Battle a Down Economy with Stronger Cash Flow
by Raymond Joabar
Regardless of the economy, construction business owners-especially first-time owners-cannot undervalue the importance of cash flow. While the number of active jobs, the size of contracts and profit margins are all important in measuring the success of a business, cash is the foundation that supports the business through good times and bad. It's what keeps a business operating on a monthly basis, paying for supplies, labor and equipment. It's also what allows your business to expand by taking on more and larger jobs. Too often, however, business owners only recognize the importance of cash flow once they find themselves cash poor and in a financial bind.
Just ask any experienced owner of a construction company about cash flow. You'll assuredly hear stories of hand-wringing, difficult times and even failed ventures. In fact, one in four small business owners cites cash-flow issues as something that "keeps them up at night," according to the Small Business Monitor, a semi-annual survey of business owners conducted by American Express OPEN.
To avoid the perils of uneven cash flow, there are five steps to measuring, monitoring and managing the cash that moves in and out of your business.
Know where you stand.
First, know exactly where you stand with a cash-flow statement. Pouring over an income statement alone won't shed light on a company's cash-flow situation. That's because income statements only reveal sales, expenses and profits at a given moment. A cash-flow statement, however, shows the movement of money in and out of a business over a specific period of time, whether a week, month, quarter or year.
A cash-flow statement will show not only what cash is left at the end of the month but also the amount that entered and left the business. In other words, it will make it easy to see whether you're adding to your business's reserves over time or slowly eroding them. It's important to see this before reserves get low; otherwise, a business with many active jobs but lagging receivables can find itself in a bind when it comes to covering unexpected expenses, or when the business encounters slow times.
There are some simple balance sheet calculations that can help a business owner understand his or her cash-flow situation. Understanding, for example, how long you're bearing the expense of supplies before being paid for them is an important calculation for construction businesses. If tracking cash flow seems daunting, then take the time to speak with a savvy advisor, your C.P.A. or a financial consultant, because there's no replacing the knowledge you'll gain from these basic figures and calculations. Consider the cost of doing so an important investment in your business.
Go to the source.
Understanding how cash-flow problems occur is your best defense. Cash-flow problems can arise from either end of the business cycle-accounts payable or receivable. And, of course, both sources can present problems in combination, which can rapidly put your business in financial crisis.
Looking at the accounts payable side, consider periods of growth when your company needs to invest in equipment, supplies and labor-especially during peak seasons. It's necessary to expand to take advantage of good market conditions, but growth expenditures can quickly deplete precious cash reserves. Also consider the basic operational costs that a construction business must cover through both busy and slow times.
On the other side of the ledger, receivables must provide a steady flow of money coming into the business, or reserves will quickly run dry. Construction businesses are particularly prone to this situation because they essentially extend credit to customers until the next installment or draw and, in some cases, until a project is completed. Almost every contractor has taken on a job to find that the initial payment was insufficient, leaving the business short on cash. Negotiating an adequately large initial payment and appropriately frequent subsequent payments is critical to maintaining cash flow.
Understanding where cash-flow problems originate will help you avoid them before they become an issue. If you know, for example, that your company will soon be facing rapid growth, a slow period or long collection cycles, you can take measures to combat these situations.
Have a fallback plan.
Despite the best of plans and most diligent cash management, there may be times when your company needs extra cash, so it's important to have tools on hand for when cash is scarce. You should make sure your company is prepared with several sources of financing in advance.
One of the reasons it pays to plan ahead is that some financial institutions may be more likely to extend lines of credit or loans to your company when it is in good financial health and less likely when cash-flow problems have already taken a toll on your finances. When seeking financing, be careful not to overlook special lending programs for which your business may qualify, such as those designed to assist small businesses owned by women or minorities.
Once you have credit available to you, use it wisely. Short-term financing options such as lines of credit, short-term loans or credit cards are best used for short-term cash needs. Likewise, long-term or secured loans should be used for the purchase of long-term investments.
Manage growth.
Consistent growth is the best way to smooth out bumps in cash flow. When growth opportunities arise, plan carefully with an eye on cash-flow projections. Make a conscious decision about how much you have to spend to reach your goal and how long it will be before you pay back the debt.
Every investment, whether in supplies, labor, or equipment, should have a clear return. Make sure each earns a profit, but also look at how long it will take to collect them. Likewise, if you look at each customer as an investment with a scheduled return, you'll not only improve cash flow, but profitability too.
Entrepreneurs go into business because they thrive on the excitement of a good challenge, but even the most daring entrepreneur can do without the stomach-churning, rollercoaster ride of variable cash flow. Rid yourself of these avoidable bad times by keeping an eye on cash flow and enjoy the real benefits of owning a construction business.
Raymond Joabar is Senior Vice President and General Manager for American Express OPEN, the nation's leading issuer of payment products for small business owners
Keep Cash Flowing
Minimize your business' fixed expenses.
A company should be big enough to cover only its most predictable, recurring needs. Find creative ways of handling peaks in demand without incurring unnecessary expenses. Hire only the labor you truly need and routinely evaluate the labor you're dedicating to each project. Also, make careful decisions about expenses such as equipment purchases. One possible strategy for "right-sizing" and minimizing cash needs is to consider renting or leasing equipment instead buying it outright.
Look for non-cash ways to make purchases.
Credit card rewards programs can be effective cash substitutes, and bartering with other businesses for services may be an option.
Delay payment through trade terms with vendors.
Of course, many expenses must be paid in cash, and construction businesses are generally hit hard by these kinds of expenses because of the heavy upfront costs of supplies and labor. Try to negotiate terms that will allow you to defer payment beyond the typical 30 days and reward you with a discount for paying early.
Stay on top of collections.
Be sure to follow up on all due payments routinely. Simply knowing when you can expect payment is half the battle. Whenever possible, consider discounts for prepayment and appropriate penalties for late payment.
