Don’t Count on Profitability: Cash Flow Management Often Matters More

Target Audience: Construction Companies, Construction Industry Interest, Accounting Consulting Firm Interest, Cash Flow Managers, Construction News and Updates Interest, Schedulers, Company Strategists, Financial Planners, Chief Financial Officers, Change Order Managers, Inventory Managers, Construction Company Owners & CEOs

Every business has its slow periods, but construction companies are particularly susceptible to ebbs and flows in income. For this reason, cash truly is king for contractors.

In fact, more construction companies go out of business because they run out of cash than because they don’t show a profit, according to the Construction Financial Management Association. What this means is that cash flow management often matters more than profitability.

A cash flow projection

When money is tight, your first instinct may be to go after more work. That’s logical, but it may not be the best approach if doing so only ties up more cash.

Before you submit another bid, put together a realistic cash flow projection to help you decide whether you can afford another project. Such a projection can also enable you to pinpoint precisely what type of job would be within the grasp of your current cash flow.

To develop a projection, look at the jobs you have scheduled for the next year. Keeping in mind that things could change, lay out your expected cash flow needs, by month if you can, for each job. Don’t overlook your expected nonjob outlays, such as overhead, materials, labor, subcontracts and permits.

Also bear in mind that what makes up job costs on any given project can significantly affect the working capital needed for that job. For instance, labor and equipment costs generally need to be paid currently before a contractor is paid for his or her work. Meanwhile, materials and subcontractor costs often don’t need to be paid until the construction company collects from the general contractor or owner.

Then look at your expected revenue by month. Timing may be difficult to predict if you’re doing a job for a new owner or are planning a project on spec, but you can use your historical payment data to calculate an average for planning purposes. This same data, accumulated over time, also can give you an idea of how quickly certain owners typically pay their bills.

When you’re finished, you should have a good idea of when you might run short of cash in the next 12 months — and you can plan accordingly.

Other recommended strategies

Of course, a sound projection alone probably won’t be enough to keep cash flow problems at bay. Other recommended strategies include:

Financing long-term purchases. Generally, you should avoid debt. But, when trying to procure long-term assets such as heavy equipment, it’s often unavoidable. In these cases, try to match those long-term assets with long-term debt. In other words, if you’re going to own something for an extended period, pay for it during that time frame and save your cash for other purposes.

 

This is, again, where projecting your cash flow can save you from future headaches. Whenever possible, set aside money for anticipated capital needs and reserve financing for unanticipated needs.

 

Improving your change order management. Change orders and claims cost you money. If you’re having trouble in this area, devise a better system for getting them approved and paid more quickly.

Easier said than done, of course, but try to get a feel during contract negotiations as to how change orders will be handled. Also look into increasing your margins on change orders to compensate for your cash outlays.

 

Tightening up your billing. It goes without saying that you don’t want to underbill. But be strategic with your overbilling: Doing so requires discipline and strong cash management skills. You need to allocate dollars properly, and you aren’t likely to accomplish this by looking only at your bank account balance.

 

Getting paid faster. Make sure your billing and collection procedures are fast and efficient, and that you have follow-ups in place to deal with any slow payors. You may need to be more aggressive in collecting your receivables.

 

Watching your inventory. You need a certain amount of materials on hand to keep your jobs rolling smoothly, but you may not need to keep quite so many on hand. Plan your orders so you can keep your inventory as close to zero as possible without jeopardizing project timeliness.

 

Resisting temptation. This is a strategy just about anyone can apply to his or her personal life as well as a business. Before you invest in something that will affect your cash flow, ask yourself whether it’s really necessary. If it’s just something that would be nice to have, look at your cash position and really think about whether you can actually afford it.

 

“Thinking cash” — always. Whether you’re negotiating contracts, budgeting for a project, buying office supplies or doing any other business activity, think of it as a chance to improve your cash flow. Make cash flow management a routine endeavor rather than a once or twice a year activity.

The lifeblood of your business

Cash flow is the lifeblood of any construction business. So if yours is going strong, give yourself some credit. But don’t take it for granted — one job-site disaster or even just a series of unexpected misfortunes can put a choke hold on even the strongest of cash flows.

Sidebar: 2 ways to boost cash flow with savvy banking

As you work to manage your cash to your best advantage, don’t overlook your bank.

Today’s lending institutions offer a number of arrangements that can improve your cash position. Two in particular are:

1. Zero-balance arrangements (ZBAs). You can use a ZBA to minimize the money you keep in a non-interest-bearing account. ZBAs automatically transfer money in and out of your primary account to cover your daily activity and still maintain a zero balance. You can link several accounts to your primary operating account for automatic funding.

 

2. Sweeps against line of credit. You can use a similar process — a sweep against line of credit — to reduce the interest you pay on your line of credit. A one-way sweep transfers money from your line of credit to your checking account when the balance drops to a certain amount.

Two-way sweeps also transfer money out of your checking account when the balance is more than a specified amount. The money is used to pay down outstanding principal.

To contact Feeley & Driscoll, please click here or call us at 1 (800) 392-6192.