CONSTRUCTION Accounting Article -
Head Off Trouble with an Annual Cash Flow Projection

Target Audience: General Contractors, Cash Flow Managers, Schedulers, Construction Accountants

Cash flow management is the process of planning, budgeting, measuring and controlling the money that flows into and out of your construction business. Among the most valuable tools in this effort is the annual cash flow projection. With it, you can set realistic profitability goals, measure your progress toward those goals and head off trouble before it gets too serious.

Forecast your fixed costs

To get started on an annual cash flow projection, use your general ledger’s income and expense account categories to budget cash inflows and outflows.

You’ll be able to easily predict many routine, fixed expenses, such as facility rent due at the beginning of each month or semiannual insurance installments due every year in January and July. Nonetheless, compare previous years’ figures to your current projection to ensure reasonableness.
Create a monthly billing schedule

Next, turn to your backlog schedule. For jobs you already have signed contracts for, but haven’t yet started, estimate when you’ll incur costs as well as when you’ll bill for them. You’ll likely also obtain work for the upcoming year that, as you’re preparing your initial projection, you’re not even aware of.

Estimating the timing of these amounts won’t be easy. Construction companies often incur costs several months before receiving the actual revenue generated from those expenses. Yet, if you put together a reasonable monthly billing schedule, you can use a systematic collection assumption to estimate the timing.

Let’s say you bill customers on the first day of each month and your January 2006 billings will amount to $300,000. In this case, your systematic collection assumption could be:

• 10% retainage = $30,000 collected in 150 days (May 2006),
• 10% of balance = $27,000 collected in 30 days (January 2006),
• 45% of balance = $121,500 collected in 60 days (February 2006),
• 30% of balance = $81,000 collected in 90 days (March 2006),
• 12% of balance = $32,400 collected in 120 days (April 2006), and
• 3% of balance = $8,100 will go uncollectible.

Granted, collections rarely work this systematically, but you should be able to pinpoint a typical cash collection timing period. And when you do, you can then estimate collections for the entire year — just as we did for the month of January above.

This analysis will help you identify otherwise hard-to-predict cash flow crunches. Even if your work volume is currently strong, you may eventually find yourself struggling through a slow season. In this instance, it will take time to catch up to your typical volume, so having a systematic collection assumption on hand will be important.
Examine other financials as well

Also compare your accounts receivable with your accounts payable. After dividing your current receivables by your total payables (excluding payroll), each dollar of payables should have at least one dollar of current receivables to cover it.

A reasonable goal is to allocate $1.50 in current receivables for every $1 of payables. If you dip below this goal, look to submit additional billings or collect past due receivables. If you still experience cash flow shortages while keeping above the $1.50 line, adjust your goal amount upward.

In addition, if you use the percentage-of-completion method for internal reporting purposes, evaluate your over- and underbilling account balances. Billing jobs ahead of when you’ll recognize the revenue, triggering a company liability, accelerates cash flow. Each month, try to stay in a net overbilling position to reduce the job revenue collection time frame.

Last, compare your total actual historical materials costs to your total historical labor expenses by dividing the amount you pay for materials by what you pay for direct labor. The ratio of your materials expenses to labor costs should be consistent historically unless pervasive evidence exists to discredit this assumption from one year to the next.

You can also use this ratio when preparing bids. For instance, if your bid amounts aren’t accurately reflecting the historical expense relationship of materials costs to labor expenses, you may need to revisit how you’re quoting jobs. Just remember that some jobs may be nonconforming and have actual materials and labor costs that don’t reflect your overall materials to labor expense ratio.
Keep on track

Because none of us has a crystal ball, there’s no exact science for predicting your construction company’s cash flow. But an annual projection can help keep you on track.

Find out how our expertise in construction accounting can add value to your business. Email us or call us at 1 (888) 875-9770.

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