The Second of the Seven Deadly Sins of the Construction Industry: Knowing Your Cash Position

The Second of the Seven Deadly Sins of the Construction Industry:  Knowing Your Cash Position

Seven Avoidable Mistakes Construction Businesses Commonly Make

Last week, I discussed accountability as the first of seven important internal controls to help solidify your company in a fluctuating market.  Over the next few weeks, I’m going to discuss seven mistakes commonly seen in the construction industry, and talk about ways you can institute internal controls to correct these situations.  This week we turn to your cash position.          

It should go without saying, but here it is:  Cash is King.  This phrase is a short-hand reference to the importance of cash flow in the overall fiscal health of your business.  Sufficient cash on hand is critical for funding short-term operations, purchases and acquisitions. 

If you have a plan implementing employee accountability, then cash planning will become your guide to success.  Establish a business plan that represents the “translation” of the revenue and profit plan into cash flow planning.  The plan should answer questions such as: When are large expenditures due?  Does your line of credit at the bank have to be cleared for 30 days each year?  Is your principle reduction on debt larger than depreciation, or visa versa?  What are the expected and manageable terms of our revenue billings?  What can be done to increase cash now and each week? 

Many companies are profitable, but cash poor. Just like you prepare, work and manage a construction schedule, so must you prepare, work and manage construction draws and requisitions.  Just like you project the substantial completion of a job, so must you project your cash flow by project so you can manage your business’ needs.

It is essential you know how to manage your cash flow.  Be clear with your billing and collection agreements. Make sure your billings are accurate and timely, which will allow you to be aggressive in your collections. Resolve disputes as quickly as possible.  Contact clients and customers who owe you money to address any issues.  This communicates to your clients and customers that you care, are on top of your billing and collection process, and that you actively manage cash at your company.  The squeaking wheel will often be the first to get paid.  Get in line for your payment, and stay there.  A proactive approach involving your construction management team will reduce the number of days in receivable, increase cash flow, and reduce write-offs.    

Don’t fall prey to hiding inefficiencies in your equity strength.  Many old line companies have large equities and strong cash flow, a position often described as “idle cash”. Most such companies are profitable, but when analyzing the components of their profit, there is often significant room for better performance.  Areas you can look to for improvement of your profit are:  interest, purchase discounts from paying early, cash discounts on quantity purchases (because your company has “the cash” to negotiate), and negligible interest expense (because your company doesn’t have to borrow). 

The form of your company may affect your bottom line.  For example, an “S” corporation that pays dividends to its stockholders when their salaries are below market, artificially increases profit on the books.

While we’re talking about corporate status, newly-approved SB392 authorized the issuance of a contractor’s license in California to a limited liability company, mirroring the provisions regulating contractor’s licenses issued to a corporation. The law became effective January 1, 2011.  California is now in conformity with most states on this issue.  The sponsors of SB392, the Senate committee on Business, Professions and Economic Development, “believe that the LLC form of business has needed flexibility for distribution of profits and losses separate from control and ownership which benefits commerce with no foreseeable detriment.”  The primary difference between SB392 and a similar bill that failed to get out of committee last year is that SB392 requires a contractor electing to organize as an LLC to carry $1,000,000 in liability insurance or $500,000 in liquid assets to “ensure that workers are protected despite the absence of case law dealing with limited liability companies.” This bond requirement likely means the LLC form is effectively only available to larger contractors with sufficient bonding capacity...another reason to effectively manage your cash position!

The next discussion point in this series will provide tips and tools to avoid poor business decisions.  Stay tuned!