CASH FLOW PLANNING FOR CONTRACTORS

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Cash management is an important, yet often neglected area of financial management for many businesses. And while analyzing cash flow is critical to the success of any business, companies in the construction industry can be especially hampered by a lack of cash planning due to the nature of their business.

Contractors know that there can be a significant lapse in time from the point at which they are granted a project, incur labor, material and other costs, and are actually paid for completed work. Factors such as retention, decisions on whether to subcontract the work or use the company’s own crews, renting versus buying equipment, and timeliness of customer payments all have an impact on a contractor’s cash flow. This makes cash management difficult but essential. Construction companies must ensure that enough cash will be available at the right time to allow the business to operate profitably and effectively. If the company’s cash position is not monitored, there is little or no time to react to a cash shortage.

CURRENT VS FUTURE CASH NEEDS

An analysis of working capital and current cash needs does not provide an indication of the company’s future cash flow needs. It also does not show a company’s ability to handle a cash flow interruption due to a problem on a current contract, nor does it indicate future cash needs as a result of being awarded a new contract. This information can only be obtained through the preparation of a cash flow projection.

The purpose of a cash flow projection is to determine the amount of cash necessary to handle the anticipated level of company operations and to determine when the cash will be needed. Each contract has its own cash flow cycle. At times, a contract will be a user of cash, and at other times, particularly at the end of a profitable contract, it will be a provider of cash. The company’s ability to supply cash is determined by the combined cash flow position of all its projects at any point in time.

CASH FLOW PROCESS

The preparation of a cash flow projection for a contractor involves three phases. First, job operating schedules must be prepared for each contract. Following the job operating schedules, cash flow projections for all current and expected contracts should be prepared. And, finally, a company-wide cash flow projection, which summarizes the cash flow for all jobs, should be developed.

A job operating schedule is a month-by-month analysis of anticipated contract production, progress billings and revenue recognition for each contract. The schedule is developed from the estimating department’s construction schedule which was created when the contract was originally estimated and bid. The job operating schedule highlights the timing of labor, subcontracts, materials and equipment which will be used on the contract.

Once the job operating schedule is prepared, the job cash flow projection can be completed. This projection indicates when the costs incurred are expected to be paid and when the progress billings are expected to be collected. Company payment policies, as well as past history with customers, will be a factor in developing these projections.

A job operating schedule and a job cash flow projection must be prepared for every contract on which the company expects to expend resources or collect funds during the planning period. This includes current contracts, anticipated work and closed contracts with remaining receivable balances. In addition, these schedules should be updated monthly in order to reflect changes in contract pricing, costs or timing.

The company-wide, or summary cash flow projection, incorporates the net cash flows from all job cash flow projections along with anticipated indirect selling, general and administrative and financing costs for the company. This projection, normally prepared for a period covering one year, should be updated monthly and compared to actual cash receipts and disbursements.

PUTTING THE INFORMATION TO USE

The company’s cash flow projection will indicate, on a month-by-month basis, whether it has a net cash inflow or outflow. In turn, management will be able to determine if the company has the financial resources and lines of credit available to properly handle the anticipated volume of work. If a shortage of cash is anticipated, the company can demonstrate to its creditors why and when an increased line of credit may be necessary, and how and when the company will be able to repay any draws on the line. By providing this information on a proactive basis, "surprise" last minute requests for an increased line of credit will be eliminated and creditors will be better able to understand and appreciate the cyclical nature of the company’s projects and business cycle. Sureties will also be interested in receiving this type of information in order to establish the contractor’s bonding capacity.

CONCLUSION

Cash flow projections can be very revealing to contractors. A company’s most profitable period may also be the period of greatest cash flow needs from outside sources. If the company is unaware of this, and therefore has not planned to obtain additional credit, trouble could lie ahead. It makes sense to forecast cash flow.

By Timothy J. Tremel, CPA, Affiliate Member IGAF

If you would like to learn more about cash flow planning for contractors, please contact Stein Larsen, CPA at (425) 454-7990 or slarsen@bpcpa.com.