Cash Management for Construction Companies
By: Tiffany C. Wright

Part 1

Cash management in this economic environment is crucial. Cash is the life-blood of any business. As the saying goes, “Cash is king”.

dollar With so many banks tightening credit standards due to what’s happening in the credit markets or within their own lending portfolios, it is crucial that businesses fully understand their cash needs IN ADVANCE and make adjustments to their operations to ensure that cash is available. Otherwise, companies may find themselves in a liquidity crisis –unable to meet payroll, pay suppliers, or pay subcontractors - which leads to bankruptcy or an operational shutdown.   

Cash is NOT income. Let’s assume you enter into a $200,000 contract to provide interior fit-out services which will take you ~30 days to complete. According to the contract you submit invoices once per month (fairly standard in commercial construction) on the 25th and the general contractor has 30 days to pay you.

You commence work on October 1. Before you begin, you buy materials such as drywall, nails and other supplies. You pay your tradespeople and foremen every 2 weeks so a check for their work is due on October 14. You buy materials and supplies for the last phase of work.

You submit your invoice for $160,000 for work completed by the 25th, as per the contract. You pay your tradespeople again on Oct. 28. Assuming you have properly estimated the job and had no cost overruns, you have already spent IN CASH $140,000 - $160,000 on materials and supplies, equipment or equipment rental, personnel and miscellaneous.    

Now you must wait until November 25 to receive payment. However, you only billed for 80% of the project, so you will only receive $160,000 maximum. You completed the job and bill for the remaining 20% or $40,000 by November 25th which you will receive by December 25. That assumes there is no retainage.

With government contracts or bonded contracts that retainage is typically 10% or $20,000 in this example. If your contract calls for retainage, then you may have to wait several months before you receive the final $20,000.    

So you spent $140,000 - $160,000 of your money in October: perhaps $30,000 the 1st week, $55,000 the 2nd week, $20,000 the 3rd week, and $55,000 the 4th and final week. You do not receive payment until November 25. You have a cumulative negative cash flow from this job of -$30,000 the 1st week, -$85,000 the end of the 2nd week, -$105,000 the end of the 3rd week, and -$160,000 the end of the 4th week.

This negative cash flow or cash flow shortfall continues for four more weeks until you receive your first check of $160,000 for the project at the end of the 8th week. Upon payment your cash shortfall goes to 0. However, if you had a 10% retainage, you’d only receive a check for $144,000 and you’d still have a negative cash flow on the project of -$16,000. A little over four more weeks later you’d receive the second and last payment of $40,000 (again, assuming no retainage).   

Yes, on this job you have a 20-30% operating profit. This looks great on paper. However, you also have  negative cash flow for as long as 12-13 weeks  or as little as 8 weeks and you are likely struggling financially trying to come up with cash to pay your people and your suppliers.

We have all heard of subcontractors who went bust during a job and another one had to come in and take over. This unplanned cash flow shortage is the primary reason construction companies go out of business. If you do not have overlapping jobs with payments coming in that can cover the cash flow shortage, your business is hurting. You must engage in this type of budget planning and analysis before each and every job in order to plan your cash needs accordingly.    

Continued...

Next: Solutions for managing your cash-flow

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About the Author: Tiffany Wright is President of Toca Family Business Services, a strategic advisory firm that provides interim CEO and CFO services, and the publisher of Equal Construction Record. She is the author of Solving the Financial Equation: Financing Solutions for Small Businesses, available at  www.tocafamilypublishing.com

Please contact her at  twright@equalconstruction.com - All rights reserved.©

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