Every business owner knows that feeling like no other:
You’ve just landed new business, and it’s difficult not to boast a little about your company’s rising profits. But when was the last time you—or any business owner you know—boasted about cash flow? Healthy cash flow doesn’t exactly come with the same bragging rights as new business, and very few friends will be inclined to raise a glass to your business’s cash-flow situation, but keeping cash moving through your business is just as critical to success as new business and strong profits.
Just ask any experienced owner of a construction company about cash flow. You probably won’t hear much bragging, but you will assuredly hear stories of hand-wringing, difficult times and even failed ventures. In fact, one in four small business owners cites cash-flow issues as something that “keeps them up at night,” according to the Fall 2007 Small Business Monitor, a semi-annual survey of business owners conducted by American Express OPEN.
Many in the construction business—and particularly first-time business owners—tend to undervalue the importance of cash flow and measure success by the number of active jobs, the size of their contracts and profit margins. While these are all important metrics, balanced cash flow is an equally important indicator of a business’s well-being. Cash is what keeps a business operating on a monthly basis, paying for supplies, labor and equipment. It’s also what allows your business to expand by taking on more and larger jobs. Too often, however, business owners recognize the importance of cash flow only once they find themselves cash poor and in a financial bind.
While you may meet frequently with your CPA to deal with financial issues, it’s important to personally understand cash flow and where problems can occur. This will put you in the position to make wiser business decision on a daily basis, which can quickly add up to a stronger financial standing. To avoid the perils of uneven cash flow, there are five steps to measuring, monitoring and managing the cash that moves in and out of your business.
1. Know Where You Stand
First, know exactly where you stand with a cash-flow statement. Poring over an income statement alone won’t shed light on a company’s cash-flow situation. That’s because income statements only reveal sales, expenses and profits at a given moment. A cash-flow statement, however, shows the movement of money in and out of a business over a specific period of time, whether a week, month, quarter or year.
A cash-flow statement will show not only what cash is left at the end of the month, but also the amount that entered and left the business. In other words, it will make it easy to see whether you’re adding to your business’s reserves over time or slowly eroding them. It’s important to see this before reserves get low. Otherwise, a business with many active jobs but lagging receivables can find itself in a bind when it comes to covering unexpected expenses or when the business encounters slow times.
There are some simple balance sheet calculations that can help a business owner understand his or her cash-flow situation. Understanding, for example, how long you’re bearing the expense of materials before being paid for them is an important calculation for construction businesses. If tracking cash flow seems daunting, then take the time to speak with a savvy advisor, your CPA or a financial consultant, because there’s no replacing the knowledge you’ll gain from these basic figures and calculations. Consider this cost an important investment in your business.
2. Go to the Source
Understanding how cash-flow problems occur is your best defense. Cash-flow problems can arise from either end-of-the-business-cycle spending or receiving. And, of course, both sources can present problems in combination, which can rapidly put your business in a financial crisis.
Looking at the spending side, consider periods of growth, when your company needs to invest in equipment, supplies and labor—especially during peak seasons. It’s necessary to expand to take advantage of good market conditions, but growth expenditures can quickly deplete precious cash reserves. Also, consider the basic operational costs that a construction business must cover through both busy and slow times.
On the other side of the ledger, there must be a steady flow of money coming into the business, or reserves will quickly run dry. Construction businesses are particularly prone to this situation because they essentially extend credit to customers until the completion of a project. Almost every contractor has taken on a job to find that the down payment was insufficient and cash was short at the end of the project. Negotiating an adequately large initial payment and appropriately frequent subsequent payments is critical to maintaining cash flow.
Understanding where cash-flow problems originate can help you avoid them before they become an issue. If you know, for example, that your company will soon be facing rapid growth, a slow period or long collection cycles, you can take measures to combat these situations.
3. Keep Cash Flowing
An ounce of prevention is worth a pound of cure when it comes to cash-flow problems, so get serious about minimizing your business’s fixed expenses. A company should be big enough to cover only its most predictable, recurring needs. Find creative ways of handling peaks in demand without incurring unnecessary expenses. Hire only the labor you truly need, and make careful decisions about expenses such as equipment purchases, for example. One possible strategy for “right-sizing” and minimizing cash needs is to consider renting or leasing equipment instead of buying it outright.
While finding and maintaining the right size of your business is critical to keeping expenses down, timing is important as well. There’s no way around purchasing the materials needed for projects, but you can delay purchases until the materials are really needed—particularly on long or complex projects or those subject to delays or postponements. Otherwise, precious cash may end up invested in materials that sit unused. Clearly, you must be careful not to cut things too close, but consistently delaying purchases by just a few days can make all the difference.
When making purchases for your business, also look for non-cash ways to get what you need. Credit card reward programs can be effective cash substitutes, and bartering with other businesses for services may be an option.
Of course, many expenses must be paid in cash, and construction businesses are generally hard hit by these expenses because of the heavy upfront costs of supplies and labor. One way you can even out your business’s cash flow is by delaying payment through trade terms with various vendors. Try to negotiate terms that will allow you to defer payment beyond the typical thirty days and reward you with a discount for paying early. Larger, more established businesses will have an easier time negotiating these terms, but small businesses with a good reputation for timely payment will have some room for negotiation with vendors.
Efficiently managing accounts receivable also plays a critical role in maintaining a healthy cash flow. To ease the accounts receivable process, make sure what you're owed arrives on time by setting clear payment terms and expectations. It's important to be diligent on follow-up and it’s critical to stay on top of collections. Simply knowing when you can expect payment is half the battle.
4. Have a Fallback Plan
Despite the best of plans and most diligent cash management, there may be times when your company needs extra cash, so it’s important to have tools on hand for when cash is scarce. You should make sure your company is prepared with several sources of financing in advance. Some financial institutions may be more likely to extend lines of credit or loans to your company when it is in good financial health, and less likely when cash-flow problems have already taken a toll on your finances which is one of the reasons it pays to plan ahead. When seeking financing, be careful not to overlook special lending programs for which your business may qualify, such as those designed to assist small businesses owned by women or minorities.
Once you have credit available to you, use it wisely. Short-term financing options such as lines of credit, short-term loans or credit cards are best used for short-term cash needs. Likewise, long-term or secured loans should be used for the purchase of long-term investments.
5. Manage Growth
Consistent growth is the best way to smooth out bumps in cash flow. When growth opportunities arise, plan carefully with an eye on cash-flow projections. Make a conscious decision about how much you must spend to reach your goal and how long it will be before you pay back the debt.
Every investment, whether in supplies, labor or equipment, should have a clear return. Make sure each earns a profit, but also look at how long it will take to collect them. Likewise, if you look at each customer as an investment with a scheduled return, you’ll not only improve cash flow, but also profitability.
Entrepreneurs go into business because they thrive on the excitement of a good challenge, but even the most daring entrepreneur can do without the stomach-churning, rollercoaster ride of variable cash flow. Rid yourself of these avoidable bad times by keeping an eye on cash flow, and enjoy the real benefits of owning a construction business.
Construction Business Owner, February 2008
