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Cash Flow Strategy For Contractors

With 2014 building starts on the rebound perhaps the most important question for contractors is not, “where is the business,” but, “where is the cash?” According to Richard Gavin, CPA at Grassi & Co. and a leading construction industry analyst, “most contractors who are going out of business this year are failing because they are running out of money, not because they are running out of work.”

Whether you are a large contractor or a small contractor, every time you start a new project you are at risk. Before you even begin a project, you need to chart your cash flow and predict the flow of cash in and out for the duration of the build time, not merely the beginning and definitely not from the end stage. The cycle is simple – it is tracking cash movement into the production process, then into accounts receivable, collection, then back in to cash for expenditures.

It is critical that you compress this cycle in to the shortest period of time possible. This keeps the cash capital – your ability to work – in your pockets for longer periods of time. Cash flow problems can be caused by a number of factors which may not be related to job profits.  Projects that are labor-intensive or sub-contractors who demand cash payments are two big issues to be addressed from the beginning.

There is also the lag time created by your own internal billing and collection of receivables. Hard goods, energy, fuel, and tool costs, all create a longer cash flow cycle. Perhaps you are involved in legal matter which drains reserves and distracts your human resources or your company has an abundance of inventory which requires storage and is not contributing to profits; these are two types of often over looked expenses when planning your cash flow cycle.

Companies with the most control over the cash flow cycle are the companies which will have the most success. Many small contractors and construction companies are awakening to the time tested cash management techniques of large companies in other industries. If you have not managed your cash flow properly it is likely you have seen diminished credit ratings, increased infusion of your own personal capital, and the inability to take advantage of new opportunities or speculate on new projects.

While it is not an exact science, hesitating to engage in cash flow forecasts will prevent you from making intelligent decisions regarding budgets, capital expenditures, compensation and prospecting. With a workable and executable plan, you will inspire the confidence of bankers, customers, business partners/investors, and bond holders. The benefit of being financially solvent speaks for itself. No one wants to do business with a struggling company, especially customers. Planning must go a step further than just forecasting and planning the construction of a project.

Your planning must combine the logistic collaboration of both your building team as well as your office/administration/accounting team. The accounting team should be communicating billing and payment timelines to the construction team consistently. Many contractors, especially small ones, do not include the finance department in the construction planning. This is a big mistake. The accounting team can weigh in on which phases of the project should be completed in what order so that supplies can be purchased when payments are due, maintaining the flow.

As a small contractor, many of your clients are first time builders. It is your job to educate them on how your payment terms are to be met ahead of time. You may not be able to avoid retainage, nor should you, this helps keep you accountable to the client and preserves his leverage. But you should try to get enough working capital from the client up front to avoid dipping into your own reserves. You walk a fine line here with over billing, however, so you must be wise. While over billing may allow you to start work with an abundance of cash, it limits your ability to collect on cash later in the project if the unforeseen happens (and it is almost guaranteed that the unforeseen will happen).

You should also work with your vendors and set clear terms ahead of time. Thirty days is the norm, but a vendor with whom you have a good relationship may be able to extend more liberal terms to you in order to keep you as a customer and keep your cash flowing. You may be able to negotiate a sixty day term, allowing you to bill your client in net thirty days and allowing you to pay your vendors thirty days after. In addition, you should also avoid under billing on projects. Once your subcontractors agree to a fee, a contract is signed and you calculate that cost to your client, consider how much of your time will be spent managing the sub-contractor – time is not free; will any of your tools be used by the sub-contractor; do you have a back-up plan if the sub-contractor makes a mistake?

These are all soft expenses which you should include in your billing to your client. Other important strategies include applying the same retainage terms to your sub-contractors that your client has applied to you. Establish an adequate line of credit with a bank for emergencies; pay fixed asset purchases or large ticket items with long-term credit rather than cash; consider leasing assets rather than purchase; talk with your tax accountant and apply accelerated depreciation methods for valuing your assets – your company may appear to be worth less, but you pay less tax on the depreciated assets.

Cash flow planning is challenging and always inexact, but you must manage the cash flow cycle from the beginning. Profitability is important, but if you lack the capital to work the project to completion, you’ll never collect the final check.

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