Cash flow is the lifeblood of any construction company and especially the ones with annual sales volume under $1,000,000. Some construction Company experts even say that a healthy cash flow is more important than your contracting company's ability to complete projects! While that might seem counterintuitive, consider this: if you fail to satisfy a customer and lose that customer, you can always work harder to please the next customer. If you do not have enough cash reserves to pay your suppliers, creditors, and make payroll, then your Construction Company is out of business, game over!
Construction Company cash flow is the movement of money in and out of your Construction Company; these movements are known in accounting circles as inflow and outflow. Inflows for your Construction Company primarily come from the sale of goods or services to your customers, but keep in mind that inflow only occurs when you make a cash sale or collect on receivables. Cash is king! Other examples of cash inflows are borrowed funds, income derived from sales of assets, and investment income from interest.
Outflows for your Construction Company are generally the result of paying labor, material, other direct and indirect costs of goods sold and overhead expenses.
Note: A construction accountant is the best person to help you learn how your cash flow statement works. Please contact us and we can help you with it.
While they might seem similar, profit and cash flow are two entirely different concepts, each with entirely different results. The concept of profit is somewhat broad and only looks at income and expenses over a certain period, say a fiscal quarter. Profit is a useful figure for calculating your taxes and reporting to the IRS.
Cash flow, on the other hand, is a more dynamic tool focusing on the day-to-day operations of a Construction Company owner. It is concerned with the movement of money in and out of a Construction Company. However, more important, it is concerned with the times at which the movement of the money takes place.
In theory, even profitable Construction Companies can go bankrupt. It would take a lot of negligence and total disregard for cash flow, but it is possible. Consider how the difference between profit and cash flow relate to your Construction Company.
Example: If your retail Construction Company bought a $1,000 item and turned around to sell it for $2,000, then you have made a $1,000 profit. However, what if the buyer of the item is slow to pay his or her bill, and six months pass before you collect on the account? Your Construction Company may show a profit, but what about the bills it has to pay during that six-month period? You may not have the cash to pay the bills despite the profits you earned on the sale. Furthermore, this cash flow gap may cause you to miss other profit opportunities, damage your credit rating, and force you to take out loans and create debt. If this mistake is repeated enough times, you may go bankrupt.
The sooner you learn how to manage your cash flow, the better your chances for survival. Furthermore, you will be able to protect your company's short-term reputation as well as position it for long-term success.
The first step toward taking control of your company's cash flow is to analyze the components that affect the timing of your cash inflows and outflows. A thorough analysis of these components will reveal problem areas that lead to cash flow gaps in your Construction Company. Narrowing, or even closing, these gaps is the key to cash flow management.
Some of the more important components to examine are:
Accounts receivable - Represent sales that have not been collected. An accounts receivable is created when you sell something to a customer in return for his or her promise to pay at a later date. The longer it takes your customers to pay the more negative the effect on your cash flow. This is why you should always get Job Deposits.
Credit terms - Are the time limits you set for your customers' promise to pay for their purchases. Credit terms affect the timing of your cash inflows. A simple way to improve cash flow is to get customers to pay their bills more quickly. One good way to do that is to accept all major credit cards including American Express.
Credit policy - Is part of your Contractor Business Plan and is the blueprint you use when deciding to extend credit to a customer. Your credit policy needs to be neither too strict nor too generous in order to allow for a healthy cash flow.
Inventory - Is excess materials or supplies your Construction Company keeps on hand to meet your customer’s needs. Excess inventory can severely cripple your cash flow by using money that put to better use elsewhere. Too many Construction Company owners buy inventory thinking it will save time going to the supply house instead of keeping only what they need for each day. Keep your inventory as low as possible.
Accounts payable and cash flow - Are amounts you owe to your suppliers and needs to be paid at some point in the near future - "near" meaning 30 to 90 days. Without payables and trade credit, you would have to pay for all goods and services at the time you purchase them. For optimum cash flow management, examine your payables schedule and in some cases you may be able to earn 36% Return On Investment from your accounts payable.
Some cash flow gaps are intentional. For example, a Construction Company may purchase extra inventory to take advantage of low prices in precious metals like steel, aluminum and copper, quantity discounts, take advantage of significant trade discounts, or spend extra cash to grow the company.
Some Construction Companies have cash flow gaps that cannot be avoided. A Construction Company that works primarily in the outdoors experiences seasonal fluctuations in the winter. These Construction Companies may have cash flow gaps during slow seasons and then later fill the gaps with cash surpluses during peak seasons. Cash flow gaps can be managed with external financing sources. Revolving lines of credit, bank loans, and trade credit are just a few of the external financing options available that you may want to discuss with us.
Monitoring and managing your cash flow is important for the vitality of your Construction Company. The first signs of financial woe appear in your cash flow statement, giving you time to recognize a forthcoming problem and plan a strategy to deal with it. Furthermore, with periodic cash flow analysis, you can head off those unpleasant financial glitches by recognizing which aspects of your Construction Company have the potential to cause cash flow gaps.
Need assistance? We can help you analyze and manage your cash flow more effectively and make sure your Construction Company has adequate funds to cover day-to-day expenses.
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About The Author:
Our Co-Founder Randal DeHart - Is a Certified PMP (Project Management Professional) with several years of construction project management experience. His expertise is construction accounting systems engineering and process development. His exhaustive study of several leading experts including the work of Dr. W. Edward Deming, Michael Gerber, Walter A. Shewhart, James Lewis and dozens of others was the foundation upon which our Construction Bookkeeping System is based and continues to evolve and improve. Check out our Contractor Success Map Podcast on iTunes and Follow Randal on Google+