Always be building (the bottom line)
A construction company may do many great things to operate profitably. But when expenses come due, its bottom line might suddenly not look so hot. Sound familiar?
Construction can be one of the most inherently profitable businesses out there. Yet there are no guarantees; you’ve always got to be building the bottom line. Let’s look at some ways to do just that.
Track your costs
It’s an obvious but important fact: A company can’t cover its costs if it doesn’t keep track of them. To this end, create a schedule of costs for the next two weeks and use it to answer questions such as:
- Do we have quarterly taxes coming due?
- Are company owners due a distribution?
- What materials bills will need to be paid?
- What operational costs will need to be paid?
Typical operational costs include recurring office utility bills, monthly equipment rentals, vehicle finance payments and insurance payments.
If you’re a general contractor, don’t overlook subcontractor progress on your jobs. Which subs will you need to pay in the next two weeks and how much? Be sure to factor in your satisfaction with their work and the relationship your company has with them.
Forecast incoming cash flows
Once you have a schedule of costs for the next two weeks, build a realistic projection of incoming cash flows over the next six weeks. Consider aspects of your customer relationships such as:
- The length of time this person or entity has been a customer,
- Average payment time from date of invoice to date of payment, and
- Contractual requirements (for example, pay when paid or net 30 or 60 days).
Use this data to create a reliable set of projected incoming cash flows. The reason you should set down costs first is because contractors often underestimate how much money they must bring in to cover costs. By itemizing costs initially and then forecasting incoming cash flows above them, you’ll typically be able to spot shortfalls.
That isn’t necessarily bad news! Customer relationships vary and requesting progress payments isn’t an exact science. As the old saying goes, “Necessity is the mother of invention.” Knowing you need to meet a $10,000 or $20,000 shortfall is a great motivator to follow up urgently with an owner who has been lagging on payments.
Plan for savings
When you’re comfortable setting out costs for two weeks and incoming cash flows for six weeks, you might expand your schedule of costs to a full six weeks. You can generally do so by duplicating recurring costs and then factoring in others that are less predictable.
Next comes a critical step: Just as a bricklayer might scrape off excess mortar, you should plan to “scrape off” (set aside) whatever excess cash you can without hindering business performance. Deposit this money in a cash reserve account that you can use to save for long-term objectives and improve your company’s financial position when applying for loans or attracting outside investors.
Set long-range objectives
Contractors need to address financial sustainability in both the short and long term. So, while establishing sound methods of projecting costs and cash flows, hold regular leadership meetings to discuss long-range strategic objectives.
For instance, look at owners’ personal tax situations and their relationships to the company. Then consider your current choice of business entity. Is your construction business a partnership or limited liability company, or have you incorporated? Make sure you’re operating under the optimal entity choice for your size and situation.
In addition, openly discuss what each owner needs from the business and set realistic compensation expectations. Keeping owners happy is one way to set the tone for a positive, generous environment in which everyone is ultimately rewarded.
Anticipate receipt of retainage
Retainage doesn’t have to be that sore subject that no one likes to talk about. Many project owners are relatively predictable in how they disburse retainage, and you can usually collect it if you’re diligent and perseverant.
Chart out a history of every project you’ve completed for each owner and tally up how many days it took to receive the retainage from the time it was billed. Use this average to project a realistic timetable for receipt of each current project’s retainage. Doing so will help you meet your cost requirements because the retainage cash inflow projections will be reliable and accurate.
Play to win
For construction companies, costs come in many different shapes and sizes. Only when you’ve laid them out in clear terms can you begin to beat these costs and keep them from weakening your bottom line.
Whom are you working for?
Watch out for slow-paying owners
Construction company owners and executives don’t always know when project owners are toying with payments because field relationships are all about production. Sometimes the topic of money is carefully avoided by the owner’s representatives in the field. Therefore, it’s important to train and encourage your project managers to heed the warning signs of an owner playing games with money.
Such warning signs may include rejecting invoices, disputing change orders and, the most obvious, stalling on payments for indistinct reasons. As you well know, these things slow cash flow and may eventually hurt financial sustainability.
Keep careful customer records. When an owner establishes a trend of slow payments, consider either removing them from future bidding or inflating your bids so that, if you still win the job, you’ll eventually receive a higher amount to recoup the time and energy you spend on collections.
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