Ratio.
 
Capital Structure Analysis
 
Current Liabilities to Net Worth Ratio & Debt to Equity Ratio
 
These two ratios are used to compare the risk that short-term creditors and other creditors have taken with respect to the risk that the company’s owners have taken respectively (Peterson, 2005). Thus, the higher the ratio is, the more risk the creditors take and the more money the company borrows to expand its business. From the “Ratio Analysis Table”, it shows GC’s Current Liabilities to Net worth Ratios was 0.69 in 2003 and 0.72 in 2002, while CC’s was 4.16 in 2003 and 3.24 in 2002. GC’s Debt to Equity Ratio was 1.1 in 2003 and 1.16 in 2002, while CC’s was 4.27 in 2003 and 3.37 in 2002.
 
Figure 3: Current Liabilities to Net Worth Ratio.             Figure 4: Debt to Equity Ratio.
 
Fig.3 shows that GC’s Current Liabilities to Net worth Ratio was close to the typical ratio in 2003 and well within the range in 2002. Because the ratio is less than 100%, the short-term creditors do not have more capital risk than the owners of GC, which is a good position for them to be in. CC’s Current Liabilities to Net Worth Ratio was high. Furthermore, CC had a higher ratio in 2003 than 2002; all of which points to the fact that CC relied heavily on trade financing and financing services. The ratios for CC were obviously too high, with a worsened trend. Fig.4 shows a similar result for Debt to Equity Ratio as the Current Ratio above. GC’s ratio was close to average. However, CC’s ratio was far beyond the industry median and range.  As a rule of thumb, the desired range for this ratio should be less than 2.00 to 1.
 
Compared to GC, CC borrowed too much from its creditors. CC had poor short term liquidity and was highly dependent on its creditors, which was a danger signal raising doubts as to whether this company could service its debts, particularly if a downturn were to occur in the industry.  Furthermore, the Balance Sheet shows that the biggest item of the liabilities is “Debt-Financial Services” which accounted for 51.67% in 2003 and 43.05% in 2002 of the Total Liabilities and Stockholders’ Equity.  In comparison with “Debt-Financial Services”, the “Total Stockholders’ Equity” only accounted for 18.98% and 22.89% among Total Liabilities and Stockholders’ Equity in 2003 and 2002 respectively. There seems to be a big difference, which is unusual.
 
Activity Ratio
 
Collection Period
 
Collection Period is a measurement of the average time it takes a company to collect its accounts receivable or the average number of days that capital is tied up in accounts receivable (Peterson, 2005). GC’s Collection Period was 54.83 days, while CC’s was 255.99 days in 2003.  GC’s collection period came close to the typical median ratio for heavy and highway companies (Figure 5). CC’s collection period was far beyond the typical median and the upper range, which indicates that CC had poor collection policies or had extended generous payments terms to its clients. That feature is reflected above also, when Receivables occupies a very high proportion of Total Assets.
 
Figure 5:  Collection Period.                                            Figure 6: Gross Profit Margin.
 
In summary, while GC has average collection policies, CC’s policies are not very good.  Hence, CC’s accounts receivable are around 50% of its total assets. Although CC is very aggressive in its business and tries to attract more clients through its generous collection policy, CC has to pay attention to the unusual high risks of bad debts.
 
Profitability Ratio
 
Gross Profit Margin
 
GC’s Gross Profit Margin was 12.3% and 12.7% in 2003 and 2002 respectively, while CC’s was 11.8% and 9.8%. This ratio is the percentage of the revenues left after paying construction costs and equipment costs (Peterson, 2005). It is a well-known fact that there is a decreasing trend in Gross Profit Margin as the firm’s size increases. Thus, for these two huge companies, their Gross Profit Margin should be lower than normal. Fig.6 shows that as GC spent 88% and 87% of its revenue on construction cost, it retained 12% and 13 % to cover overhead and profit in 2003 and 2002. Its ratio was far less than the median for heavy and highway companies. Although GC is a large firm with relatively lower Gross Profit Margin, it needs to increase its profit and overhead markup or exercise better control over its construction costs. CC spent 88% and 90% of its revenue on construction costs, and retained 12% and 10 % to cover overhead and profit separately in 2003 and 2002. Its ratio is far less than the median for single-family residential companies as well. For the same reason, CC also needs to increase its profit and overhead markup or exercise better control over its construction costs.
 
General Overhead Ratio (General and Administrative Cost Ratio)
 
In 2003 and 2002, GC’s General Overhead Ratio was 8.2% and 8.3% respectively, while CC’s was 1.0% and 0.7%. This ratio represents the percentage of the revenues used to pay the general overhead expenses.  Fig.7 shows that CC does far better than GC because CC’s overhead is only around 1%. As a rule of thumb, the general overhead in construction companies should be less than 10%, and it appears that firms with higher overhead expenses, relative to their total sales, experience “lower levels of profitability”
 
CC’s General Overhead Ratio is not only much lower than GC’s but also unexpectedly much lower than average. That means CC will get much more profit than GC finally, because they have similar Gross Profit Margin. Moreover, because of GC’s higher general overhead, the profitability of GC is not good as CC at the end. Efficient management and control of the enterprises’ overhead is a key factor for profitability.
 
Figure 7: General Overhead Ratio.                                          Figure 8: After-Tax Profit Margin.
 
Pretax Profit Margin & After-Tax Profit Margin
 
GC’s Pretax Profit Margins was 5.3% and 4.7% in 2003 and 2002 respectively, while CC’s was 11.1% and 8.9%. As to After-Tax Profit Margin, it shows that GC’s was 3.3% and 2.8% in 2003 and 2002 respectively, while CC’s was 8.0% and 6.6%. This ratio, also known as the return on sales, may be measured before or after income taxes. It is a measurement of how well a construction company can withstand changes in the construction market, such as reduced prices, high costs, and less demand. For the same reason, CC has better profit margins than GC’s not only in 2003 but also in 2002 (Figure 8).
 
 
Discussion
 
To better compare these two companies, a scorecard is used to get a clearer result of ratio analyses. An evaluation score is given to each ratio: Average as “0”; Good as “1” and Bad as “-1” (Table 1).
 
Table 1
 Scorecard table
NO
Ratio Name
Granite Construction Inc.
Centex Corporation
 
Evaluation
Score
Evaluation
Score
 
1
Quick Ratio
Average
0
Average
0
2
Current Ratio
Good
1
Bad
-1
3
Current Liabilities to Net Worth
Good
1
Bad
-1
4
Debt to Equity Ratio
Good
1
Bad
-1
5
Collection Period (Days)
Good
1
Bad
-1
6
Gross Profit Margin
Bad
-1
Bad
-1
7
General Overhead Ratio
Average
0
Good
1
8
After-Tax profit Margin
Bad
-1
Good
1
 
Total:
 
2
 
-3
 
Each company has its own positive as well as negative points. Hence, it may be erroneous to conclude that one company is better than the other for any reason. However, if we assign equal value to all ratios, GC does much better on 4 ratios out of 8 with a total score of 2, than CC with a total score of -3, and hence is the better of the two companies from a financial point of view.
 
The authors also notice that, for different industrial sectors, for the same ratio, the range and median values are quite different due to particular characteristics corresponding to that sector e.g. the average Fixed Assets to Net Worth Ratio is much higher for Heavy and Highway sector as compared to the Single-Family Residential sector due to a heavy investment in construction and excavation equipment. From a potential investor’s point of view, it will be safer to invest with GC as it appears to be able to give a steady return on capital invested by the company’s shareholders. CC on the other hand is a high-risk company, as it has a high profit margin, but also has heavy debts.
 
 
Conclusions
 
Each ratio calculated above helps people to look at the two companies from a different perspective. Though all creditors are faced with a normal level of risk, GC is better equipped to withstand detrimental changes. However, the large investment in excavation equipment makes it dependent on maintaining a steady stream of work. If there is a downturn in the industry, GC will suffer more. CC is not that dependent on maintaining a steady stream of income. The low investment in equipment and the low overhead expense make it more liquid. From a negative perspective, CC heavily relies on trade financing and financing services and uses its suppliers and subcontractors to perform a large portion of its work. It is undercapitalized and may face financial problems during the next year. It may not be able to service its debt, particularly during a downturn in the industry. CC is less efficiently run from the point of view of using its assets.
 
The forecast regarding the outlook and expectation of the two companies’ financial futures, is that, GC has a very promising future if it controls its costs, while there is a long way for CC to go before it becomes financially strong. Forecasting the potential financial problems or risks faced by the two companies, GC may face problems during an industry downturn due to its heavy investment in construction and excavation equipment, while CC may not be able to pay off its debts. Regarding cost control and budgeting systems used by the two companies, it appears that both either have poor collection policies or must have extended generous payment terms to their clients, leading to a decrease in profitability, as they may require external financial assistance to make up for this shortage in cash. However, CC has managed to keep its overhead expense to a very low level. As far as managing their finances is concerned, both need to increase their profit and overhead markup or exercise better control over their construction costs.
 
 
Reference
 
Centex Corporation – CC. Retrieved Nov. 10 2004, from http://www.centex.com/About_Centex/
 
Granite Construction Company – GC. Retrieved Nov. 10 2004, from http://www.graniteconstruction.com/about-us/index.cfm
 
Jackson. J. (2002). Financial Management for Contractors. FMI Corporation.
 
Peterson, S. (2005). Construction Accounting and Financial Management. Pearson Education, Inc.
 
 
Appendix
 
 Ratio Analysis Table
 
No
Ratio Name
Formula
Granite Construction Inc.
Heavy & Highway
Centex Corporation
Single-Family Residential
2003
2002
Median
Range
2003
2002
Median
Range
1
Quick Ratio
(Cash + Accounts Receivable)/Current Liabilities
1.03
0.97
1.20
2.1~0.8
0.75
0.72
0.90
2.1~0.3
2
Current Ratio
Current Assets/Current Liabilities
1.77
1.67
1.70
2.8~1.2
1.19
1.12
1.60
3.2~1.1
3
Current Liabilities to Net Worth
Current Liabilities/Net Worth
69%
72%
65%
29~132%
416%
324%
88%
29~241%
4
Debt to Equity Ratio
Total Liabilities/Net Worth
1.10
1.16
1.00
0.4~1.9
4.27
3.37
1.20
0.4~3.0
5
Collection Period (Days)
Accounts Receivable(365)/Revenues
54.83
 
51.00
31~73
255.99
 
23.00
8~45
6
Gross Profit Margin
Gross Profit/Revenue
12.3%
12.7%
25%
 
11.8%
9.8%
24%
 
7
General Overhead Ratio
General Overhead/Revenue
8.2%
8.3%
<10%
 
1.0%
0.7%
<10%
 
8
Pretax Profit margin
Net Profit before Taxes/Revenues
5.3%
4.7%
 
 
11.1%
8.9%
 
 
9
After-Tax profit Margin
Net Profit After Taxes/Revenues
3.3%
2.8%
3.2%
7.3~1.0%
8.0%
6.6%
3.3%
8.1~0.9%