Identifying and Correcting Cash Flow Issues

Fri January 08, 2010 - National Edition
Josh Stearns

Many contractors struggle with cash flow, juggling payments due with revenue received — and often coming up short. Over time, poor cash flow can jeopardize the financial health of your company. But there are things you can do to secure positive cash flow now and in the future. Consider a three-step approach for identifying and correcting cash flow issues.

Identifying Problems

Although many factors can cause cash flow problems, admitting you have a problem is the first step to recovery.

Once you admit to having a cash flow problem, you need to identify where the problem originates. Your construction software reports can help. Here are five reports that can help you identify cash flow issues before it’s too late to recover.

• Analyze cash flow by job. The sobering reality is that many construction companies are one bad job away from bankruptcy. As each job progresses, it’s important to monitor how much cash is going out and how much cash is coming in. Negative cash flow should be a red flag that there is a problem with a job.

• Monitor over- and under-billings. Monitoring over- and under-billings is the key to maintaining a positive cash flow on your jobs. You can calculate over- and under- billing amounts by comparing how much should have been billed based on the work you have completed with how much was actually billed. Over-billings need to be recognized as a liability (don’t buy a boat with your over-billings.). Under-billings can indicate a future cash flow crisis.

• Factor in committed cost. To ensure that a job stays on or under budget, you need to factor in committed cost. Many job cost reports fail to factor in all the commitments made that will impact cash flow. Even if you haven’t been invoiced for purchase orders or subcontracts, these commitments need to be looked at as future costs on the job. Running a committed cost report will show you the whole picture and identify problems with your estimate early on. A committed cost report also will show you just how much cash you’re going to need in the future.

• Measure profit fade. The profit calculated when bidding a job can fluctuate dramatically as the project progresses. Change orders might increase profit while a poor estimate might decrease it. Profit fade needs to be measured on each job to identify problems early enough to make profit-saving corrections. To measure profit fade, you need to look at increases in both cost and profit. Ideally, if you see a big increase in cost you should also see a contract increase due to change orders. If the value of your contract does not increase incrementally with cost, you need to identify why. If the original estimate was bad or you’ve performed extra work that hasn’t been billed as a change order, you may be headed for a negative cash flow situation.

• Monitor backlog. Your backlog can help you estimate what your cash flow situation might be in the future. Monitoring estimates-to-complete for earnings, cost and profit will put a dollar amount on your backlog. This information will help project growth and also warn you of slow times with potential negative cash flow situations. If your backlog is shrinking, you want to make sure that you bid enough new work for the future.

As you look at the information obtained by these reports (individually and as a whole), you will begin to get an idea of how your jobs are progressing, whether or not you’re on budget and how healthy your cash flow is. You can have a job that comes in under budget, for example, that still jeopardizes the financial status of your company by having negative cash flow throughout the job.

Many contractors use credit lines to circumvent cash flow problems — and ultimately spend their profit paying interest. While using a line of credit is necessary in some cases, the more profitable decision is to use your construction software reports to identify problems before you get into a negative cash flow situation. With the right tools and real-time information, you can make informed decisions to secure positive cash flow.

Taking Action

Once you’ve identified cash flow problems, the next step is to take corrective action. Taking action to secure positive cash flow requires direct communication, detailed billing and proper documentation of changes to a job’s original scope. As you read through each action segment, make a note of how you can improve your processes to support positive cash flow.

• Communicating With Your Staff

Communicate to your sales and estimating departments that getting paid on time is very important and can often stop flow problems before they even start. Setting this expectation up-front allows these individuals to focus on securing work with general contractors and owners that have a reputation for paying on time.

In the field, communicating job progress vs. budget spent lets project managers and superintendents know whether their projects are on target or their crews need to work faster to stay on budget. By making sure your jobs are progressing at the same rate as your budget expenditures, you can be confident that progress billings will continue to cover overhead expenses.

• Communicating With GCs and Owners

Before you start a job, find out what payment terms the GC or owner is accustomed to. Ask questions like: When should we submit our billing? When should we expect payment? What is the worst-case scenario for payment terms? What is the best case scenario? What do we need to provide each time we submit a billing? How would you like change orders handled?

In addition, discuss issues such as proof of insurance, certified payroll and lien releases, and ask what issues have come up in the past that have delayed payment to vendors. Straightforward communication about payment terms and potential problems will ensure that your invoice doesn’t get overlooked due to a technicality.

• Communicating With Subcontractors and Material Suppliers

After establishing payment requirements with a project’s GC or owner, you should communicate this information to the job’s subcontractors and material suppliers. Help these parties understand the payment terms for the job — and let them know that you will pay them accordingly. Explain the best and worst case scenario for payments, and touch base regularly until payments are made.

• Billing

The way you bill your scheduled values can really help to eliminate cash flow issues; most notably, by billing for preliminary items up front. For example, invoice for insurance expenses and temporary storage mobilization at the start of the job.

• Collecting

When payment delays do occur, collect aggressively. Remind the GC or owner of the project’s original payment terms and that you expect each party to live up to its end of the agreement. Having a collection fall-back plan can dramatically increase your chances of getting paid without further delay.

• Putting Priority on Change Orders

Establishing standardized processes for managing change orders is the best way to help your staff secure proper approvals and avoid getting burned by unapproved or undocumented changes. Make it a priority to get the appropriate paperwork and documentation signed by the GC or owner so the approved change order can get on the next billing.

For optimal change order management, tracking documentation such as e-mail correspondence, faxes and other paperwork in a single, electronic system is ideal. Having a project data repository with change order correspondence will keep everyone on the same page and establish a proven paper trail if litigation is necessary.

As you begin to take action through direct communication, detailed billing and documenting change orders, you should begin to see a dramatic improvement in your cash flow.

Maintaining a Standard of Excellence

Once you’ve taken corrective action to get cash flow back on track, the third step is to maintain a standard of cash flow excellence.

When it comes to cash flow, maintaining a standard of excellence is easy. All you need to do is follow a formula that I call filling the GAP. This formula has three simple steps that, when followed, produce great results. By filling the GAP, you can ensure that your company maintains positive cash flow.

• G Equals Goal Establishment

The first — and most important — step toward filling the GAP is to establish cash flow goals for each project and write them down. Statistics show that people who write down their goals have a more than 80 percent higher achievement rate than people who don’t. Writing down your goals will not only make them clear in your mind, but also will give you a gauge by which to measure results. Write down your main cash flow goal for each project and establish milestones that must be reached in order to achieve the goal.

• A Equals Assign Responsibility to Individuals

The second step toward filling the GAP is making sure that everyone involved in the project understands their individual responsibilities toward the cash flow goal. Establish who is in charge of maintaining and meeting the milestones for specific tasks, such as billings, job progress, paying vendors, handling change orders and so forth, and make sure that everyone agrees that the division of work is fair and achievable. Write down each person’s responsibility toward the overall goal to solidify accountability. By assigning responsibility to individuals — and making them fully aware of what is expected of them — you will dramatically increase your chances of maintaining positive cash flow excellence.

• P Equals Progress Tracking

The third step toward filling the GAP is to hold weekly job meetings to track the progress of your goals and milestones.

Revisit each goal to see if you’re on target. If individuals are not meeting their responsibilities, ask them why. Was the original goal unrealistic or did something unexpected happen? If the goal is not being met because of unexpected or unrealistic situations, revise the goal and devise a method to overcome the obstacle. Weekly meetings that track individual and team performance demonstrate to your staff that you will hold them accountable for their commitments. They also allow your staff to take an active and ongoing role toward maintaining a standard of cash flow excellence.

Securing Positive Cash Flow: Tying It All Together

As this three-step approach demonstrates, securing positive cash flow is a dynamic process that requires ongoing effort by the entire project team.

The process begins by using your construction management software to identify and monitor potential cash flow problems. Next, you must take action to secure positive cash flow by focusing on direct communication, detailed billing and proper documentation of changes to a job’s original scope. And finally, to maintain a standard of cash flow excellence, you need to fill the GAP by establishing goals, assigning responsibility and tracking your progress.

By taking steps to secure positive cash flow now, you will experience the benefits of a secure and stable construction company far into the future.

Josh Stearns is vice president of sales and marketing at AccuBuild (www.accubuild.com), Austin, Texas. He can be reached at josh@accubuild.com or 800-728-6853, Ext. 801.

This story was reprinted with permission from Contractor’s Compass Magazine, First Quarter 2010.