Cash Flow

Cash Flow’s Impact On Your Company’s Financial Stability

Cash flow can be a very tricky issue for any company, but this is especially true in the construction industry where delays and timing issues run rampant. The truth is, cash flow is absolutely critical in the long-term success of a company; and it’s tied directly to the establishment of wealth for owners.

UNDERSTANDING CASH FLOW

So why do so many business owners avoid tackling it? One of the main reasons is a misconception that profitability and job margins are the same thing as managing cash flow. The assumption is that as long as the jobs are profitable, the company will be fine. This is especially true when the economy is strong and work is abundant. The risks that are blended into managing your cash are significantly reduced during strong economic growth, which can develop extremely bad habits. These risks become even more prevalent if, or when, the economy dips or when a company grows too quickly and their cash disappears as they fund this growth.

Unfortunately, all it takes is a single event or occurrence for a contractor to learn the importance of managing their cash flow. Both profitability and cash flow are tied into performance and are vitally important to the success of a company. They can positively or negatively impact one another, so managing both in harmony is an important financial goal.

MANAGING CASH FLOW

The first step in managing your cash flow is evaluating your own company. The way cash flows will vary from company to company. Are you heavy on payroll or subcontractors? What kind of terms do you have with vendors? Do you generally work in the public sector, private sector, or in both? These are just a few of the questions that can impact how each company’s cash flows through their operations. It is also highly dependent on the information available. How well are the books kept, and is there confidence in the reports and numbers you are looking at? Successfully managing and working your cash flow takes reliable information. When that is achieved, each company can evaluate their cash flow management by looking at two different aspects: process and performance.

Process represents how your company acts out a task. It includes billing, payroll, job costs/budgeting and cash receipts, just to name a few. In your analysis, look at each of these processes and determine their impact on your cash flow. How do they impact your ability to project future cash flow? The key to process evaluation is to look at the gap, or number, of days between cash outflow and inflow. For example, if you are running payroll weekly, invoicing monthly, and collecting on that invoice in 60 days (all industry averages), the gap is over 90 days. To increase the cash flow, look at the process and see if the delay can be reduced to 60 or even 50 days. Could invoicing be done more than once a month; or could collections on that invoice go from 60 days to 30 days? Is the payroll process delayed because it’s not automated? The answer could be in all of these, or entirely unrelated. Common ideas to help improve process challenges can include:

• Change order timing
• Project manager training on cash flow
• Over-billings and under-billings (the goal in a perfect world, these would be $0 for cash flow)
• Set a goal for day sales outstanding, as well as A/P
• Check communication between A/P and A/R functions
• Payroll automation with job costing
• Bill regularly – automate Invoicing
• Review financial stability of clients
• Review and include more detail on the payment structure in the contract
• Provide multiple payment methods

The second aspect to review is performance. This includes items like job selection, sub-contracting, impact of retention, equipment and inventory management and funding sources. Timing is never a perfect game, but, through margins, discounts, and controlled bidding, high-performing contractors can monitor and manage their cash flow through job selection. Additionally, look not only at profitability, but at the impact of sub-contracting or of internally self-performing each job, and understand that the answer could be different in each situation. It depends on the cash needs or the abilities of the company at a given time. Providing critical consideration as to where the cash would be best spent can maximize the company’s return.

EQUIPMENT’S IMPACT ON CASH FLOW

Equipment is also a significant cash flow discussion. We all dislike paying taxes, and it seems to be the easiest way to defer them. This seems to overshadow the impact that equipment and inventory have on a company’s cash flow. A tremendous number of contractors are charging their customers for the use of the equipment, but how many are running profitability reports on each piece of equipment? Consider treating your equipment like you would a project manager. Do you want to keep that project manager around, or to simply break even? If companies considered equipment in this way, they might possibly look at selling equipment to increase their cash reserves, or using the funds for a different piece of equipment that would generate more money. And oftentimes equipment comes with debt. From a cash management perspective, is this debt being monitored? Is there refinancing? Are there other alternatives available to lower interest rates, extend terms and increase current cash flow to the company? These are all questions to consider.

When the economy is strong, companies who are in a position of cash strength have the ability to effectively grow, and can do so without taking on a tremendous amount of risk. The same is true when the economy turns. A strong cash position keeps the company’s risk and reliance on customers, banks, and suppliers to a minimum. It gives them more control over success and helps generate long-term wealth for everyone at the company. This proves the importance of working on and improving cash flow policies, processes and goals. It is truly a financial win for everyone involved.

By Josh Tyree, CPA – Harris

This article was originally published in Idaho AGC’s “Building Idaho” publication. September 2019. Copyright © 2019 Harris CPAs. All rights reserved. 

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