Construction Cash Management in a Tough Economy

For the last ten years, construction has been a fast-growing but risky industry to be in.  Contractors have always had to deal with tight margins, project delivery delays, labor shortages and now we have more uncertainty than ever before.

Contractors are scrambling to build an accurate statement of cash flows and forecast cash into the future and they are finding many barriers to accurate forecasting.  They can’t look at cash management the way they always have.  They have to adopt a multidimensional approach to forecasting to gain a comprehensive view and insights.

Contractors need to be monitoring key KPI’s like margin fade, job borrow and days of cash on hand and they need to be doing this daily or weekly, not just monthly or quarterly or annually.

Every contractor has a WIP (Work in Progress) report and they need to be watching closely for under billings to see which jobs are using cash.  The WIP report needs to be flexible and viewable over time to allow for deeper analysis.

The challenge is having access to this data in a fast and easy way to make quick decisions.  Many contractors have to pull the data from multiple systems and that is complicated and time-consuming.

In most cases, data resides in multiple systems.  The accounting system holds the majority of the data around cost and billings.  The project management and scheduling solutions have the cost to complete and timeframes required.  The CRM solutions have the pipeline of jobs coming up to bid.  The estimating solutions have the jobs currently being bid but not yet awarded.  To accurately forecast, contractors have to pull data from all of these systems and then coordinate with multiple individuals within their company to get this information.  They then have to deal with combining it into a large spreadsheet with lots of formulas that can easily get corrupted or deal with version control and emailing back and forth. It is inefficient, cumbersome and error-prone. When you are trying to quickly forecast cash you do not have time to deal with these types of problems.

CFMA (Construction Financial Management Association) puts out a benchmarking tool every year that allows contractors to benchmark or compare themselves to other contractors to see how they stack up.

I pulled their results a few weeks ago to see what the average days of cash a contractor had on hand.  I was a little surprised to see how close the days of cash on hand were across all sizes of contractors.  It ranged from 18.5 days to 21.3 days with the smallest contractors having the most days.  The average contractor in the United States only has 20 days of cash on hand.

And this survey was done before the impact of Covid-19!

The Days of Cash KPI (Key Performance Indicator) is the number of days of revenue you have available in cash.

A contractor under normal circumstances should have at least 20 days of cash on hand.  In today’s difficult circumstances, contractors need to have more cash available and need to look at drawing down on their line of credit and using typical cash saving strategies like better collections, delaying payments to vendors and faster billing to help drive up their cash balances up before it is too late.

Many of the banks are really tightening up credit, it is more important than ever to be working with a bank that understands construction and the cycles we go through in this industry.  Determine how much cash you need to cover payroll and fixed payments like equipment loans for at least 2 to 3 months and make sure you have that available on your line of credit.  While owners like to pull cash out of their companies every year, make sure you are advising them on how much cash and lines of credit you need to weather market changes.

All contractors should be watching their backlog to make sure it is growing to drive revenue growth or if it is falling, then making the appropriate cost cutting measures now to align to the new levels of work. Backlog comes from the WIP report and you now need to look at backlog in a new way.  You could have work on the books, meaning valid contracts, but if that work is halted or chance of collection is low, then you have now reduced your backlog significantly and cost cutting measures will have to be taken.  You have to look at each job and assess your likelihood of the job continuing or not and adjust accordingly.  It is time to re-assess the credit worthiness of every customer you are working for.

Assess how much gross profit you have in the remaining backlog.  Is your revised estimated gross profit enough to cover overhead expenses like G&A?  Even in good times, your backlog could be going up while your backlog gross profit could be going down.  This is a good KPI to be watching to assess your overhead.  Typically, the backlog GP should exceed 50% of your G&A expenses if you want to turn a profit.

One thing I learned long ago in construction accounting; underbillings are bad and overbillings are good.  This is as basic in construction accounting as debits equal credits or assets equals liabilities plus equity.

Contractors will always have some jobs with under billings, which just means you have recognized more earned revenue on the job than you have billed the customer for, but that should be the exception, not the norm.  Each job with under billings should be scrutinized.

If you get too high of a % of under billings in relation to your equity, the sureties and banks are going question your real profitability and how well you are running your company.

Cash to over billings.  It should always exceed a ratio of 1.  If you think about it, if you have overbilled a project, unless it is still sitting in receivables, you have not incurred the cost yet and you will therefore need this cash in the future to fund your job.  While we normally think of overbillings as good, if you are taking that cash and using it for other non-operational items like buying equipment, you could have a problem funding operations in the future.

The Net of current receivables and payables KPI is another good indicator of how a contractor is managing their cash flow.  An unusually low number could indicate that a contractor has experienced or about to experience cash flow problems.

And, of course, Contractors should always be looking at the standard liquidity ratios

  • Current Ratio – Should always exceed 1.25
  • Quick ratio – Should always exceed 1
  • High Liquidity ratio – Should exceed 1

Right now, the high liquidity ratio is the most important since it is based on a month(s) time frame rather than the current year.  The high liquidity ratio is the ratio of assets which could be liquidated in 30 days to liabilities which are due on demand or within 30 days.

Many Contractors may have never heard the term CPM.  And if they have it probably means critical path method, which is a common practice used on the operations side of construction.  CPM means Corporate Performance Management in the finance world.  CPM software takes data from lots of sources like the ERP, Estimating, Project Management, CRM solutions and pulls it together for reporting, analysis and what-if scenario planning.

In this case we are showing you how a CPM solution can bring all of your cash KPI’s into a dashboard to have all of your data in one easy to interpret place where you can then drill down to do more analysis as you see trends you need to investigate.

CPM is not just a reporting tool.  It is a Corporate Performance Management tool.  In other words, it allows you to act on the data.  It allows you to do what-if scenarios.  It allows you to add data to the data already being collected.  It allows you to do budgeting and forecasting and setup workflows around the process.

This dashboard is an example of a good cash dashboard for a contractor to use to manage cash.

WIP reports are an integral part of cash management.   All contractors have a WIP report as I said earlier.  The problem is they typically look at it one way.  You need to be able to slice and dice the WIP in multiple ways to really spot trends that impact cash flow.

So maybe you have a standard WIP report in job number order like the top one that gives you your typical information but includes fade by job for the current month. But what about one by customer, that shows backlog and profitability by customers and maybe includes aging data as well.  And how about a WIP by project manager to show how profitable jobs are by PM or over(under) billing by PM to spot issues with billing or profitability by PM

The point is you need to be able to analyze your WIP in a lot of different ways.  Type of work, to show what work you make the most money on.  Estimator – To show what estimators do the best job estimating.

What about a WIP by state or city right now with shutdowns?

With states and cities shutting down, you had to be able run your WIP by city and state to see what work is still really active.  It is no longer about what you have contracts for.  It is about where can you really work!

Here are a few things to consider around over and under billings and why it is so important to manage this through your WIP review.

  • Over billings tend to consistently turn into profit. Underbillings tend to turn into margin fade and potentially job losses
  • Timely billings lead to timely collections. Slow billings lead to slow collections which lead to bad debt
  • PM’s should be taught to be conservative in their estimates. Being aggressive leads to profit fade which is frowned on by the sureties and banks
  • You should always have a high ratio of Net over billings to under billings. It is okay to have some jobs with under billings but it should be the exception and not the rule.

Many contractors will go out of business this year due to a lack of cash to run their business.  Many of them may have even been profitable and could have been prevented.  Hopefully having good cash KPI’s and monitoring them closely will prevent many other contractors from following the same course.

Contractors that use CPM software are better positioned to monitor their cash KPI’s and do WIP analysis to find cash issues before it is too late.

Eric Newton