Best practices in cash management

In the construction business, the road to success is paved with effective cash management. A well-designed currency management effort that accelerates receivable collections eases the way for contractors. When money is in the bank, contractors are in control on so many levels, from work type, to paying bills in a timely manner, to getting competitive prices from vendors and subcontractors. With a solid balance sheet and good liquidity, a cash management program optimizes all aspects of the business and bolsters banking and bonding.

The first step in proper cash management is to coordinate inflow with outflow. Cash goes out but may not necessarily come in at the same rate. For example, laborers need to be paid at the end of every week, but that’s not how the property owner disburses money to the contractor.

By day 60 on a project, contractors have expended money for labor and other costs before they deposit their first check from the project owner. That’s why it’s so important for contractors to harness cash management techniques to ease the lag time between financial output and inflow.

Every item on a contractor’s balance sheet contributes to generating cash flow. Let’s start with accounts receivable. If a contractor does not collect accounts receivable in a timely fashion, he or she will be short on cash when it is time for payouts. Even if a construction firm has decent working capital, the contractor may not have converted that receivable to cash. The lesson is to process collection of receivables in a timely manner.

Each contract is unique to a specific project. It is imperative that project management and accounting personnel know the nuances of each contract as they relate to contract provisions involving the monthly billing such as cut off, stored materials and retention to name a few.

A pivotal point for accounts receivable is getting the bills out on time, in sync with payout practices of customers. On the property owner’s side of the equation, there are often internal meetings to approve payables, and if a contractor misses the cutoff to be considered, it may be another 30 days before a check is cut.

Develop a front-loaded schedule of values. It’s safe to assume that while contractors want to receive as much cash as possible, property owners have incentive to pay as little as possible. Negotiating these terms can help ease the cash flow crunch.

Determine how to bill with a good schedule of values. In a typical project, the contractor may be able to bill in phases for line items such as mobilization, site development and finally walls and finish. Therefore, place value into the job’s front end. Don’t put all the profit into the landscaping or roof, among the last tasks to be completed. Place the profit in the front end to help mitigate that natural cash outflow that begins when the job originates.

Retention rate on construction projects can be as high as ten percent. At the end of 60 days, a bill may go out for 90 percent, not 100 percent, of completed work. Many contracts provide that the contractor can eventually get a reduction in retention. One common strategy, for example, allows for a 50 percent reduction in retention once 50 percent of the contract is complete. Try to have this provision in each contract.

While it’s not possible to hold that retention against materials and supplies, subcontract cost is another story. Rather than an unbalanced cash outlay, pass along the retention to subcontractors and withhold at the same rate if possible. Check applicable state and municipal regulations on payment of subcontractors to ensure compliance.

Keep a sharp eye on inventory. Sometimes a great bargain can incentivize a contractor to purchase an excess of materials and warehouse them for future use. But if the contractor is not moving supplies, then a lot of cash is tied up in these resources. Don’t allow inventory to build up beyond what’s needed in the short to mid-term. Sell off any excess to generate cash.

It is very important to monitor cash flow at the individual contract level. Each job is unique and must be looked at as such. It is very important to know the net cash position for each project. Those projects with cash flow losses need to be immediately monitored to mitigate any losses on the project. It is also important to monitor the amount billed versus the amount of revenue recognized for accounting purposes under the percentage of completion method. Those projects with more revenue recognized than billed need to be reviewed to understand why. If you are doing the work you need to bill for it!

Heavy highway contractors may accrue a lot of property and invest heavily in equipment, but if that equipment is not out on a job, it’s not generating cash for the business. Every item on a balance sheet has a responsibility to contribute cash. The latest and greatest may look shiny and powerful, but if it’s sitting unused, it’s losing money for the business.

Find other ways to use the equipment. Can you rent? Can you sell? If it is not generating cash flows then why have it? Are your equipment usage rates accurate? Knowing your cost to run each piece of equipment is a must.

It’s all about balance. Accelerate your cash inflows by billing in a timely fashion, collecting receivables when they are due, negotiating reductions in retention, remaining in a state of overbilling, maintaining good inventory control, monitoring cash by each project and limiting the amount of equipment downtime.

In addition, decelerate payments by holding off payment of subcontractors, vendors and suppliers, if allowed by law, until the owner has paid. Negotiate with vendors to extend credit from 30 to 60 days.

Finally, develop a solid banking relationship to provide a cushion through a line of credit that can cover unexpected expenses. Remember, it’s not if problems will occur in construction projects, but just a matter of when.

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