Cash flow is a normal problem for construction contractors – even in a profitable business! There are some pretty straightforward explanations for this. We have an accumulation of costs before we get the billings, so this timing difference naturally creates a cash flow problem. We also have retention, which naturally results in a cash flow variance.
Beyond those obvious reasons for cash flow problems, here are three signs that will give you a heads up that you may want to engage in cash flow management.
Warning Sign #1: Job losses
If a job doesn’t perform in the black, there are cash flow consequences. This may seem like an obvious sign, but there’s more to it than meets the eye. That’s because the losses from one job can almost create a snowball effect with your cash flow.
- The loss typically shows up much later in your financials than the actual recognition of the job loss (this could be 30-90 days later, depending on your terms).
- The loss can be masked by good performers.
- Catastrophic jobs create really nasty cash flow consequences, because it pulls the whole cycle down.
Dealing with job losses is natural, but we can mitigate the resulting cash flow problems by keeping our costs and billings very closely associated with each other in timing.
Warning Sign #2: Underbilling
This really comes down to not recognizing timing differences. Consistently underbilled jobs create a cash negative, and you’ll find yourself in a very bad situation. Not only are you not getting the billing out in a timely manner, on top of that you’re still waiting to get paid by the customer.
Consider this scenario: You accumulate 2-3 months worth of costs (labor and material) before you bill the job. Then your customer takes 60 days to pay you, which means your cash cycle is now 5 months. Yikes! That’s going to be very tough to manage.
Once again, keeping your costs and billings on a very tight schedule is going to help you mitigate these types of situations. One of the places you can see an underbilling is on your WIP schedule. If you’re keeping these on a monthly basis, you’ll be able to see a job that is consistently or largely underbilled right at the end of the month. If you see this, get ahead of it!
Warning Sign #3: Too much debt or the wrong utilization of lending
Having too much debt or the wrong kind of debt can appear in some sneaky ways. One example of this which is common in the construction business might look like a line of credit that’s too small – especially if your company has grown and you need a larger credit line because of that growth. This becomes a problem when we get a large contract and our current line of credit doesn’t match up with what we’re going to be spending (and our timing on the job).
If we have too much equipment that’s underutilized, that lending problem will also rear its ugly head in cash flow. Essentially we have a piece(s) of equipment we’re paying for, but we’re not getting the revenue off of it.
Another sneaky type of debt is related to owner transactions – for example, an owner transition or succession when there’s a buyout. This situation often puts a lot of pressure on the cash flow, because we have to make enough money to pay the old owner while still operating the business.
What can you do now to minimize cash flow problems?
- Use cash flow forecasting.
- Talk to your banker, and make sure to give them good financial statements.
- Consider selling underutilized equipment.
- Keep costs and billings on a tight schedule.
- Do whatever you can to minimize the job loss.
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