Chapter Corner

Cash Is Everyone's Business

Posted in: Features, September/October 2018

A construction CPA recently told me about a contractor with a rock-star income statement. Every job was profitable, and it was propelling them into bigger and bigger projects as the business continued growing – until they folded. Why? They ran out of cash. Like too many construction companies, they didn’t have a profit problem; they didn’t have a spending problem; but they did have a cash flow problem. And more than likely, they could have prevented it.
While a lot of data accounting departments ask the field for might just seem like numbers, cash is where it all meets the road. Without cash, there are no jobs. There’s no gut feeling about whether you’ll be able to make payroll next week. So good cash flow reporting isn’t just crucial for a business to survive its next project – it should be a common goal that puts operations and accounting on the same team. Everybody needs to care about cash flow reporting.

The case for the importance of cash is simple. Cash is arguably the single resource that contractors can’t survive a week without. If you run out of materials, you can buy more. If you don’t have labor, you can subcontract it. But if you don’t have access to cash as soon as you need it, everything grinds to a halt – labor, production, billable work, etc. When everything stops, there’s no more cash to be made. When contractors fail, that’s often why.
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On paper alone, contractors are vulnerable to cash flow issues. Construction businesses often have a substantial delay between work completed and payment. Depending on the contract, work might be billable periodically or at project milestones or only once the punch list is finished. Even then, payment terms of 30, 60, or 90 days are prevalent, plus retainage. 
Of course in practice, the time between performance and collection is even longer. Many companies fail to bill their customers as soon as they’re eligible to do so. Project documents might sit for weeks before invoices are entered and issued, and manual payment processes can eat up time. Customers can also cause collection delays. In a recent survey by TSheets and zlien, 92% of respondents said that timely payment is at least sometimes an issue, and on average, it might take over 70 days for contractors to get paid. “Pay when paid” and contract disputes put subcontractors even further back for cash receipts. 
In general, the construction industry naturally has irregular and sometimes unpredictable cash cycles. Even with a steady backlog, receipts aren’t spread evenly across a project. Costs are often taken on up front, with the bulk of collections occurring much later. Depending on how payments and receipts are stacked, even a portfolio of profitable jobs can sink an otherwise successful contractor.
To keep an eye on cash, construction businesses need more than just a balance sheet and income statement. In government, three branches provide checks and balances for each other; in construction, a three-part financial
statement keeps businesses healthy. Construction financials should include cash flow reporting, both in the form of a company-wide cash flows statement and cash flow by job.
The function of an income or profit and-loss statement (P&L) is essentially to tell you the direction and speed of your company over time. A P&L simply subtracts your various expense types from your revenue sources to show your profit or loss over a specified time. What it doesn’t do is tell you the impact of profitability on your cash.
Income isn’t the same thing as cash. Neither is profit. That’s because, in accrual accounting, revenue hits the P&L when it’s billed as a receivable – not when it’s collected. Similarly, costs hit when they’re recognized, not when they’re paid. So if you receive several big invoices in March but pay in April, your Q2 P&L might tell a different story from your bank account.
In contrast, the balance sheet is a point-in-time snapshot of what a company has (assets) and how it pays for it (liabilities and equity). One or more asset accounts will be cash accounts. So on the one hand, a balance sheet can tell you exactly how much cash you have. Just knowing your current cash isn’t enough, though. Like a P&L, you need to see the direction and speed.
Cash flow statements look specifically at how changes in your financial statements over time impact your cash accounts. While the P&L and balance sheet are built to show the company’s long-term viability, cash flow statements are designed to show short-term viability. That’s your ability to pay bills in the near future so you can keep progressing in your jobs.
It does this by restructuring your balance sheet in order to factor out the two things that make the balance sheet difficult for cash reporting: non-cash assets (like receivables and inventory) and non-cash liabilities (like accruals).
A cash flows statement is typically divided into three sections:
  1. Cash flows from operating activities takes your total income from projects and subtracts noncash assets and current (shortterm) liabilities. The total is your net cash provided by operations.

  2. Cash flows from investing activities totals any cash inflow from sale of investments, like fixed long-term assets, and subtracts any long-term assets purchased for revenue-generating activities.

  3. Cash flows from financing activities relates to shareholders and creditors, including dividend payments and loans.
The sum of all three sections provides the net change in cash for the period in question.

In addition to the cash flow statements produced from the general ledger, contractors also need to watch cash flows on a contract level. This shows where each project stands in its cash cycle and how it’s affecting the company’s overall cash activity. A struggling project can hide on a company-wide statement. Not here.
More than just healthy billings, each project needs cash receipts to prevent drawing on your bank accounts and credit lines. When too many jobs borrow company cash, contractors need to take on additional debt or else grind to a halt in the field. In TSheets’ study, 38% of respondents admitted needing to take on short-term loans to cover payroll during a cash flow problem; in the midst of a historic skilled-labor shortage, 12% lost employees when the company couldn’t cover payroll. 
With a good system in place, project cash flow reporting by job is easy. In its most basic form, it details the following in columns:

  • estimated gross profit (contract amount - estimated costs)
  • cash received to date (billings - open A/R invoices)
  • cash paid to date (costs + labor - open A/P invoices)
By separating out non-cash assets and liabilities, the actual impact of project revenues and job costs on cash is visible.
Each project’s net cash flow is found by simply subtracting cash received to date and cash paid to date. Dividing each net  cash flow by the estimated gross profit, then yields the cash flow to gross profit. Contractors can monitor this percentage figure against additional metrics as the job progresses, such as percent of contract billed, job progress by cost, and more.
With this kind of data available, contractors can remain knowledgeable about which jobs are funding other projects and which jobs are putting pressure on the company’s cash position. And by being in the know, they’re positioned to take action. They can control their cash flow where possible before reaching a crisis. As contractors continue learning from monitoring project cash flows, they can also bid and schedule more strategically. Some projects, like government contracts, might have high profit margins but long payment delays that tie up receipts. Over time, the cash-conscious contractor should be able to discern how to balance these contracts in the right mix of work to keep the business thriving.
Too many good contractors are hit by unforeseen cash flow issues that could be anticipated and prevented with the right reports. Alongside a company’s other financial statements and job tracking, cash flow reporting is absolutely critical to keep both projects and businesses healthy. Like a lot of project reports, though, this requires timely and accurate cost and billing data, which is everyone’s responsibility. Here, cash can become a common cause from the field to accounting. Because when a construction company runs on cash, cash is everyone’s business.
As VP of Business Development for Foundation Software, Steve is responsible for continual revenue growth from our many products and services. He invests much of his time building partnerships and relationships across the construction industry with contractors, CPA firms, associations and technology vendors. Over 18+ years, he’s led more than 1,000 software selections and implementations for contractors of numerous sizes and trades.