Contractors take on tremendous risk when they perform work. However, more contractors go out of business due to poor cash flow than lack of profitability. Why? Is there as much emphasis on billing and collections as there is on daily construction operations? While management executives typically have a firm grasp on the cycle of cash through their organizations, what does the financial acumen of your remaining staff look like?

More importantly, how educated are your PMs, project administrators, and A/R clerks in the art of billing and collections? Are your company’s systems and processes standardized in these critical areas?

A contractor’s cash flow is largely driven by one thing: the cash flow of its individual projects. In this article, we will discuss the key indicators that are necessary to give early warning to cash flow issues, the importance of a properly crafted schedule of values, how to implement a structured billing process, and how to define the internal escalation process for collections.

Key Indicators

When a project’s cash flow goes south, it is not usually a surprise. Your team can spot the early warning signs only if it has the right tools and knows how to use them. There should be standard reports both at the corporate and project levels that allow for cash flow visibility. While monitoring cash flow at the corporate level is important, the solutions to cash flow are derived at the project level.

Corporate Level

It is critical to monitor key financial indicators at the corporate level so that upper-level managers can detect a cash flow issue early. There are many items to review regularly that can serve as early warning signals.

At the enterprise level, monitoring current ratio and quick ratio give a snapshot in time of the asset to liabilities calculation as a roll-up. Establishing minimums for these ratios and building red flags into your reporting structure is key to identifying issues quickly. Analysis of working capital by dollars, percentage, and yearly turnover are also important indicators of the company’s financial health.

From the corporate perspective, a roll-up of project overbillings and the cash position are also essential to review. Lastly, looking at debt to equity ratios and establishing a maximum threshold for this is also an important data point to monitor. All of these are key indicators that would compel you to dig deeper once a problem was identified. (You can also use such tools as CFMA’s Financial Benchmarker to compare this data. Visit www.financialbenchmarker.com.)

Many companies create a balance sheet and income statement either monthly or quarterly. Interestingly, fewer publish a statement of cash flows. Best in Class companies also publish a forward-looking cash projection, which could be crafted as a 12-week look ahead based upon the projects on the WIP and the PMs’ understanding of their project schedules and work planned. This cash projection gives the company time to react to an oncoming shortfall more effectively.

Project Level

There are relevant indicators that can be created at the project management level. Within your company’s job status report, there should be two very clear indicators of cash position of the project: overbillings/underbillings and net cash position. During the monthly project review, these two key data points should be reviewed and expectations for the PMs to uphold should be set.

The PM is the singular point of responsibility over a project. There is a distinct difference between a “Project Witness” and a “Project Manager.” If expectations are clearly set around overbillings, such as a net overbilled position of at least 20%, this can be measured and the PM can be held accountable.

There is a quantifiable data point to measure the PMs’ effectiveness in this area. This measurable can be incentivized, drive the desired positive behavior, and turn those who might be simply witnessing a job’s cash position into those who want to drive it and ensure that they hit their targets.

The very same can be said for the net cash position, which simply states how much has been paid out vs. what has been collected. While this may seem remedial to some, driving this level of knowledge to the project level is key. A true PM wants to manage all of the direct job costs, the billing, and the collections process. (Billing and collections strategies will be discussed later on in this article.)