More companies go out of business due to a lack of cash than a lack of profitability.
How can this happen?
Here are a few of the more common causes:
- Labor-intensive projects that require large, frequent outflows of cash in the form of payroll
- Working for project owners who are notorious for paying at 90 days
- Profitability and cash flow look great early in the project, but outflows increase later and catch companies off guard
Cash really is king, especially for a construction company.
“As chief financial officer of a construction company, I can tell you that cash flow management is my biggest responsibility,” says Kevin Gallagher of Head Inc. “It might sound funny, but a financial controller can actually generate more profit on a project than the project manager. It all comes down to effective cash management.”
Culture of Cash
Gallagher says construction companies must establish what he calls a “culture of cash.” To do that, there must be buy-in from not only the finance department, but also project managers and senior management. When everyone is focused on improving cash flow, consistent behaviors can set in with respect to billing, collections and other cash-related policies.
Cash managers, whether CFOs or their staff, must be empowered to reinforce the culture. Gallagher says common duties should include:
- Preparation of annual cash budgets
- Forecasts of cash inflows and outflows
- Maintenance of cash balances and investments
- Initiation of fund movements
- Development of historical information
- Distribution of cash flow information to key managers
- Proposal of cash management policies, controls and procedures
Cash Flow Lifecycle
To begin exercising all of these duties, cash managers must understand the concept of cash flow lifecycle.
Pre-construction. Ask questions and learn as much about your client, suppliers and subcontractors as possible. For example, how does the client like to be billed? When will the client pay? Who will our suppliers be and what are their payment and discount policies?
Monthly billing and collection. Cash managers must understand the project owner’s requirements for billing and approvals. Procedures must then be put in place to track and collect payments. “A client once told me they would have our check ready on Friday,” Gallagher shares. “I said ‘Great, I’ll stop by at 10 to pick it up.’”
Monthly disbursement cycle. One of the cash manager’s duties is to forecast inflows and outflows. To that end, policies and procedures should be developed for handling subcontractor and supplier invoices, as well as any discount programs suppliers might offer. With subcontractors, it’s also important to have a process in place for reviewing their work before paying them.
Project closeout. Neglected tasks such as punch lists and CAD drawings can kill cash flow. Failure to complete these steps could give project owners the wiggle room they need to withhold payment. “Cash managers must ensure that there are systems in place to stay on top of these things,” Gallagher says. “Also push through any final claims that might be holding up cash. If you have a job that holds a 10% retainage, that might be your entire profit margin on the job. You have to make sure these things are handled so you can get paid.”
Cash Forecasting Tools
There are several cash forecasting tools Gallagher has found useful.
Weekly cash forecast. This report shows projected daily inflows and outflows for a given week, along with daily totals and weekly net cash flow. Inflows are broken down by receivables, maturing investments, fixed asset sales, interest and dividends, short-term borrowings, and “other” inflows. Outflows start with payables followed by payroll, drafts, capital purchases, scheduled loan payments, short-term loan payments, and “other” outflows. “You always want to compare actuals to your projections,” Gallagher says.
Eight-week-ahead cash forecast. This report measures the same inflows and outflows as the weekly cash forecast, only on a weekly basis over an eight-week period.
“We actually like to use this report for every project we do,” Gallagher relates. “That’s because we’re only doing roughly 10 big projects a year. Companies that do 100 projects probably won’t be able to use this report for every project. Still, it’s a great tool for looking at cash flow over a couple-month period to help you make some decisions. For example, you might see that you’re expecting to get paid during week two. Given that, you could plan to pay your subcontractors during week three.”
Forecasting future revenue. To start, cash managers can look at the company’s existing backlog based on projected billing schedules. Then, future forecasting can be based on bidding volume and hit rate assumptions. For example, if you historically bid X dollars a month and secure 60% of that, you can put a future revenue forecast together.
“Part of this process involves staying in contact with developers, etc. to see what is happening in your market and what opportunities might emerge,” Gallagher says. “Then you can look at project duration and typical billing averages.”
Long-term cash forecasting. This report is also more forward-looking. It looks at monthly data with quarterly totals over an extended period of time, perhaps a year or several years. Data shows monthly changes in accounts receivable, other receivables, inventory and prepaids, WIP and CIE, long-term assets, fixed assets, accounts payable, accrued expenses, WIP and BIE, and total debt.
This exercise requires cooperation from estimators and project managers. “You can’t just watch money moving around,” Gallagher warns. “You must track history and understand how projects work, where money comes from, and how fast it moves in and out.”
Step one is to develop historical trends to make projections, and then track actuals. Monitor changes over time. “Also keep in mind that market changes can come into play with long-term forecasts,” Gallagher points out. “Look forward and try to anticipate slowdowns.”
Gallagher stresses that not every cash management tool or technique will work for every company. Some will work great, some will need a little tweaking, and some will simply not work at all. One of the cash manager’s key duties is to help make these determinations.
Regardless of which tools are used, the two key objectives of effective cash management will always be accelerating receipts and decelerating payments. With a strong culture of cash, construction companies can begin accomplishing both of those objectives on a regular basis.
Kevin Gallagher is chief financial officer and treasurer at Head Inc., a national contractor specializing in airfield paving, including the production of concrete and asphalt to supply their projects.
