Cash flow mismanagement is a primary cause of construction business failure. Many contractors started their business undercapitalized and had to apply the art of cash flow management by “kiting” checks, overdrawing working capital lines of credit, and “informal” borrowing from suppliers to get over the rough spots. As these businesses matured contractors advanced their cash flow arts by taking their banker golfing and putting their best foot forward when filling out bond applications. However, as these contractors grow the risk of cash flow interruptions and shortages becomes more complex and critical. The artful application of schmoozing and relationship building is no longer sufficient to guarantee adequate liquidity as multiple projects of varying sizes and durations progress toward completion. Building a one room log cabin doesn't require the same degree of engineering as erecting a five-story office building. "Seat of the pants", "gut feel" cash flow management is no longer adequate in a contracting firm doing $multi millions in annual revenue. It's time to call in the “financial engineers” – the CFOs. It's time for Your CFO to apply the science of cash flow management.
Proper Prior Preparation Prevents Poor Performance
The science of cash flow management begins with planning rather than reacting. Every new large project that a contractor takes on begins with a design plan, an engineering plan, and an operating plan. This is the stage at which the CFO should integrate a carefully researched cash flow plan. What is a carefully researched cash flow plan?
Every new project a contractor takes on is like going into a new business and requires its own stand-alone cash flow plan. Each project cash flow plan begins with the most recent company cash management statement and is developed from that starting point. These are the variables that must be taken into consideration when creating a project cash flow plan:
- From a cash flow perspective, each owner differs in their ability and willingness to pay on time.
- Each design firm (or owner’s representative) has different "sign off" protocols.
- Different suppliers demand different payment terms.
- Banks view different projects differently and will offer varying lines of credit based on the company's current financial condition and the liquidity demands of new projects.
- Sureties look carefully at a contractor's capacity to complete given projects.
- Owners handle retainage and payment for extras differently.
- Contract terms governing line-item values and payment terms often have a dramatic effect on cash flow.
- Potential profitability of each bid differs.
The CFO must factor in all the above variables, project by project as he or she integrates their cash flow plan into the overall plan, and then monitor the impact of each variable as the project progresses.
In a well-managed construction company, the CFO bears a heavy burden of responsibility to ensure that enough cash is available to complete each project successfully. This determination must be made in advance and should become part of the go/no-go decision. Imagine if your CFO could all but ensure adequate liquidity before the onset of each project. Preferably, before signing any of your firm’s larger contracts, the CFO checks in with all financial partners (Owners - Bankers - Sureties - Suppliers) to determine what is required of each to ensure the liquidity of the company to the completion of the project. Decisions about whether the project goes forward or not should include this information.
As projects progress each variable impacts cash flow either positively or negatively. The CFO should constantly monitor the fluctuating cash flow to make necessary adjustments if/when events diverge from the original plan. A periodic cash flow statement can alert management to any unexpected shortfalls or interruptions to the plan.
- Cash flow problems often arise because contractors do not insist on prompt payment. The CFO should be responsible for supervising both accurate, prompt billing and responsive, respectable payment.
- Conflicts over completion percent and payment for extras should include the CFO. By maintaining contact with the company’s project team the CFO can assit if payment conflicts arise unexpectedly and can help to assure they are dealt with in the normal course of business on a mutually cooperative basis.
- The CFO should provide financial reports promptly and accurately to banks and sureties to prevent any unexpected change in credit standing. (Financial partners like banks and sureties do not like surprises and will usually adjust to changing conditions if alerted in advance by a diligent CFO.)
- The CFO should maintain an active credit relationship with all subcontractors and suppliers paying promptly in the normal course of business and negotiating better terms whenever circumstances require.
CFO's Essential Role
If a CFO did nothing else in a construction company but actively manage cash flow from the project planning stage to final billing and payment their role would be essential to the company's survival. The accounting and financial reporting functions can usually be handled by their staff, but active cash flow management is the CFO’s personal area of expertise. If you do not see your CFO from this perspective, I recommend you take a closer look.