Cash Flow: Just as Important as Profitability

By Jim Jordan

All key players need to work together and be mindful of cash flow in every decision they make, Jordan writes.

Because many contractors cling to the notion that profitability is the sole measurement of success, weak cash flow is common in our industry. Too many contractors continue to believe that if their end-of-year bottom lines finish in positive territory for a couple of years, a shortage of cash doesn't really matter. In fact, it matters a lot. Because of the unique nature of our industry – one involving multiple suppliers, lump sum contracts, retention, price instability, etc. – ready cash is a necessity.

Cash flow is important for more reasons than just greasing financial gears, however. It also serves as one of the best measurements of a contractor's overall efficiency, including the company's policies, systems and even performance of employees. At companies where cash flow is weak, overall performance is almost always weak. Here you will find a lack of focus -- and clearly a lack of foresight. These companies are getting by, but not by much, and the financial road is narrowing all the time.

Step inside a progressive contracting firm, however, and the culture is very different. Managers at these firms consider cash flow to be the true harbinger of long-term success. And it is long-term, not short-horizon success that is the brass ring these companies chase. Toward that end these managers make cash flow a goal for everyone in the company, not just top officers.

All employees should understand that cash flow and profitability aren't synonymous. A contractor can pull his or her hair out over poor cash flow during a project, even though it turns out to be profitable. Or conversely, cash flow can be solid across the course of a project that turns out to be a financial stinker. However, banks and sureties believe long-term profitability is found most often at contracting companies with strong cash flow. That's why recurring under-billings on projects raise red flags with them. They see a cash shortfall and under-billings as nothing more than signals that profits are about to fall. More often than not, they are correct.

There are many steps a contractor can take to improve cash flow, but a few are more important than others. Let's take a look at them:

Knowing the client Before bidding on a project, contractors must learn all they can about the client. At a minimum, contractors should check out a project owner's credit status through Dunn & Bradstreet or other credit report sources. Contractors also should know if the owner has a history of litigation. In general, contractors need to know what type of reputation the project owner has. If it isn't good, contractors should think twice about pursuing the project.

Understanding the owner's payment procedures Once a bid has been submitted and accepted, contractors need to sit down with the owner to learn exactly how and when pay applications are processed and who is in charge of approval. The best systems integrate payments so the process is seamless for all parties involved.

Requesting contractual information Specialty contractors should request a copy of the general contractor's contract with the owner. They also should make certain they understand all key provisions, especially those regarding payments.

Paying for extras Contractors need to know how the owner processes and approves payments for "extras.'' Also, establish a separate cost code to specifically track work that is outside the scope of the contract.

Punch lists Long punch lists extend the time it takes to complete a project, delay final payment and cut into profits. Contractors shouldn't wait until the end of the project to handle punch-list items. Logs and records should document the process, which can protect the contractor in the event that a third party is delaying completion of the punch list.

Schedule of values Contractors need to make certain that each line item on the schedule of values accurately reflects their anticipated costs. Major material procurement should be reflected as separate line items so the contractor can get paid as soon as the material hits the job site. It's also important that before contracts are signed, contractors should make it clear that the owner is responsible for financing deposits of specially fabricated items or special materials. In addition, project managers should be required to use front-end loading techniques when preparing the schedule.

Establish a cash management system Contractors should create a cash flow forecast for every job. It should include several scenarios, including a "most-likely-to-occur'' scenario and a "worst-case'' scenario. This will help create a cash-flow forecast for the entire company, and also provide management with the data needed to develop a contingency plan for the worst-case scenario.

Handling bad jobs The longer a bad job hangs over a contractor's head, the larger its effect on cash flow. Address bad jobs as quickly as possible and bring them to completion. Problems can be minimized by thoroughly understanding contracts in the beginning. By doing so, contactors can detect where change orders or claims may cause a slowdown in cash and prepare an action plan.

Collecting money Be aggressive in collecting. To avoid job borrowing, make certain that subcontractors and suppliers are paid with revenues from projects on which they worked, not an unrelated job.

Make cash flow a companywide goal For too long only the chief financial officer has been responsible for worrying about cash flow. That needs to change. If a company is really going to enhance its cash flow, project managers and superintendents need to be an integral part of the effort and evaluated accordingly.