Common Pitfalls Contractors Make When Seeking Bank Financing Part I

By John Kraus, Premier Credit Insights & Solutions LLC

Contractors often assume banks make lending decisions primarily on revenue growth, backlog,equipment values, or annual profits.

In reality, experienced commercial lenders begin with a much more fundamental question:

Can this contractor consistently convert projects into profitable cash flow while successfully managing execution risk?

After more than four decades in commercial banking—and many years underwriting contractors ranging from electrical and HVAC firms to general contractors and site developers—I found that many financing requests encountered the same recurring issues.

Most were preventable.

Conversations with contractors often begin the same way:

"We're doing $8 million this year."

"Our backlog is stronger than ever."

"We've landed several major projects."

Those accomplishments certainly attract attention. However, they rarely answer the question lenders care about most:

Are those projects producing sustainable gross profit margins that generate the cash flow needed to support the business and repay debt?

1. Focusing on Revenue Instead of Gross Profit

Many contractors proudly discuss sales growth. Unfortunately, lenders know that revenue alone doesn't repay loans. Gross profit margins often reveal whether growth is creating value—or simply creating more work.

When margins begin to decline, lenders naturally begin asking questions.

• Was the project underbid?

• Have labor costs increased?

• Were material prices underestimated?

• Did change orders go unapproved?

• Were projects poorly managed?

Rapid revenue growth accompanied by shrinking margins is often viewed as a warning sign rather than a success story.

Banker's Takeaway: Revenue creates opportunity. Gross profit creates cash flow. Cash flow repays loans.

2. Weak Financial Reporting Makes Margins Difficult to Trust

Even healthy margins lose credibility if the underlying financial information is inconsistent.

Contractors sometimes submit financial statements that contain unexplained fluctuations, incomplete expense classifications, or outdated information.

Without reliable financial reporting, lenders struggle to determine whether reported profits accurately reflect actual project performance.

Reliable financial reporting builds lender confidence because it demonstrates discipline, organization, and management control.

3. Poor Job Costing Conceals Profitability Problems

Every contractor knows which jobs are going well—or at least believes they do.

Banks require more than intuition. Effective job costing should answer questions such as:

• Which projects are the most profitable?

• Which jobs are losing money?

• Are labor costs exceeding estimates?

• Are material costs being controlled?

• Are change orders being captured promptly?

• How are margins trending from project to project?

When contractors cannot clearly measure profitability by job, lenders become concerned that future earnings may be less predictable than reported.

Job costing is not simply an accounting exercise. It is one of management's most important decision-making tools.

4. Weak Work-in-Progress (WIP) Reporting Masks Emerging Risks

A contractor's Work-in-Progress schedule often tells lenders whether reported margins are likely to hold—or whether they are beginning to erode.

A well-prepared WIP report helps lenders evaluate:

• Percentage of completion

• Costs incurred

• Estimated costs to complete

• Gross profit fading

• Underbillings

• Overbillings

• Jobs requiring additional attention

Without accurate WIP reporting, lenders have difficulty determining whether current profits will ultimately be realized—or whether cost overruns are beginning to surface. For many contractors, the WIP schedule is just as important as the financial statements themselves.

Margin compression rarely happens overnight. It often develops gradually across multiple projects, which is why experienced lenders monitor trends—not just annual results.

Year-end financial statements" ties directly back to WIP.

A Real-World Example

The following example is based on an actual client experience. Certain facts and financial details have been modified to protect client confidentiality while preserving the underlying credit lesson.

Years ago, I worked with a successful general contractor whose annual revenues were approximately $6.0 million. The owner was ambitious and set an aggressive goal of significantly increasing the business to $12 million in just one year by bidding on substantially more projects.

While I admired the ambition, I expressed concern that such rapid growth could place significant pressure on the company's gross profit margins, working capital, and overall profitability.

One year later, the contractor returned for its annual line of credit renewal. At first glance, the numbers looked impressive. The company had nearly doubled its revenues and met the growth target it had set the year before.

But as I began reviewing the financial statements and Work-in-Progress reports, a very different story emerged...

The company had successfully doubled its workload—but it hadn't improved its profitability.

Despite nearly doubling revenues, net operating profit remained virtually unchanged at approximately $100,000. Throughout the year, I had monitored the company's Work-in-Progress reports and observed gross profit margins steadily compressing. The trend wasn't isolated to one project—it was occurring across the portfolio. Several projects generated little profit, while others actually lost money. Whatever additional gross profit dollars the company produced were largely consumed by higher operating expenses associated with managing the increased volume of work.

I asked the owner a simple question: "Why assume substantially more risk, invest more capital, and manage twice the workload if the bottom line doesn't improve?"

To his credit, he understood the lesson.

The following year, the company became much more selective in the projects it pursued, focusing on jobs with stronger margins rather than simply increasing volume.

Annual revenues declined modestly, but profitability more than doubled. The owner was able to increase his own compensation, strengthen the company's financial position, and generate significantly more cash flow—all without chasing unnecessary growth.

The experience reinforced a lesson I've carried throughout my banking career: For contractors, the quality of revenue almost always matters more than the quantity of revenue.

Final Thoughts

Contractors often believe banks are primarily evaluating collateral, equipment, or annual revenues. In reality, experienced commercial lenders begin by asking a much more fundamental question:

Can this contractor consistently convert projects into profitable cash flow?

Gross profit margins provide one of the clearest answers.

• Strong margins reflect disciplined estimating, effective project management, cost control, and sound execution.

• Weak or declining margins often signal challenges long before they become visible elsewhere in the financial statements.

Premier Takeaway

For contractors, gross profit margins are more than an accounting metric—they are one of the strongest indicators of future cash flow, financial strength, and bankability.

Healthy gross profit margins produce profitable cash flow.

Profitable cash flow repays loans.

That's what banks finance.