Key Performance Indicators With Construction – Backlog and Pipeline of Work (Part 2 of 3)

Backlog and the associated pipeline of work is the second group of key performance indicators for a contractor. With construction, understanding the volume of existing contracts, i.e. backlog, aids the management team in setting production goals in the near term. In conjunction with pipeline information, a contractor can quickly ascertain future financial performance. In order to do this, the contractor must create a set of key performance indicators that identify existing dollar value of signed contracts not yet started along with their respective time constraints. Furthermore, the pipeline of potential work is stratified in groups and historical performance guides the management team with what to expect for future work beyond the near term.

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This is the second part of a three part series explaining the various key performance indicators used by contractors. Backlog of work refers to existing signed contracts, their corresponding dollar value and timeline for completion. Whereas the pipeline KPI is broader in scope. The pipeline of work refers to a funnel effect whereby the final outcome is a signed contract. At the very top of the funnel, the widest point, sits all potential contracts that are considered leads. As the report steps into the funnel, not all leads turn into requests for estimates. The goal is have estimates turn into negotiations tied to the dollar value and time frame. The final part of this pipeline is of course final negotiations related to terms and conditions within the contract; e.g. there is a letter of intention by the customer to sign a contract given some reasonable terms and conditions.

This article explores and explains the two sets of key performance indicators for future work. The first section covers backlog and proper presentation and interpretation of existing backlog and the financial implications tied to this workload. The second section below covers the pipeline and the four major tiers of the funnel of potential work. The final section ties both sub groups of KPIs together and assists the management team in understanding and evaluating the impact on the financial performance of the company.

Backlog as a Key Performance Indicator in Construction

Backlog is defined as signed contracts. Do not include contracts pending nor contracts in negotiation. Only signed contracts are included in this key performance indicator report. It is essential that the management team have three key pieces of information along with some auxiliary information.

The first data point is the contract identifier; it may be the company’s unique identifier or the project’s address. Most contractors use a naming convention for their respective projects. The second piece of information needed is the contract’s full value. Some contractors include change order values approved to date. Others include change order values as auxiliary information. The final data point is the dollar value of the contract completed to date. Below is simple backlog report for a residential contractor. This contractor uses the contract signature date as the naming convention.

Nailed It Construction, Inc.
Backlog Report (Financial)
July 31, 2020
Project   Face Value % Completed Open Balance CO’s Approved   CO’s Completed CO’s Open Bal. Total Open Balance
190814 $1,359,900 84.5 $210,785 $118,600 $93,400 $25,200 $235,985
190921 961,999 92.5 72,150 185,150 172,750 12,400 84,550
191010 2,071,400 71.0 600,706 53,200 53,200 -0- 600,706
191024 1,249,000 82.0 224,820 21,750 11,750 10,000 234,820
191109 3,161,200 63.5 1,153,838 253,400 106,000 147,400 1,301,238
200112 2,547,999 66.5 853,580 26,700 26,700 -0- 853,580
200201 1,099,000 51.0 538,510 72,400 26,025 46,375 584,885
200228 1,649,999 42.5 948,750 106,950 57,800 49,150 997,900
200406 2,218,499 27.5 1,608,412 21,800 8,650 13,150 1,621,562
200408 995,000 41.5 582,075 7,450 -0- 7,450 589,525
200430 2,000,000 25.0 1,500,000 43,800 9,650 34,150 1,534,150
200603 1,749,900 7.5 1,618,658 -0- -0- -0- 1,618,658
200612 1,955,000 2.5    1,906,125 -0-    -0-   -0-       1,906,125
Totals $23,018,896 51.34% $11,818,409 $911,200 $565,925 $345,275 $12,163,684

This report provides a wealth of information to the management team. Take note of the following:

Face Value – the face value does not mean it is all contracts since a certain date; it merely identifies those contracts in process on the date of the report. Other jobs may have been on this report from the prior accounting period. Those jobs are now completed and removed from the open balance. Thus, do not assume that this contractor does $23M worth of home construction per year. It just simply means that the face value of all contracts equals $23M.
Open Balance – this particular column is easy to understand and in general the management team should see an increasing open balance of face value as the project’s tend towards recent signatures. Because this contractor uses an identifier convention of the contract’s signature date; it is easier to determine the age of the contract. If your organization uses a non date naming convention; please include a column for the contract’s signature date thus allowing the reader to determine the age of the respective contract in the row.
Percentage of Completion – notice that in the aggregate that the percentage of completion is 51% done. This average should stay within 40 to 60 percent from one accounting period to the next. If the percentage begins to go over 60% it means the company’s backlog is weakening and there needs to be some aggressive behavior with acquiring additional backlog. If the percentage of completion drops below 40% on average, this could be a good sign as there may have been a lot recent contracts signed. It would indicate that the team needs to increase productivity in order to keep up with the workload. Don’t misinterpret the values if they exceed the range; it could mean that there was an increase in productivity recently (average exceeds 60%) or a lack of productivity (average decreases below 40%). Any deviation beyond the two limits requires some subjective interpretation to determine the underlying cause.
Change Orders – this particular contractor includes this auxiliary information as a set of separate columns in the report. Take note how change orders increase in average value as the projects tend towards maturity. More recent projects do have have change orders executed yet or recent change orders are not as significant in value as mature projects. This is normal in this industry, most change orders occur as buyers begin to make selections and want exterior changes (hardscaping, landscaping, decks, etc.). Therefore, do not apply limits with evaluating change order performance. Another article on this website explains in more detail how to analyze and evaluate change order production.
Total Open Balance – this value is the most important piece of information from this report. It identifies the current total open balance. If management is aware of the average production rate from field operations, then management can determine the average number of months of work available for the company. For example, assume this contractor averages $2.3M of volume of production per month. This means there are just over 5 months of work available. Many controllers will advocate for open balances of volume of at least the common production cycle. In this case, assume the average turn around time from contract signature to completion is 9 months. This would inform the management team that the open balance of work is approximately 58% of the desired volume. Each contractor must create their own desired comfort point as to number of months of backlog. The author recommends a minimum of 6 months of backlog in order to address the many variables that exist with new home construction; these include economic factors, weather, capital reserves and workforce availability.

A second backlog report ties directly to the 5th point of the above. The management team needs to assess the timeline related to the respective projects. Understanding the timeline allows the management to communicate with potential customers regarding availability and projected dates of completion. It is essential to evaluate timing of work as it can identify throughput issues and manpower needs. More importantly, many contracts have a clause that specifically penalizes the contractor for failure to get a project completed by a set date. Without knowledge of the backlog timeline, often projects become rushed to avoid these penalties. In many cases, the cost to rush the project’s completion exceeds the respected penalties. Thus, a practical backlog report addresses potential delays and gives management an opportunity to address well in advance to avoid issues.

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Continuing to use the above company’s project’s, their backlog timing report is below.

Nailed It Construction, Inc.
Backlog Report (Financial)
July 31, 2020 Contracted Date Within
Project     % Completed Total Open Balance Phase Of Completion Compliance Issue
190814 84.5 $235,985 Trim-Out 08/31/20 No Missing Light Fixtures
190921 92.5 84,550 Landscaping 08/31/20 Yes None
191010 71.0 600,706 Flooring 09/30/20 Yes None
191024 82.0 234,820 Trim-Out 09/30/20 Yes None
191109 63.5 1,301,238 Walls 09/30/20 No Awaiting Selections
200112 66.5 853,580 Walls 10/31/20 Yes Countertops
200201 51.0 584,885 Trades 10/31/20 Yes None
200228 42.5 997,900 Trades 11/30/20 Yes Awaiting Selections
200406 27.5 1,621,562 Framing 12/31/20 Yes Change Order Submitted
200408 41.5 589,525 Windows/Doors 01/31/21 Yes Awaiting Selections
200430 25.0 1,534,150 Framing 02/28/21 Yes None
200603 7.5 1,618,658 Site Dev. 04/30/21 Yes None
200612 2.5       1,906,125 Site Dev. 05/31/21 Yes None
Totals 51.34% $12,163,684

With the above, the management team is aware of two serious issues related to getting projects completed on time. In addition, the issues column identifies a common issue with construction. Getting the buyer to complete their selections is a bottleneck with this contractor. Completing the selections aspect of construction in a timely manner allows the project manager adequate time to issue purchase orders and get the respective materials delivered on time to complete the project by the contract’s respective deadline. Thus, with project 190814, the missing light fixtures may cause the contract to go past the 08/31/20 expected completion date. Many contracts allow for delays due to the customer’s inaction or delays related to getting the respective materials delivered and installed.

Other contractors use different timing backlog reports. Here are some examples:

Stucco Siding – square footage percentage determines the timeline position and compliance.
Engineering – number of man-hours expended against original estimated plus modifications.
Concrete – yards of concrete poured against estimated plus change orders.
Solar – milestone percentages of completion against the respective milestone requirements as a percentage of the entire project.
Trades – combination of material cost to cost and actual labor hours against adjusted estimated labor hours.

Many subcontractors do not use timing based backlog reports due to the nature of their respective operations. In effect, the turn around time is so short that the report’s benefits are non existent. Think of roofers, masons, flooring and painters. By the time the report is issued, those jobs within the report shall have been completed. Thus, time compliance backlog reports are designed more for general contractors and sub contractors with very large projects (projects taking longer than 3 months to complete from start to finish).

The goal of the report is to get management to pay closer attention to projects with pending issues and get these issues addressed.

Backlog reports address both financial and production timing for the management team. It helps to paint a near term picture (less than one year) of field production value. To find out about longer term future work, another set of key performance reports are required – pipeline reports.

Key Performance Indicators – The Pipeline of Work in Construction

Unlike backlog, the pipeline refers to unsigned contracts, potential contracts, leads and sources of potential work. In effect, the pipeline is a tier of various projects at various points within the funnel of potential work. There are generally four tiers of potential work. The first and most valuable are contracts in negotiations including those with letters of intention. The second tier refers to work whereby proposals have been submitted and accepted by the client. The third tier of potential work are estimates in progress. The final tier are leads. Leads are projects posted or customer requests to have an initial meeting with the contractor to discuss preparation of a proposal. At this level, it is rare to assign a dollar value to the potential project. Thus, leads are just contacts and can often sit on the list for upwards of a year. The following subsections go into more detail and explain how to interpret each successive level within the pipeline of work in construction.

Contracts in Negotiation

As stated above, the pipeline refers strictly to unsigned contracts in various stages of progress towards an actual signature. The absolute most valuable group of pipeline projects are those projects at various points with negotiation. Typically, once a proposal is submitted to the client/customer; the customer will respond with one of several requests or statements:

The client/customer counter offers a value.
A meeting is requested to discuss the proposal in detail.
The client/customer communicates acceptance of the proposal and states to the contractor/builder they are in the process of reviewing for further discussion or response.

The underlying trigger to move a proposal into this tier is a response from the client/customer of receipt and a desire to take further steps. The management team needs to be careful here to properly classify the proposal to the negotiation level. Just because the customer has received the proposal doesn’t qualify the proposal as a member of this tier. The customer must indicate some form of a desire to discuss or take action that is positive or in favor of the contractor over others. It is a fine line and often the estimator or a manager wants the proposal included at this level. Some contractors will automatically include the proposal at this level once the client/customer confirms receipt of the proposal. However, proposals submitted are actually a function of the second tier and not at this level. In effect, a contractor can combine the two levels, but it is recommended to keep them separate as combining them will distort the overall picture of the long-term workload. Separate the two tiers, what qualifies the proposal as in ‘negotiations’ is when the client/customer specifically confirms a desire to discuss or proceed with the proposal. Some contractors are more restrictive and only include the proposal at this level once the initial meeting is completed. It allows them to get a sense of the client/customer’s position related to the proposal. Often proposals are rejected at these meetings due to several conditions such as price exceeds their budget, the timeline proposed is outside the desired completed date or the scope of services/work is significantly different than requested.

The key for any contractor is to be consistent with transitioning a proposal to this tier. Apply the rules equally over time and then the entire management team will delineate proposals appropriately.

An example of a report that provides the respective contractor with an understanding of proposals submitted, accepted and in negotiation is as follows:

Solstice Energy is a solar array engineering, design and installer of solar photovoltaic panels. The company does both removal and replacement of existing systems or can provide the necessary engineering and design work to build a complete system. All systems proposed exceed 100kW (100 Kilo Watts of Energy). The contract in negotiations presentation format is always in order of proposed value and not tied to the date of submittal or the company’s unique identification system.

Solstice Energy Inc.
Contracts in Negotiation
July 31, 2020 Proposed % of Projected
Contract ID Dated Submitted Client Location System Size Type Value Probability Start Notes
CA-200204 03/10/20 PG&E Turlock 485kW EPC $1,287,500 70% 11/01/20 Requires Engineering Approval
AZ-200107 02/06/20 IBS Phoenix 623kW R&R 896,740 100% 09/15/20 Awaiting Contract Signature
CA-200106 01/14/20 SEM Oakland 1,284kW Install 871,600 80% 08/15/20 Negotiating Price vs. Competition
OR-200227 03/16/20 Kantor MedFord 296kW EPC 791,999 90% 10/01/20 Terms & Conditions (Engineering Approval)
CA-200317 04/01/20 PSUSD Palm Springs 451kW Install 506,000 100% 10/01/20 Terms & Conditions (Prevailing Wages)
CA-191213 01/08/20 Kantor San Diego 387kW R&R 371,200 90% 09/15/20 Rcvd Letter of Intention
OR-200403 04/15/20 Kantor MedFord 307kW R&R 351,700 100% 08/15/20 Awaiting Contract Signature
AZ-200528 06/05/20 Kantor Tacna 361kW Decom 269,400 50% 07/31/20 Negotiations over Price
CA-200508 05/18/20 IBS Lancaster 185kW R&R 253,000 90% 09/30/20 Terms & Conditions (Engineering Approved)

Some controllers will add a projected value column which is the proposed value multiplied by the % of probability equating to the expected value of future signed contracts. This is acceptable contingent on multiple contracts in negotiation. When the pool decreases below a certain number, the volatility of the estimated end value increases. A good minimum number of contracts in negotiation to use to determine the pool’s expected value is 10 proposals at various stages of negotiation. Furthermore, it is simpler to exclude those that are already confirmed and only estimate the aggregated value of those contracts with a high percentage of probability and completely discount those below this threshold. In the above exhibit, this contractor completely discounts any proposal in negotiation that has lower than 80% chance of signature OR if the proposal is in competition with another solar service provider. Thus, of the above contracts in negotiation, the management team accepts that future contracts are worth $1,754,440 for those contracts with a 100% probability. Only three other contracts meet the required conditions as set forth above to qualify for an estimated value of future contracts. See the below schedule:
Solstice Energy Inc.
Contracts in Negotiation (Stratified for Acceptance and High Probability)
July 31, 2020 Proposed % of Projected
Contract ID Dated Submitted Client Location System Size Type Value Probability Start Notes
AZ-200107 02/06/20 IBS Phoenix 623kW R&R 896,740 100% 09/15/20 Awaiting Contract Signature
OR-200403 04/15/20 Kantor MedFord 307kW R&R 351,700 100% 08/15/20 Awaiting Contract Signature
CA-200317 04/01/20 PSUSD Palm Springs 451kW Install 506,000 100% 10/01/20 Terms & Conditions (Prevailing Wages)
. $1,754,440
OR-200227 03/16/20 Kantor MedFord 296kW EPC 791,999 90% 10/01/20 Terms & Conditions (Engineering Approval)
CA-191213 01/08/20 Kantor San Diego 387kW R&R 371,200 90% 09/15/20 Rcvd Letter of Intention
CA-200508 05/18/20 IBS Lancaster 185kW R&R 253,000 90% 09/30/20 Terms & Conditions (Engineering Approved)
. $1,416,199
Total $Value of Future Contracts $3,170,639

With this schedule, Solstice is expecting to have contracts worth $3,170,639 that will start in the 3rd quarter of the year with the latest start on October 1, 2020. Solstice’s can use this information to evaluate the workload during the 4th quarter of the current calendar year and the first quarter of 2021. Based on historical subjective criteria, the management team is highly confident of the dollar value of work pending transfer to the backlog schedule. The three jobs dropped from this list still stay on the full contracts in negotiation list but until there are further client/customer movements. Management will not include them in the value equation for future contracts used to determine workload and timing (backlog reports). Notice with this list, the proposals are organized by percentage of probability of getting a signed contract and excludes the proposal based on either low probability or if the contract is in competition with another solar service provider.

Proposals Submitted

This tiered level of the pipeline is simple, it is merely a list of all proposals submitted to clients/customers. Its aggregated dollar value informs the management team of several pertinent points. First, the aggregated dollar value is used to gauge the volume of estimates prepared recently by the estimating team members. In addition, the aggregated dollar value is tracked in the aggregate over time to evaluate the overall industry and company’s pattern. Another point of interest to monitor is if the trend line is declining and if so, by what percentage. If the trend line decreases (use a two month running average) it is a key indicator of potential issues six to nine months down the road depending on the period of time to negotiate contracts and commit to a start date. A slight decrease is not an indicator of trouble, but any change of more than 5% should raise eyebrows with the management team.

Remember, proposals in this tier are all proposals in receipt by clients/customers but without an indication by the client/customer to proceed. There must be some form of client communication indicating a desire to move forward with the submitted proposal before it is transferred from this list to the negotiations list. An indication by the client/customer of acceptance does not fulfill the trigger to move this proposal into the negotiations stage of the pipeline.

Many contractors use an aging out formula; a time period to remove the proposal from the list, i.e. the client/customer is not moving forward with the proposal. The most common drop off the list date is 90 days after submission. To drop off the list, the client/customer either confirms that the proposal is not accepted or there is no communication during this time period. Naturally, the contractor must make several attempts to communicate and understand the client’s/customer’s position or intention. Often the most common reason to remove the proposal from the list is that the project lost funding.

Each contractor is different, each industry within the construction sector is different with how long it takes from lead origination to actual physical start of work. Some projects have cycle times as short as 30 days; many are in the six to nine month range to get started. And those involved with government contract work acknowledge that often contract fruition is in excess of a year. Thus, there is no hard set number of days to use as the drop factor in this tier. However, it is a good idea to create a reasonable removal time period or this tier of the pipeline will just constantly increase in value. Thus, instead of a funnel look for the pipeline, it will resemble a snake trying to consume a rodent down its body as it processes its kill into food. If new in the industry, start with a longer drop out period until a pattern is recognized. With the solar service provider above, they use 150 days as the drop out point. Many estimates stay stagnant due to funding and the many layers of client/customer approval (funding, engineering, permitting, developer issues, etc.) required. Whereas, the new home contractor uses 60 days as customer decisions are frequently tied to a desire to move by a certain date.

Just like the upper tier of contracts in negotiation, the spreadsheet identifies the unique project identifier, proposal date submitted, dollar value of proposal and of course the customer’s name. Note that there is percentage of probability here as there has been no discussions nor maturation of customer inclination towards the proposal. Once the customer indicates a desire to discuss or counters the proposal, the proposal moves into the next upper tier – contracts in negotiation.

One last word of caution. The author has experienced (quite frequently) client/customer requests for a proposal simply to discover the cost of a project. They may use the proposal as a guideline or to counter another contractor’s proposal. In one case, the author witnessed a government procurement officer wanting a proposal only to use it to submit a request for funding based on the proposal for a project. In effect, the local government had not approved the project. For regular customers, submitting proposals is acceptable and in some cases, the proposal is submitted knowing it will never be approved due to circumstances, but the proposal is submitted due to client/customer relations. For those involved with new customers, it is best to charge a fee to create a proposal but the fee will be applied as a deposit on the project if the proposal is accepted. The author urges caution, preparation of estimates and proposals takes time and costs money to prepare. Be selective in how you perform this step in the pipeline process.

Estimates in Progress

The third tier in the pipeline are actual estimates in progress. At this level, every estimator should be working several estimates at various stages of estimating. Some estimates can be completed in a relatively short period of time such as those in the restoration industry that use Xactimate software while others require long tedious procedures requiring engineering consulting, take-offs, bid submittals by trades, material negotiations and even governmental input.

Measuring the value of estimates in progress is not necessarily done in the form of dollars but is often tied to some other measure of value. Home contractors will cite square footage or level of customization; bridge builders may cite length, width and height; concrete contractors may use tonnage as a measurement of value; hardscapers may use types of structures; developers will use number of units and so forth.

With estimates in progress, the management team is interested with knowing the size of the pool of available work in the market. It can’t be measured in dollars as the estimates are incomplete at this stage of the pipeline. Thus, the requirement to use some other measurement criterion as the indicator of value.

Just like proposals submitted, a spreadsheet is created listing the various estimates in progress and the value of the alternative measurement. Other pertinent data for this report include dates of request for the proposal, customer name, location, estimator’s name and deadline date. Some contractors will add status, sub proposals needed, and a code system to indicate either type of customer (government, institutional, consumer, commercial, etc.) or the type of project. The key to this spreadsheet is to ensure all estimates are processed and proposals submitted; thus, no work is potentially missed due to failure to act.

Leads

The fourth and final tier are leads. At this level, management wants to see an active engagement with potential work and/or customers. Thus, any form of request for information or a contact input is recorded and followed up by someone to ensure no potential work is lost. With most contractors, there is system in place to identify potential work, record this potential and then a requirement to discover the status. For example, many companies use multiple lead generation tools such as an internet contact form, phone calls, government websites, client discussions, meetings and even hearsay to identify potential work.

Much of this potential is discarded once all the information is discovered. Often leads end up nowhere as the potential customer is merely fishing for information. In some cases, this fishing expedition is really a future lead; thus none of the leads are discounted immediately until adequate information supports elimination.

Since leads are merely potential work, their relative position along the timeline is at the beginning and many contractors recognize the long process to turn a lead into a contract. The goal for this list is to identify potential, follow up and create requests for estimates/proposals. Furthermore, this part of the pipeline is used to differentiate among the various venues of lead generation. What works? What is the most effective tool to create requests for proposals? It is constant sampling systems as venues do change and the entire organization must be alert and attentive to how the market finds the contractor. To do this, the contractor must seek out the market. This part of the pipeline is vast and requires a constant lead generation report identifying the various sources and status of the respective lead. Any missed opportunities should be discussed and lessons learned report generated to avoid future errors.

Evaluating Key Performance Indicators in Construction – Backlog and Pipeline

Key performance indicators act as a barometer of near term and long-term production issues. They also act as trigger mechanisms to cause action. A well developed reporting format provides a wealth of information to the management team. Backlog provides information related to short-term field production volume. Since backlog is tied directly to signed contracts only, these jobs are currently in process and their activities are generating economic transactions which show up on the financial statements, discussed in Part 3 of this series. The pipeline of data is oriented towards the longer term production volume. Any slight deviation from aggregated calculated proposals in negotiations can indicate trouble or the need to ramp up production.

For those contractors having sales less than $2M per year, keeping track of this information can be done in your head. It really isn’t necessary to have a formal documentation plan. However, contractors with sales greater than $2M per year must have a formal set of backlog and pipeline reports. It will be impossible to grow beyond $8M per year without this set of key performance indicators. Growth is tied to having knowledge of backlog and what is in the pipeline. Owners and the management team have a fiduciary responsibility to the entire organization to develop and monitor these indicators. Long-term security for all employees is tied directly to the ability to predict the near and long-term production of the organization. Growth beyond $8M per year without this set of reports is either coincidental or purely luck. The management team must review these reports in detail monthly. The owner or controller should receive updates weekly as to the status of the existing backlog and progress in each of the tiers within the pipeline of potential work. Any deviation from the expected requires immediate action to protect the organization’s financial well being.

For those involved in high volume low dollar jobs; utilize a work order system to substitute for a formal backlog/pipeline process. A work order system records the initial contact and tracks the lead all the way to an actual contract and finally job completion. Examples of construction business operations that should exercise a work order program include:

Residential Roofers
Trades (Residential and Light Commercial)
Painters
Flooring Companies
Insulation
Maintenance Operations
Fire Suppression and Control
Masons (Residential and Light Commercial)
Landscapers and Lawn Maintenance
Restoration Contractors (Most Cases)
Utilities Contractors (Residential Only)
Fencing

With each of the respective batch of reports tied to backlog and pipeline of work, set boundaries and thresholds to trigger action. For example, if leads decrease in the area of internet contacts, have the IT team review website statistics and discover any issues related to the website. If volume of phone calls is the source issue, find out what changed recently. What drives phone calls? Get at the key underlying cause and create a remedy. Your company’s long-term success is dependent on your actions. Backlog and pipeline key performance indicators provide the necessary impetus to trigger action ensuring long-term financial success. Act on Knowledge.