Follow these guidelines to keep your construction business afloat in an unsure economy.
Most experts agree that there has been improvement in the overall economy so far in 2010. But there is a decided lack of enthusiasm among construction contractors. In spite of federal stimulus spending, homebuyer incentives and other attempts to jump start the industry, many are still suffering from a recession that will not seem to quit.
For almost two years now, it has not been easy to stay above water. It has taken smart, fundamental management to survive, and it is going to take more of the same to make it to the other side of the recession.
As we approach the closing months of 2010, it may be helpful to look at some of the fundamentals that will help the strongest survive.
Maximize Cash Flow
Construction businesses of all sizes, in all sorts of economic conditions, suffer the consequences of poor cash-flow management. Sloppy practices and missed opportunities are never as evident as they are in periods of hit-and-miss work like the past couple of years.
Banks will come to the rescue with short-term working capital only so many times before demanding more effective financial management. Right now, lenders are even less charitable than usual. Strong relationships with lenders are more important than ever. In addition, lenders are asking for detailed cash flow forecasts to ensure that cash is being generated and used wisely. A forecast showing contracts that are generating positive cash flow throughout the project will help those needing to secure short-term financing.
Optimizing effective tax rates can also enhance cash flow. Every dollar not spent on taxes can be put to more profitable use in the business. The first six months of 2010 saw the passage of two pieces of legislation that may offer relief for some.
HIRE Act Credit for New Employees - The HIRE Act provides an incentive for boosting employment through the end of 2010. The temporary tax "holiday" exempts employers from paying their share of Social Security tax on the wages of qualified (previously unemployed for 60 days or more) employees through Dec. 31, 2010. Unlike most tax credits, which are claimed at the end of a tax year, HIRE provides immediate cash flow relief. The amount of the credit depends on when employees are hired and what wages they are paid.
Health Care Tax Credit - While the full impact of health care reform may not be known for years, there are parts of the historic package that take effect in 2010. Small contracting companies, in particular, may be able to take advantage of a tax credit of up to 35 percent on the cost of providing health insurance for employees. Contractors with no more than 25 full-time equivalent employees may qualify.
This may not be the right time to begin providing employee health care insurance, but if a plan is already in place, it makes sense to take advantage of the tax credit. Eventually, all Americans will be required to have a minimum level of insurance coverage. After 2013, the full small business credit will be available to only employers who purchase health insurance for employees through a state health exchange.
Control Overhead Costs
Contractors tend to overlook overhead costs when setting rates and preparing project bids. As a result, jobs that appear marginally profitable may actually lose money when overhead costs are factored in. Direct costs like materials and labor are easy to calculate, but they are only part of the picture.
What contractors often fail to recognize are indirect costs like insurance, equipment and support staff (supervisors, etc.) that must be allocated to every project. It is critical to recognize these costs in labor rates and material mark-ups, while working to manage and control them on every job. In periods of high competition and low-profit margins, it is even more important to understand these costs.
Enhance Bonding Capacity
Contractors who have survived so far may find themselves in a sort of economic catch-22. After fighting to keep the doors open through the darkest days of the recession, they may not be able to get the surety backing they need to win the large contracts that will ultimately put them back on solid ground.
It is a vicious circle. One of the primary factors in determining bonding capacity is working capital, or the ability to sustain current operations and generate positive cash flows into the future.
Explore Joint Ventures
Another solution to the bonding dilemma may be to investigate the opportunities presented by joint ventures. Some joint ventures are set up for a single project; others are long-term commitments. In either case, entering into a joint venture agreement is not a decision to be made lightly. In tough economic times, it may be tempting to jump into a joint venture just to survive. But such "shotgun marriages" are almost certainly doomed. Before saying "I do," carefully consider whether it is the right strategy, the right timing and the right partner.
The truth is, there are no quick fixes. While the construction industry is lagging behind the rest of the economy, the survivors must do everything they can to sustain their position. A struggling company cannot solve all of its problems by entering into a joint venture, by lowering overhead costs or by reducing taxes. Long-term success requires deeper and broader strategies for reducing costs, improving productivity and being selective about the future.
There are several ways that a construction company can improve its working capital and increase its bonding capacity:
- Finance new equipment through long-term debt rather than paying cash.
- Refinance short-term and long-term debt to extend the terms and reduce annual debt service payments, especially if any balloon payments will be due within two years.
- Generate cash by selling idle equipment and property.
- Reduce inventory, which the surety typically discounts from working capital.
- Stay on top of receivables so they are being collected in 90 days or less. Amounts aged more than 90 days may be discounted from working capital.
- Avoid related-party receivables, which a surety will take out of both working capital and equity.
- Keep under-billings below 25 percent of working capital or be prepared to explain the amounts to the surety.
- Obtain immediate approval for change orders to avoid delays in collections.
Construction Business Owner, October 2010