Dear 29-Year-Old Ted,

Cash is King. Subcontractors rarely go out of business because they have lost too much money – although it can often be a contributing factor. Subcontractors go out of business because they run out of money.

I hope this letter teaches you some of the cash flow lessons that I’ve learned in my many years of being an accountant for subcontractors.

Cash & Volume

You need more cash when your subcontractor is increasing in volume than when it is decreasing in volume. Subcontractors tend to get paid in 30-90 days, and when there is retention being held by the GC, the subcontractor is only getting paid 90-95% of what it bills. Meanwhile, the payout for costs happen at a much faster rate: Payroll is usually weekly or every other week. Suppliers generally need to get paid in 10 to 30 days. And when your subcontracting firm ramps up in volume, the cash outflow for costs ramps up faster than the firm’s ability to collect receivables. Pretty simple concept.

Correspondingly, when volume declines for a subcontractor, cash payouts for costs decline and, hopefully, payments from current receivables and retention receivables have a chance to come in from billings sent in prior months where the volume was greater.

So be afraid of rapid increases in volume – especially after long periods of low volume. Partly because of what I described above, but also because I’ve found that rarely do actual costs stay under estimated costs in such a situation – often because the subcontractor has to hire new/inexperienced employees when the long period of low volume ends (because some of the better/more experienced employees who were laid off find work in other industries or with other construction companies).

Set Cash Aside

Always set aside cash for payroll and related payroll taxes. Subcontracting tends to be labor intensive and bad things happen when a subcontractor can’t pay its payroll or, worse yet, bounces payroll checks. One of the subcontractors I worked for had their payroll checks all bounce one week (several years after I worked there), which ended the subcontractor’s operations. Employees walked off the job with tools, materials, equipment – just about anything they could get their hands on. And I am told that the subcontractor went out of business shortly thereafter because it was never able to recover.

And don’t forget the payroll taxes. As I will explain shortly, there are lots of vendors that can be converted into temporary lenders, but the IRS and most state payroll tax entities don’t take kindly to a subcontractor (or any other payroll tax paying entity) using them as a lender. The IRS, for example, will garnish whatever is left in your subcontractor’s bank account and can jail the payroll tax return signer(s). So always set aside enough cash to pay both the payroll and the payroll taxes.

Ask Your Owners/Officers for Money

If your owners/officers believe in what your subcontracting firm is doing, they shouldn’t have a problem pitching in and helping out in a time of cash flow need. I have found that the best approach to asking owners/officers for money involves offering a greater rate of return than they can get from other sources. For example, in today’s low interest rate market, an owner/officer might be enticed with an interest rate of 5-10% since this is way more than what they could get in the market. And loans to owners/officers can be easily worded in a way to provide enough flexibility for most subcontractors to report the loans as long-term debt on the balance sheet.

Revise Vendor Payment Terms

Increasing vendor payment terms can effectively delay cash outflows for weeks or months. One of the first things I’ve often done when cash flow has declined is to stop paying vendors within discount terms or asked vendors if my subcontractor could continue to take discounts despite paying in 20 or 30 days. In addition, I have asked vendors to temporarily accept payments in 45 days rather than the customary 30 days. I have also simply arbitrarily paid 30-day vendors in 45 days or more and waited to hear if any of them complained. (As someone once told me, “sometimes it is easier to ask for forgiveness than it is to ask for permission.”) This, of course, is a much kinder/gentler version of the next steps.

Rotate Vendors

If you have multiple vendors who supply essentially the same products/services, consider rotating from vendor to vendor in order to stretch your payments. Frankly, I was only able to do this once when I worked for a plumbing subcontractor. There were multiple vendors at the time providing plumbing supplies to plumbing subcontractors. We had three plumbing suppliers that we used. At any given time, we were on “credit hold” with two of those plumbing suppliers. Essentially, when our unpaid invoices got to 45 to 60 days with one plumbing supplier, that plumbing supplier would put us on “credit hold”. At that point, we would pay off one of the other plumbing suppliers (whose unpaid invoices were most likely at 90 or more days) so that we would be removed from credit hold with that supplier. It was a very frustrating process for me as the accountant and, I imagine, for the suppliers. But they had been going along with this process for several years prior to my becoming the plumbing subcontractor’s accountant, so all three plumbing suppliers were used to the payment rhythm – so it worked.

Vendors as Temporary Lenders

Vendors can become temporary lenders if you communicate honestly with them and keep your promises. One of the subcontractors I worked for got squeezed for money due to a confluence of increased volume, lower margins and a balloon payment made on a bank loan. I began to ask vendors to accept partial payments for amounts owed to them – with promises to pay additional partial payments on a weekly basis until the amounts owed to the vendors were paid in full.

For instance: It was July 1 and supplier X was owed $50,000 on a May 2 invoice. At that time, I had very little money available to pay Supplier X without taking a risk of being unable to make payroll that week. So, when Supplier X called, I explained my predicament honestly and promised to pay Supplier X $10,000 that week and an additional $5,000 on that day every week until Supplier X’s May 2 invoice was paid in full. Then I did this same thing with multiple other vendors.

Here’s what I learned:

• Most vendors accepted this sort of offer because I was promising to pay them money right away.
• Most vendors would continue to work with me as long as I kept making the weekly payments that I had promised.
• Most vendors called me every week to see if I was going to be paying them again that week – which meant I spent a lot of time on the phone and which led to me having to work nights/weekends to get my regular accounting work done.
• I needed to prepare a spreadsheet to keep track of the “loans” that I had agreed to from all the vendors turned “lenders.” This was an important step in my ability to be honest with these vendors;
• After making a few payments to a vendor, I was able to “skip” a weekly payment if I had been faithfully paying up until that time. Usually, the best vendors to ask for a skipped payment was a vendor who called me regularly every week – in part, because we had developed a relationship and, in part, because they had been able to trust that when I promised them a payment, they got a payment. The key is that I had been honest with them from the start.
• Be sure to take into account lien releases needed for owners and general contractors; often, special payment agreements like I described in this section have to take into account that a lien release is needed from the vendor in order to get paid by the General Contractor. No vendor will sign an unconditional lien release if they are still owed payments on an invoice.
• As I’ve told several accounting friends, “It’s a lot easier to have one or two lenders than it is to have 30 or more.” Because each of those vendors that I converted into lenders wanted a regular status report on their money – which ate up a lot of my daylight hours.

Honest Communication

Honest communication with owners, management, key employees, bankers and bonding agents must be maintained during periods of declining cash flow. Nobody likes surprises and everyone wants to get paid. Your owners, management, key employees, bankers and bonding agents need to have a general idea what you are doing – so that they know how to react when vendors ask them what is going on with their payments. And sometimes this communication can pay off. For example, at one of the subcontractors I worked for – a bridge builder – we had so front end loaded the payment schedule with the GC that the dirt moving sub we had on the job was going to be paid more for the last two pay items on the payment schedule than what we were going to be paid by the GC. In that instance, our project manager arranged for a delay in the completion of those two pay items so that we could temporarily avoid the negative cash consequence of having that dirt moving sub actually do that work. As they say, “teamwork makes the dream work.”

I’m sure that I am forgetting some things that might be helpful to you, 29-year-old Ted. But you don’t get to be your 59-year-old self without forgetting more than a few things. Good luck to you in your work and here’s hoping that you always have enough cash to make payroll!