Setting up an operating capital reserve account (OCRA) is one
of the smartest investments you can make. It is an investment
not only in your company, but also in your future. If set up
and used properly, this account will:
* give you the ability to weather downturns in business and
* let you walk away from a job you don't want
* protect you if unexpected bills appear -- from vendors or
* protect you if you face an unexpected loss of income from a
customer who refuses to pay
* provide coverage if errors occur in your bookkeeping or by
* help you take advantage of sales pricing on tools,
equipment, and vehicles
Know Your Overhead
First, you need to know your average monthly overhead
expenses. A good definition of overhead is all non-job-related
expenses. If you do remodeling work, your overhead will
normally fall between 28% and 34% of gross sales. Specialty
contractors can expect their expenses to be a little less,
around 22% to 26%, while new home construction companies will
have overhead expenses in the range of 12% to 20%. Your numbers
may be higher or lower than these, but the important thing here
is to know what they are.
Next, you need to know your job cycle. A job cycle is the time
expended from the first day of advertising through the day you
collect the last payment for a given job.
Job cycle. To determine your average job cycle,
calculate the length of time it took to do the last 10 to 12
jobs, add those times together, and divide the total by the
number of jobs. We're after the average here, not the longest
You need enough funds in your OCRA to cover the overhead for
at least your average job cycle and maybe a little more. This
gives you the cushion to advertise, do the work, collect the
money, and get it into an account to pay your bills before you
run out of money.
If you prefer not to use the job cycle approach, here's a good
rule of thumb you can follow. If you are a specialty
contractor, you should have a minimum of three to five months
of overhead expenses in the account, preferably five. A general
contractor doing remodeling should have a minimum of five to
seven months, preferably seven months, of overhead expenses in
the account. A GC doing new home construction should keep a
minimum of seven to nine months, preferably nine months, of
overhead expenses in the account.
Of course, some new homes and larger remodeling projects can
run 18 to 24 months or longer. We have all seen new home
projects that took three to five years to complete from start
to finish. If you do jobs of that size, set the goal for your
OCRA based on that extended period of time.
Let's say that you have a small company and you are rolling
along hitting your sales and production goals without too much
trouble. Life is good; then you come across this article. You
don't have an OCRA, so where do you start?
Let's make some assumptions: You will sell, build, and collect
$340,000 this year. Your overhead is running 32% of sales, or
$9,067 per month average. You decide you want seven months'
worth of overhead in your OCRA, or $63,469, and you want to
build that account over 24 months.
Let's do the math and see what kind of increase in sales this
new account will require, and how much you will need to
withdraw from each check that comes into your company to reach
If we divide $63,469 by 2 (for two years), we get $31,735,
which is the additional amount you will need to make in each of
those two years. If your existing overhead is $108,804 ($9,067
x 12) for this year and we add $31,735 to that amount, we get a
new overhead expense of $140,539. If we divide that number by
32% (our overhead percent), we learn that you must increase
your sales for the next 12 months to $439,184 ($140,539
That means you must sell an additional $99,184 ($439,184
$340,000) in the next year, or $8,265 per month, to
provide the money for the new overhead expense.
The following year you must do the math again and adjust your
numbers so that by the end of the second year, assuming that
you don't make any withdrawals from the account, you will have
reached your goal of $63,469.
If you think that the increase in sales to reach your goal is
more than you can achieve, then set the time period for
building your OCRA for three or four years. If spread over
three years, your increase per year would be $21,156 ($63,469
÷ 3); over four years, your increase per year would
be $15,867 ($63,469 ÷ 4).
Setting Aside the Money
How do you collect the money for this account? It should be
considered part of your overhead and be treated as an overhead
expense. It should be part of your markup on job costs to
arrive at the sales price for your work. If you're on the
two-year plan, you should allocate $8,265 ÷ $439,184
= 1.88% of each check you receive to your OCRA and no place
else. If you want to build your account a little faster, then
allocate 2% or even 2.5% of each check to the OCRA.
Remember, this is not a "new toys" account. This is money that
is to be used for just one thing -- to provide an immediate
cash reserve in case an emergency of some kind hits your
company. That's why I strongly recommend that this account
require two signatures for money to be withdrawn. Withdrawals
should not occur when the owner is in an emotional state; they
should be thoughtfully planned and the money spent
When You Reach Your Goal
When you've reached your goal for this account, you can scale
back your contribution to 1/4% or 1/2% from each check that
comes into the company. But don't, for any reason, stop
allocating something from every check that comes in. You can
put the balance of the money you were spending into the profits
category or give Christmas bonuses to yourself and your
If you have to pull money out of the account for some expense
-- taxes or a new transmission -- you can boost your
contribution back to the 1.88%, and it should not affect your
cash flow. The single most important issue here is to take a
percent of each check that comes through the door and deposit
it to your OCRA account. The sooner you start, the better, and
once you start, you should never stop.
First, I would not use this account to pay your normal tax
bills. Keep your taxes in a separate account. This makes for
cleaner bookkeeping. The account can be used to pay taxes, but
only if there is no other source available for that
Second, you should discuss this account with your CPA and
consider all the tax consequences to you and your company
before you start.
Third, do not use the OCRA to purchase tools, equipment, or
vehicles, unless they have been budgeted. If they are not in
the budget to buy, don't buy them.
Whenever I speak to groups of builders on business topics, I
ask those present whether they have an OCRA, by whatever name.
About 10% to 15% say they do, and not one has said that the
account has harmed their business. Many say that the OCRA
account is the main reason they've been able to sustain the
company through hard times. Building the account takes time and
discipline. But once you get started, it's easy. You'll be glad
to have it when the going gets tough.Michael Stone has more than three decades of
experience in the building and remodeling industry and is
Markup and Profit: A Contractor's Guide
(888/944-0044). Visit his website at