Three cash flow management strategies

By Randy Bonnecaze

Among the most important keys to operating a successful construction business is proper cash flow management. Think how hard handling your household bills would be if you couldn't coordinate paying them with receipt of your paycheck.

Of course, managing your company's cash is much more difficult than balancing the family checkbook, because you typically don't know what profits current and future projects will generate and when owners will pay you. And while struggling with these uncertainties, you still must deal with your suppliers' and lender's payment demands.

To bring some calm to this din, here are three cash flow management strategies to consider.

Forecast your future. Let's begin with a simple fact: Pinpointing your cash flow to the nearest dollar is virtually impossible. In fact, if you try to do so, you'll waste time and effort on a wild guess. You need to instead forecast your future as best you can by focusing on specific patterns and trends. These include:

Current jobs. Look at these and their respective payment schedules on a percentage of completion basis. Although you may have already incurred 50 percent of a job's total costs (thus recognizing 50 percent of your expected contract revenues), you may not yet be able to bill for these contract revenues. Therefore, you should correlate cash receipts with billings, not revenue recognition.

Anticipated billings. These will determine the expected amount of cash receipts you'll receive. The prospective level of billings also provides the basis for projected cash disbursements. Naturally, some contracts are easier to project future billings on than others. For example, one contract may stipulate that billings must occur in five equal installments over the contract's duration at a fixed price. But another may have less certain billing arrangements, such as on completion of a specified project phase. And as you surely know, unavoidable circumstances (bad weather, supplier delays) often arise and throw jobs off schedule. Estimate billings on these contracts conservatively based on historical trends.

Accounts receivable. Look here for collection patterns to determine, as precisely as possible, how long after billing you'll actually receive the cash. Develop some cash receipt assumptions, including a collections model that presumes, in any one month, you'll collect 10% of that month's billings, 65% in the next month, 15% in the third month and 10% in the fourth. Use your company's own collection pattern to develop this model.

Cash disbursements. These generally fall into three major categories: job cost payments (including inventory, supplies and other job-related expenses), administrative expenses (such as salaries and rent) and debt service payments (including interest). Using this information, develop a model that allows your current projected billings to consistently cover your variable expenses from month to month. But commit to only the purchase and operating expenses your incoming cash will support.

For instance, based on your current operations, you may foresee that 75% of your billings will cover variable contract expenses such as labor, materials and equipment rental costs. And say, as is typical, you might factor your fixed costs - including rent, administrative salaries and debt payments - using fixed dollar amounts.

By projecting these items over several months, you'll be able to see where your cash flow may weaken (perhaps during winter months when weather delays often occur) and where your cash flow may strengthen (maybe during the summer when you have several large projects underway simultaneously).

Use other people's money. Resourceful contractors know how to legally use more cash than is actually sitting in their bank accounts. You do this every time you buy something on credit. That's why you need to establish and nurture trustful, credible vendor relationships - so you can obtain the best possible terms.

To that end, actively negotiate your own payment terms rather than just accepting those offered. Many vendors will allow the use of their cash for an agreed-on period and, though they generally would like you to fully pay within 30 days, accept extended terms - especially if your business volume is significant. Remember, there are no set rules; consider the amount of business your company does with a vendor as well as its size and current financial position. Strive to achieve 45- to 60-day terms with most of them.

A lender's terms will also let you use other people's money to support your construction business. Naturally, this option comes with the expense of interest. Nevertheless, it may be an effective means to expand your existing operations while maintaining acceptable payment terms with other creditors.

Collect what's yours. Although keen internal awareness and helpful accounts payable terms help, a healthy cash flow ultimately depends on its source - your customers. Have you done everything possible to encourage timely payments? Good places to start include:

• Negotiated contracts where you can bill earlier for greater amounts,
  
• Front-loaded billing schedules that provide strong billings in early project stages,
  
• Payment discounts or incentive plans for early payments, and
  
• Accelerated payment options, such as wire transfers.

In addition, do you have an efficient, well-trained billing and collection department? Errors in either the amounts or timing of bills delay collection and stymie your cash flow. So make sure your billing clerks know the due dates for pay applications and follow proper procedures, such as attaching backup documents (for example, certified payrolls and lien releases).

Plan to survive. A robust, consistent cash flow is critical to your construction company's survival. And the three strategies just discussed can go a long way toward minimizing unpleasant surprises and maximizing your ability to submit competitive bids, perform high-quality work, and finish jobs quickly and completely.

Editor's Note: Randy J. Bonnecaze is a Certified Public Accountant (CPA) with Hannis T. Bourgeois LLP, Baton Rouge.