Tips for Maintaining Even Cash Flow

In the numerous “Top 10” lists of why small businesses fail (51% don’t survive after five years according to the Small Business Administration) cash flow is usually near the top. Entrepreneur Jack Stack has said that a company can get by for a long time without profit, but it can’t get by until the next pay period without cash flow.

“You can borrow enough to keep going and you can fool yourself into thinking you’re OK,” says Seattle-based business consultant Judith Miller, “but you can’t fool the bank, and you can’t fool the cash flow.”

Like car engine oil, cash flow keeps the machine running smoothly. Without it, the gears won’t turn: you won’t be able to pay the bills, put money into the war chest, pay employee bonuses, or have a cushion.

The challenge: How to keep the money coming in and going out at the right speed.

Bill Early, Bill Often

“Paper profit doesn’t mean you have cash on hand,” says Melanie Hodgdon, president of Business Systems Management, in Bristol, Maine. At the end of a job, if you just have money on paper but won’t receive your actual cash payments for three weeks, and you receive a large materials bill, you won’t have the money to pay it.

When Gary Rochman, owner of Rochman Design-Build, in Ann Arbor, Mich., started out, he did what many remodeling company owners do: asked clients for progress payments based on construction milestones. For example, when framing is complete, the company receives x%; at the end of drywall, another x%; and so on.

A few years later, Rochman made what he calls an “incremental change” and began charging clients at the beginning of a construction sequence rather than when work is completed. “I realized that if you have clients’ trust, they’re willing to give you money; they want their project to go well.” This led him to see that he could uncouple payments from milestones altogether. Now he takes 10% of the project cost at contract signing, another 10% on the day his company shows up to do the work, and divides the remaining 80% into equal, regularly scheduled monthly payments over the life of the job. (See “Deposit Decisions,” below.)

This means that Rochman must be vigilant about accurate job scheduling and timely job completion, so he continues to earn his clients’ trust. “Clients see that we’re organized,” he says, “and this continues to earn their trust.”

Other remodelers invoice clients weekly or bimonthly. Whatever the schedule, the key for better cash flow is on-time payments and client education:

• Make sure you receive client payments before you pay your subcontractors and suppliers.
• Talk with clients up-front about the importance of quick payment. “It takes some sales skill,” Rochman admits, but clients need to know that if you have money in the bank to pay subs and suppliers, you can pay them promptly. The result: early payment discounts, subs make your jobs a priority, and the client will see lower costs, better results, and higher-quality service. (See “No Shows,” below.)

Pay Suppliers Early

If you invoice a client and get paid right away, you’ll have the cash to pay your suppliers, who often give early-pay discounts—e.g., 2% off if an invoice is paid by the 10th of the month. “If you miss [the] discount because you don’t have cash and you have to draw on your line of credit to pay the lumberyard, you’ll soon incur finance charges,” Hodgdon says. “Most contractors don’t place sufficient value on discounts. When you run the numbers, the savings are astonishing.” Hodgdon offers this example: That 2% discount means that you’ll have to pay about 20 days earlier than if you paid by the end of the month. But the effective annual return on that discount is 37+% (see chart, below).

“So it’s a no-brainer that you should take every discount possible, unless for some reason the cost of borrowing to make that payment exceeds the benefit of the discount.” Paying early usually pays off. But paying promptly can have equivalent rewards. If you want to be sure that your subs put you at the top of their A List, and accommodate you quickly, be sure to pay them promptly. This translates to dollars saved when you consider the impact of unplanned delays and the related schedule shifts. And “the biggest issue with getting ‘behind’ in cash is that it usually precipitates a downward spiral,” Hodgdon says.

Stagger Big Bill Payments

If your workers’ comp is due in March or August and that’s the same time as your corporate taxes are due, consider staggering your payments so that you’re not getting walloped with multiple charges simultaneously.

Attend to Change Orders

It’s inevitable that there will be changes during a job. Charge for these immediately. “We ask for 100% of the change order payment before we start,” Rochman says. Hodgdon suggests either charging a higher markup or a change-order fee to cover the additional time and effort required to deal with the domino effect of change work.

And get it in writing because, Hodgdon warns, “If you don’t have a signed change order, you might as well wrap up the change order and put a bow on it because legally, it’s the equivalent of a gift.”

Deal With Punch Lists

The best-case scenario is that you have no punch list. You don’t want jobs dragging on with final payments tied to completion of punch-list items. Since there are increased costs associated with picking at punch-list items, get them wrapped up before you get off the site to avoid having to send crews back again, possibly multiple times.

“Take care of punch-list items as they come up,” Hodgdon advises. “If a painter leaves a hole in a wall, it’s not a punch list item; call in the painter and have it taken care of.” Incorporate cleanup as part of your regular work process. When a three-month punch list becomes the norm, there’s something wrong.” Plus, if your payment schedule is tied to punch-list completion, you won’t get that final payment in time to cover that job’s cost window. But the insidious additional cost is your good reputation. Delaying your departure can mar an otherwise good relationship with your clients.

But, if you do end up with a short punch list, Les Cunningham, owner of Business Networks, a peer review group, suggests that you make each item worth “x” amount and, upon successful completion of that item, you get paid. “The worst-case scenario is that you lose your last punch-list item payment,” he says.

Autopsy Jobs

One side effect of getting swamped by punch-list items is that you may not get back to evaluating how you did on the job until months later. This means you might discover too late that your estimating system is out of whack, and you’ll continue to estimate future work incorrectly using the same erroneous assumptions.

This is a profit matter, but it affects cash flow because unless you’re pricing jobs correctly, you’ll end up trying to cover the Smith’s job with the Jones’ deposit.

Price It Right

It should go without saying that you need to add in your ongoing business expenses to your project estimates, but too often new remodelers in particular don’t price appropriately. Let’s say your annual overhead is $52,000, or about $1,000 per week. If a job is estimated at $50,000 in costs and is scheduled to take three weeks, then pricing the job at $53,000 would theoretically cover (barely) the overhead. But there’s no allowance for profit in that price, and if there are cost overruns, you’ll go into the red. Each month you continue this practice means you’re losing thousands of dollars because you don’t have enough gross profit to cover your overhead.

Prepare for Added Costs

Along with staggering your big bills, you need to consider large expenditures you’ll be making in the near future—new employees, another truck, and so on. “If you want to hire an estimator in May, change your pricing structure now,” Hodgdon says. You want the dollars there when they will be required, otherwise you can run out of cash because of those new demands.

Establish a Line of Credit

It’s good to have a line of credit, just in case—but you can’t wait until you need one to get one. Your business must be healthy before you approach the bank. Your books should be in order and your balance sheet should show a healthy current ratio, Hodgdon says, i.e., total current assets divided by total current liabilities should be 1.25 or higher. And you should have a healthy debt-to-equity ratio (total liabilities ÷ total equity) of less than 1. “The lower the better,” Hodgdon says.

And get to know your bankers. Developing a personal relationship with lenders can make the difference between appearing as a set of numbers or having somebody on staff go to bat for you. Knowledge of personal integrity and the circumstances leading to the need for a line of credit during tough times can make the difference between a thumbs up and denial.

Michael McCutcheon, owner of McCutcheon Construction, in Berkeley, Calif., adds this caveat: “Remember that credit-line terms can be canceled with virtually no notice. It’s not like a home mortgage where, just because you make the payments, the bank keeps it open. They can look at your financials and yank it at any time.”

Share and Share Alike

Bartering with a strategic ally might seem to be a way to improve your cash flow, but the terms of a barter have to be carefully worked out, and there are tax implications. This is the sort of gray area that should be discussed with a qualified tax accountant. Hodgdon outlines an example this way:

A remodeler has a plumber who is a subcontractor. The remodeler hires the plumber to do work on the Jones’ job in exchange for doing a remodeling project at the plumber’s office. To make things simple, assume that the estimated cost for both projects is identical, and that both parties use the same markup for pricing. The terms could be charted like this:

Obviously, no cash is saved. The remodeler actually gets his markup (he spends $15,000 on the plumber’s office project, avoids paying the plumber, yet still collects $21,750 from the Joneses). The plumber gets (for $15,000 spent working on the Jones job) $21,750 in value on his office upgrade. The tricky part is showing the appropriate amount of costs, income, and profit on the part of each of them so that appropriate income taxes can be paid. “Be sure that all parties are not only satisfied, but—if audited—are singing the same song,” Hodgdon says.

Deposit Decisions

Be aware of the laws in your state regarding up-front deposits for construction work. Some states, such as Maryland, Pennsylvania, and Maine, restrict a deposit to 33% or less of the total job cost. In California it’s 10% or $1,000, whichever is less, “unless you bond around it, which most people don’t do,” says D.S. Berenson, an attorney in the home improvement industry and a REMODELING columnist.

A common problem, he points out, is that some contractors will take a deposit for a window job, for example, and then return and re-measure a week later and then take more money. “If you take a payment on a re-measure in California,” Berenson says, “you’ve arguably violated the law because you haven’t done any actual new work.”