Cash flow is just as important to a contractor's business as profitability.
As a contractor, there are many things you can do to enhance your cash flow. In order for your company to succeed, you need the strategies and tactics to stimulate that growth. By adopting some of the following strategies, you will be able to enhance your cash flow and improve your overall business.
Cash Flow Strategies
To improve cash flow, boost cash reserves and strengthen borrowing capacity, there are some preliminary actions that must take place. Your company should maintain general, payroll and money market accounts. Having each of those accounts will allow you to budget properly and use your capital wisely. You should apply a retention to payments to subcontractors that corresponds to the retention applied by the owner. Be sure that change orders and claims are billed and collected as soon as possible after they are approved. When claims and delinquent change orders arise, make sure that those "delayed payments" include the cost for cash. The owners' delay in paying you should not cost you money. You must establish adequate credit lines and secure long-term financing for fixed asset purchases. Get involved in your tax planning process.
Contracts
No matter the size or type of job, you must have a contract in place. The contract is a roadmap of how you will get paid, when you will receive payment and what is involved in that process. You need to be familiar with all contract terms. In order to further the billing or the collection process, the contract should map out when to submit requisitions and the supporting documentation needed to be submitted with the requisition. Also, it is very important to review the contract's cash flow and ensure "positive money" is included in the earlier stages of the job. By doing so, you will keep the project funding itself and not require additional cash. You must evaluate the cash flow impact of payment terms and retention release provisions. Make sure all questions and/or concerns are resolved before signing a contract because the pre-contractual period is your best opportunity to negotiate terms.
You should have a Contract Abstract, which explains the terms of the contract in a succinct fashion. This can be used as a reference tool should any contract problems arise. You should eliminate all barriers to payments. By knowing the details of the contract and following them exactly, you will be able to enforce the contract as written. You cannot miss deadlines. Submit all requisitions in a timely fashion and include the proper supporting documentation. Some of the supporting documentation might include: proof of insurance coverage (certificates of insurance); invoices for materials, equipment, or rentals; and certified payrolls. Pay attention to the contract's details. If multiple copies of the requisition are required, make sure you provide them. If you do not follow the specific contract terms, payment can be delayed, throwing a wrench into your cash flow.
Credit worthiness is another important part of the contract process. You need to know if the customer can pay your requisitions up front. Make sure you conduct your due diligence and research your customer's credit worthiness. Whether it is through a local trade organization or by running a credit report, invest the time and effort into researching your business partner. Technology has helped to improve the collections process. Not only does it speed up the collections process, but it also eliminates excuses about the payment being lost in the mail, etc. The quicker the money is transferred to your account, the quicker your cash flow improves.
Paying Bills
No matter what your agreement is, you must pay your subcontractors when required. Some subcontractors give you a price contingent on a payment plan. The law says you must pay when paid. You should always try to take advantage of discounts for paying in a timely manner. For example, a discount of 2 percent adds up over the span of a year, so paying your bills promptly is to your advantage. However, if a bill is not due for a while, your money should be invested in something that works for you. If you can earn interest on your capital, you should take full advantage of it.
Collections
Plan the way a job will be billed before it starts. Although over-billing can improve cash flow, too much over-billing may mean a contractor is borrowing from one job to pay for another. To avoid job borrowing, match payments to subcontractors and suppliers with collections from related projects. Always avoid under-billing. As we mentioned earlier, technology provides you with the tools to speed up your collection process. Utilize electronic funds transfers or services such as PayPal. Don't look at the collection process simply as a basic financial function. If it is managed strategically, it can be a method to acquire significant financial gain. Improving the collection process leads to fewer outstanding account balances, fewer bad debt write-offs, and a better working capital to put to good use.
Be aggressive in the collection process. You must be aware of all of the circumstances surrounding each project. Know when payments should be made, have been made and haven't been made. Follow up with the owner when payments are due. Once you suspect something is wrong, consult an attorney. The earlier you discover discrepancies, the quicker your cash flow can recover. Make sure your staff develops a solid rapport with all of your customers' accounts payable staff. If an issue surfaces, a relationship should prevent them from avoiding you. Don't be afraid to follow up with owners and push your requisition along in the process. Any improvement in the complete collection process will directly improve your cash flow.
Financing
When planning out your project, consider taking advantage of any available financing. If the strategic plan is built around "paying over time" and investing your capital in other projects, financing will allow you to further stretch the payments out. You can lower your monthly cash flow to enable you to fund more cash positive items, such as contract work. Another consideration is leasing equipment. There is a possibility, depending on what you do, that you can keep payments lower than financing and not invest in a piece of equipment that depreciates in value or may only be needed for one specific job.
There are other very important components when we examine the topic of financing. You need to have a line of credit available to your company. Depending on the size of that line of credit, you can use this tool in a variety of situations (new contract work, to push along a "bad job," etc.). It is important to review all terms (or covenants) in the credit line to make sure it fits your business model. Cash surrender value of life insurance is another item to keep in mind. This is sometimes overlooked on the financial statements and can be considered as another source of financing. You should also be aware of hidden equity in your depreciating equipment. The equipment can be used as a source of capital.
Your company's bonding potential is another key to its overall success and to enhancing your cash flow. It is extremely important that you plan for the surety's assessment of the company's financial statements. Some of the keys to obtaining surety credit in today's surety market include demonstrating that the company is well managed, that it completes projects according to projections, is profitable and financially sound. Consequently, the financial statements are the focal point of the surety evaluation. You need to have the right accountants-both internal and external-offering you the proper advice, connecting you with the right contacts and providing you with the necessary financial information to arm your company for the future. The financial statements are supposed to give you an overall financial picture of your company, allowing the internal analysis of information to make strategic decisions.
In order to present the company in the best way possible, you need to follow a number of steps when preparing for your financial statement dates:
- Maximize cash balances.
- Release any restrictions on cash.
- Bill all contracts to their completion percentages.
- Don't avoid over-billings just make sure they are in the bank or receivables.
- Eliminate all receivables from stockholders, officers, employees and affiliates.
- Resolve all change orders or claims or provide support for their inclusion in the surety's formula.
- Consider having stockholders buy old, but collectible receivables from the company to increase working capital.
- Consider converting old contract receivables to formal notes receivables that are due within one year.
- Reduce inventory levels.
- Avoid year-end purchases of long-term assets (equipment) by paying for them in full-these should be purchased using long-term debt, which has repayment terms tied to the useful life of equipment.
- Consider making joint venture distributions to the company prior to year-end.
These items are just part of what the surety will be looking to see on your financial statement. By including these items, you will increase your bonding potential, which can help finance profitable work and growth, and will ultimately enhance your cash flow.
Taxes
Tax planning is an important tool to enhance cash flow while fueling growth. Get involved in the tax planning process. You should accelerate all available deductions (i.e., equipment purchases, Section 179, etc.) to benefit from the tax savings. In addition to those deductions, your company should take advantage of the new qualified production activities deduction. Another item that might help you in your quest to reduce your tax liability is the possibility of tax free exchanges on larger pieces of equipment. You should understand the impact of various activities and tax strategies and how they directly relate to your company's cash flow.
Operational Reviews
Many companies need guidance from external sources, including independent consultants who will be unbiased and fair in their appraisal of your company's operational methods. Third-party, independent operational reviews can provide your company with the objective information and benchmark data necessary to obtain information and critical insights into the steps necessary for you to retain or regain your competitive edge in the industry. These reviews will look at the number of employees you have and see how they can be used more efficiently. A review of your insurance plans can uncover wasted resources. Consultants can recommend a number of things, ranging from altering plans to taking advantage of retro plans. Other things an operational review can discover include the correct classifications of employees (for workers' compensation) and/or if an owner has wrap up insurance. Wrap up insurance is when the owner supplies insurance for a project and all labor on that project should not be charged against your company's policy. All of these operational methods and procedures can amount to a savings of capital and an enhancement of your cash flow. If you can save money that would have been allocated for unneeded insurance or inflated insurance premiums, you will free up additional resources for other, more profitable endeavors.
Bad Jobs
We all encounter what we call "bad jobs." Whether it was a bad bid, a difficult owner or a poorly managed project, you need to consider the cash flow impact. When you are stuck on a bad job, you need to work hard to minimize the effect on your cash flow. Companies should have a system in place for damage control. This is an especially good time to review the timeline of the job versus the cash flow. If you can review the contract early and thoroughly, you can detect where change orders or claims may arise. If you determine there will be claims involved, it is important to hire a claims consultant and/or a construction attorney to be prepared. There are timing issues involved with claims, and there will most likely be a deadline for notice.
When dealing with a bad job, you will want to have your line of credit available to help you. The most important point: You must not give the project less attention if it is not going to be profitable. You should address the situation as quickly and efficiently as possible to stop the bleeding. The more attention you give the bad job, the quicker it will go away. Don't bury your head in the sand. The longer the bad job hangs over your head, the larger its effect will be on your cash flow.
As you can see, cash flow planning is challenging and inexact. Even a profitable company with enough jobs to sustain their pipeline can be headed for disaster if there is no handle on cash flow. It is critical to be aware of potential problems in order to minimize their impact on your business. We all must realize that long-term planning is needed to truly structure a successful business growth model. The implementation of many of these cash flow strategies can help enhance your cash flow, stimulate the growth of your business and help you reach the next level of success.
Construction Business Owner, August 2007
