CONSTRUCTION Accounting ARTICLE -
Control Your Debt (So It Won’t Control You)
Target Audience: Construction Industry Professionals, Contractor Business Appraisal, Job Costing, Spending Planners, Project Managers, Contractors, Construction Accountants
As fuel costs fluctuate and project income becomes less reliable, contractors are increasing their debt load in record numbers. In fact, most contractors have come to depend on debt as a source of liquidity to keep their operations running smoothly. Yet, in an unstable economy, having a plan for managing debt is vital — especially now that bankruptcy is more common than ever.
Determine Where You Stand
It’s important to first step back and thoroughly evaluate your company’s financial status. There are many financial ratios that are used by banks and sureties when reviewing your financial statements, including your debt-to-equity ratio (your company’s long-term debt divided by its equity). This will help you gain a better idea of the size of your debt relative to your overall financial standing. It is recommended to constult with a construction accounting firm.
The lower your ratio, the better poised you’ll be to pay off your current debt and take on any additional debt if necessary. In a January 2009 Construction Financial Management Association survey, the average construction company surveyed had a debt-to-equity ratio of 2:5, while the healthiest companies’ average ratio was 1:4.
When you have a good idea of the size of your debt, decide on which accounts to focus first. Credit card or other high-interest debts should always be your first priority, since paying down such accounts can increase your current ratio by reducing your current liabilities. But also target any personally guaranteed debt that puts your personal assets at risk.
Consider a Fixed Rate
Although shorter term debt is typically preferable, think about locking in an interest rate if you expect your debt to take several years to pay back. At face value, this may seem counterintuitive — especially if your floating rates have been relatively low.
A fixed rate, however, will help you set a long-term budget and a schedule for repayment because you’ll know exactly how much you’re going to owe over time. Also, having a set amount in mind will help you to set money aside.
And if you have a phobia of fixed-rate commitment, you can take comfort in knowing that it’s smart to hold onto some floating interest debt (that which moves along with the market or an index). Maintaining a balance between fixed- and floating-rate debt will help you hedge your bets when it comes to fluctuating interest rates.
Term Out (Or Rein In)
Even though your line of credit is meant to be used primarily for working capital needs, it is possible to “term out” a portion for capital expenditures, ownership buyouts and loss supplementation.
“Terming out” a portion of your line of credit means recategorizing short-term debt as long-term debt. Doing so can improve your working capital ratio, which is determined by your current assets divided by current liabilities. You just have to make sure you don’t end up using more short-term debt than you need (and reducing liquidity). You can also consolidate various short-term loans into one long-term loan, which will reduce monthly payments without damaging your credit.
When negotiating with your bank, be sure to ask about incentive pricing. You should be able to put an agreement in place in which the bank will lower pricing if you deliver a strong financial performance during the payback term. Of course, they can adjust any loan covenants that were in place and can administer penalties for poor financial performance as well, so be sure the agreement is realistic.
Prevent Additional Debt
Managing debt doesn’t just mean figuring out how to pay back the debt you’ve already accumulated. You also need to work actively to prevent additional debt from mounting. For instance, examine your current capital spending and postpone any large expenditures you can do without. If you have any equipment that gets little to no use, consider selling it.
In addition, actively pursue new customers while paying special attention to existing ones. Excellent customer service has never been more important for contracting companies. Then again, neither has staying on top of accounts receivable — even if it means getting more aggressive about your collection efforts. As long as you’re putting money toward unpaid debt, you need to be bringing in everything you’ve worked so hard to earn.
More and more customers are asking about early payment discounts. Consider them carefully, but be wary of giving away too much while you are trying to get money in the door more quickly.
Don’t Lose Hope
These days, debt is a common problem among contractors, but it’s rarely a hopeless situation in which bankruptcy is the only option. There are ways to get back in the black, and planning and use of your advisors (financial and legal) can make it happen. It all starts with some proactive self-analysis and the discipline to stay on track.
In Tough Ttimes, Honesty and Open Communication Count
Despite all the steps you can take and plans you can put in place to repay debt, nothing can replace good old-fashioned honesty and open communication with your creditors and suppliers.
Paying down debt in the most efficient way possible often requires the assistance of others through guidance or cooperation. If your mounting debt is getting beyond your control, consider discussing solutions with your creditors and suppliers. They may have a hardship plan that will offer you more feasible payment terms. Some creditors will even convert your debt or a portion of it to an equity position.
And, as always, before making any decisions regarding debt restructuring and repayment, talk to your financial advisor. He or she can review your bank covenants and financial statements and, together, the two of you can discuss a variety of ways to repay what you owe without compromising your construction company’s ability to compete.
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