Contractors are especially vulnerable to cash shortfalls.
years ago, I authored a training manual, titled “Essentials of Profitable
Wholesale-Distribution,” for the American Supply Association and National
Association of Wholesaler-Distributors. Last year, I was asked to update the
book, and in doing research in conjunction with the task, I came across some information
that startled me. Various business consultants insist that more businesses fail
because of cash-flow problems than due to unprofitability. In other words, even
if your revenues ultimately surpass your costs, you still can go broke if you
don’t collect your money fast enough.
Some businesses are more vulnerable than others to cash-flow problems, and that
certainly describes construction trade contracting. Slow pay is part of the
construction industry’s culture, and it’s not something most of you have a
great deal of control over. While you await progress and retainage payments to
materialize, you have payrolls to meet and suppliers to pay, along with fixed
overhead needed to keep your business running.
To illustrate the cash-flow dilemma, I’ve constructed a couple of simple
charts. Chart A assumes you have won a contract worth $100,000. Material and
equipment costs for this job are pegged at $25,000, labor $50,000 and overhead
$20,000, leaving you with 5 percent or $5,000 net profit at the end.
Now let’s assume this job has a work schedule entailing three monthly progress
payments of $30,000, with the final 10 percent held out as retainage to be paid
after everything on the punch list gets cleared up. In Chart B, I have
frontloaded material costs somewhat, on the assumption that all materials and
equipment going into the work will have been purchased and paid for well in
advance of the work being done. I realize this doesn’t necessarily happen in
the real world, but in my ideal scenario, you would receive discounts for
timely payment, which has been factored into the job’s
As you can see, even though there’s a decent profit factored into this job,
your cash flow runs in negative numbers until the third month, and you don’t
get to enjoy all the profits until four months after work began. In the
interval, you have to pay your workers and all material bills plus overhead out
of retained earnings, or borrow the money from the bank.
Multiply this example by all the jobs you do, and it’s easy to see how at any
given point in time you can owe thousands upon thousands of dollars more in
payments due than you have cash on hand. You either have to finance the
shortfall out of your own pocket, or take out a bank loan to meet your
obligations. If you don’t have the money and your credit has run dry, you can
be driven out of business, even though, theoretically, you would be able to pay
everything once all the money owed to you comes through.
My examples, of course, are oversimplified, but I’ve been around construction
contractors enough to know that this example conceptually depicts the kind of
cash-flow dilemma that is epidemic throughout the construction industry. Throw
in factors such as delayed progress payments and jobs bid under cost, and the
situation turns from difficult to disastrous for many
Another factor that can lead to a cash-flow crunch is rapid growth. People
normally don’t think of booming business as having a downside, but when a
contracting firm experiences growth on the order of 15 percent or more in a
single year, it creates a need for capital expenditures that get frontloaded
ahead of revenues. Rapid growth requires more cash for materials, labor and
overhead, along with additional tools, equipment, office supplies and
equipment, etc. Much of it has to be purchased on the fly without a lot of time
available to shop prices or compare value.
And if business is booming for you, it’s probably booming for competitors who
are going after the same things, and thus driving up prices through increased
demand. Often, you end up having to purchase from unfamiliar suppliers who
might not extend friendly credit terms like the business buddies you’ve been
dealing with for years.
Here are some ways to stay out of cash-flow hell.
Be choosy about whom you work for. Some GCs and owners are notorious for making
life miserable for their subcontractors. Experienced subs won’t even bid on
their jobs, so they rely on newcomers who don’t know any better to take the
bait. Do your homework before bidding on any job with an owner or GC you don’t
know. Also do a little snooping to find out their financial and payment status.
It doesn’t matter what you contract documents say about payment terms, if the
guy ahead of you doesn’t get paid on time, it’s unlikely he’ll be any quicker
to sign your check.
Reduce overhead expenses. This goes without saying as something to be done
every day in every way. But when times are good, it’s real easy to pad the
front office with a lot of stuff that’s nice to have but nonessential to
running your business. It only starts to hurt when business slows
Negotiate dating terms.Almost everyone haggles with suppliers over the price
of materials, equipment and services, but eventually, you’ll run into the
lowest price anyone is willing to offer. That will be the point at which you
begin to ask not for a lower price, but an extra 30 days to pay for the goods
Do things right the first time. Mistakes kill profits and cash flow. Nobody
will pay you until you fix what’s wrong. When you make a mistake, deal with it
right away. Better yet, avoid mistakes.
Send invoices promptly. Most people set aside certain times of month to pay
bills, which is sensible. Many contractors do the same thing when it comes to
sending out invoices, which is foolish. Get in the habit of sending out your
invoices as soon as possible. Oh, and add a late payment penalty, just like a
lot of utility companies do. The penalty is likely to be unenforceable, but
adds a little bit of a psychological edge.
Stay on top of past-due collections. Call late payers the first day a payment
is past due. Keep calling. Send follow-up collection notices, using
businesslike but increasingly stern language. Credit and collections
professionals recognize that the longer someone owes money, the greater the
chance of never getting paid. Debts that are more than 90 days past due
generally sell for around 30 cents on the dollar to collection
Cash that check. When you do get paid, don’t let the check sit around until you
“get a chance” to go to the bank. Put it into an interest-bearing account right
Smart Business: The Cash-flow Dilemma
June 1, 2009