Too busy? Not busy enough? So many factors influence a contractors' revenue cycle. How do you maintain your sanity on this revenue rollercoaster?
What Causes Peaks and Valleys?
Many things can lead to both expected and unexpected fluctuations in revenues. Weather can wreak havoc on some trades. Rain can prevent excavators from moving ground, sometimes for extended periods of time. Having your workforce waiting for weather to clear can result in large payroll and overhead expenses with no offsetting revenue.
Seasonal factors can impact some contractors, especially in the North where snow and frozen ground can significantly reduce a contractor's working and billing season. Road builders in Michigan have several months when work is very limited.
However, beyond Mother Nature factors, you may also experience industry fluctuations. For example, if a good portion of your revenue comes from governmental contracts and the regional climate for governmental units is poor, that will impact your bottom line. Are your areas of expertise diverse enough to avoid serious operational issues if an industry you specialize in suffers poor economic times?
There is also the "time" factor. Some companies are so busy servicing existing clients that they do not devote enough time to planning ahead, insuring that future projects are scheduled. When you are busy completing and managing current projects and do not focus enough time on bidding and lining up future work, you fail to ensure an even transition from one project to the next. Contractors start wrapping everything up on a project and are suddenly faced with a big lull. I call this the feast or famine syndrome. This occurs most often in organizations that have not established a completely separate estimating department. Some companies will have employees that perform both the estimating and the project management function. If they have bid and have been awarded a project, they are then responsible for managing it. During busy times, these individuals are so occupied with managing their projects that they don't have time to bid on new projects, magnifying the valley period. If you can somehow separate the estimating function from the project management function, this will allow for a smoother transition. This solution requires a really good estimator-one the project managers are confident will bid projects at standards and conditions that they can meet.
It is best is to plan ahead and know when the ups and downs are going to occur. This allows for a more proactive approach to managing these swings.
Steps to Managing the Peaks and Valleys
Know what to expect and when. Review prior financial information to determine what trends your business can expect. If your company has been around a while, review the monthly sales and collections information for the last three years and use this information to estimate the current year's projected sales and collections on a monthly basis. Factor in any economic and industry expectations, as well as any other factors you know will be occurring over the next six to twelve months. Also, schedule out known projects you have been awarded and make sure the related sales are consistent with your monthly projections. Then, take a proactive approach to smooth out the peaks and valleys in sales and ultimately, collections.
Project Timing
Review the projects on your schedule to determine if scheduled fieldwork is bunched into a single timeframe. Then, review each project to determine if any can be delayed to a later time or started sooner than originally scheduled to level out your production.
Filler Projects
Look for projects that we call "filler projects." These are flexible projects that are not as time-sensitive and can be used to fill up slower times. These may be minor repairs or warranty work that have some flexibility and can lead to additional time and material billings.
New Product Lines or Services
Look for new product lines or services that compliment your current services. Review industry trade journals to see what new products or services are being marketed that you could pursue. This is the landscaper that also does snow plowing and/or Christmas decorating during the slower off-season, or the roofer that also installs garage doors. When the weather is really poor you can't get on roofs, but installing a garage door is a viable alternative.
Cost Control
If you have done everything possible to level out the flow of work, then look at managing your costs. Analyze both your fixed and variable costs. Fixed costs are costs that the organization will incur regardless of the volume of activity-such as rent, office utilities and office staffing. Fixed costs generally exist regardless of the company's volume and often cannot be reduced. Variable costs, however, are tied to the production process and only occur if you have work. These costs may include equipment rental, or tools and vehicle expenses. If you have identified potential valleys in revenue, you need to ensure that you are proactive in reducing variable costs. This might require making some difficult decisions regarding the elimination of various employee benefits and services. For example, a common benefit today is providing cell phone service and vehicles to key employees. Slow times may require a practical approach toward reducing or even eliminating these types of benefits.
The opposite can be said for peak times. Avoid overextending yourself with additional fixed and variable costs unless you know the increased volumes will be long-term. Moving to a larger location with much higher fixed costs or purchasing equipment with long payment terms during a temporary surge in sales can be detrimental when those volumes drop. If you will have a large volume of work due in a short period of time, evaluate if it would be more efficient to subcontract a portion of the work to others, as opposed to incurring the cost of hiring and training additional employees. Also, consider renting equipment for a short period of time as opposed to purchasing new.
In addition to controlling costs, you might also consider matching your costs to the current period or the period of income. This could include paying worker's compensation insurance based upon your actual labor costs each month as opposed to an estimated one-twelfth of the prior year's labor costs. This will allow you to match your costs to your revenue and avoid a large audit premium. Often the peak period has passed when the audit premium is then received and the revenues and profits have disappeared.
Cash Flow Controls
Even if you have done everything to control the company's revenue and expenses, peaks and valleys can also be magnified by cash flow issues. For example, if you are an excavator during a surge in revenue, you need to recognize that this impacts your cash flow. Excavators are one of the first contractors on the job, yet many times they must wait for final completion of the project to receive the final retention payment. This waiting period can be one to two years or even longer. Some things you can do to improve cash flow include:
Accounts Receivable
Do everything possible to ensure prompt payment. Issue invoices immediately and monitor them to ensure payments are made timely. Reread contracts to ensure that you are invoicing the correct party and providing all the correct supporting data. If the invoicing is required in AIA format with 10 percent retention, be sure to use that format to avoid having to re-invoice and delay the receipt process. Many large organizations only issue checks once or twice a month. If you do not submit the invoice correctly, it can significantly delay your receipt of payment.
Accounts Payable
Develop a relationship with your vendors that will allow you to receive some flexibility in making payments if cash flow is poor. Structure loans so that you have no payments due during your slow periods. The next time you are purchasing a large piece of equipment, check into structuring the payments so that they occur for only nine to ten months of the year, skipping the months when your cash flow is poor.
Available Credit Line
No matter how much planning you do, most companies have times when outside assistance is needed. Ensure you have the necessary resources available by establishing a relationship with a bank and having a credit line available prior to the need. Also, only use your credit line for cash flow issues related to operations. Always use a term loan to finance capital acquisitions, not your credit line.
Finally, while going over those peaks or through those valleys on the revenue rollercoaster, remember the ride will come to an end, and if you were in the front seat leaving the gate, that's where you'll want to be when you return. Ensure that you have been proactive and your company will be stronger and ready for subsequent trips on that rollercoaster, hopefully with smaller bumps.
Construction Business Owner, January 2006
