Construction is considered to be an essential industry in many states, but as the impact from the coronavirus deepens, the industry’s ability to weather this storm continues to be threatened. Nationwide, almost 40 percent of construction firms have laid off job-site workers. Many contractors have pulled back from existing jobs and halted progress on future ones. In such a tumultuous business environment that will probably get worse before it gets better, construction contractors need to be doing these essential things now to protect and conserve their cash flow.

Understanding Cash Flow Management

In normal times, when there’s a steady flow of new jobs and profitability is normal or high, the health of a construction company is determined to be good. It’s easier to authorize using cash for buying fixed assets or outside investments, or maintaining lax collection policies because everything seems fine. So when things are going well, cash flow can be an easy thing to miss. During a crisis, though, cash flow is everything.

Contractors can start by making sure they have a clear understanding of what cash flow management is. It’s the process of monitoring, analyzing, and optimizing the net amount of cash receipts minus cash expenses. Net cash flow is an important measure of financial health for any business, and for contractors right now, it could be the measure by which they remain operational or need to shut down.

Go about the process as if estimating and bidding on new work: there’s analysis, projections of different scenarios, and determining what will work and what won’t. Follow these steps to arrive at a basic cash flow analysis of where things stand now so that decisions can be made regarding current and future planning.

  1. Determine the break-even point. This is the point at which the business will become profitable. Profitability in the future seems like a long-lost goal in a coronavirus business climate, but it’s necessary because it provides a target to project future cash flow. There are two methods of calculating the break-even point: unit-based or dollars-based. In both scenarios, fixed costs are treated the same. With the first method, subtract the variable cost of each item from revenue per item sold. Then, divide that number by the fixed costs. With the second method, solve for the contribution margin, which is price of service or product minus variable cost. Then, divide fixed costs by that number.
  2. Project cash flow. This involves looking at different areas of the business to identify potential problems. Are collections past due? What is owed out? Use a cash flow worksheet to project future cash flows or deficits. This can be done in Excel or industry-specific software. Either way, it must be updated regularly to make a difference in cash flow planning. Assign this task to someone who can monitor it weekly if possible. An 18- to 24-month forecast is ideal and using different budgets for various estimates. Areas of cash flow projections to focus on include accounts receivable and accounts payable, or money out and money in. For receivables, clearly identify what is owed, how many days outstanding, and whether there are strategies to collect quicker. Examples include incentivizing customers to pay sooner with a 5% discount or allowing credit card payments online. Throughout this process, analyze A/R aging and work to collect old debts using internal “collectors” or external companies “factoring receivables,” if necessary. With A/P, clearly identify what is owed to others and extend payables as long as possible, if needed. Measure days sales outstanding and set a goal for collecting unpaid debts faster. Projecting cash flow should also include analyzing and pursuing a collection of retainage. Retainage can cause significant financial challenges for contractors if left uncontrolled. Especially now, pursue any withheld amounts and try to negotiate different terms for new projects.
  3. Manage shortfalls or surpluses. Although surpluses aren’t likely in the current economic climate, there might be a rainy-day fund to pull from. Utilizing lines of credit or COVID-19-related financial relief programs are the first options. Beyond this, remember there are options to defer the employer portion of social security taxes and the employee retention tax credit if payroll is maintained. The tax deadline has been pushed back, so if taxes are owed, wait to pay them to preserve cash now. Consult the insurance provider if the contractor has business interruption coverage, as this could also be a source of cash in the short-term. And because government programs quickly run out of funding, if there isn’t one already, establish a line of credit with the bank. Another option is to maximize favorable accelerated tax depreciation for asset purchases to decrease tax expense. Also, choose the correct tax structure and strategy; construction companies have options for how they are taxed that can lead to significant deferrals in tax expenses.   Federal defense contractors should also be aware of the Navy’s recent guidance regarding withholds and retention. Read more here.

Strategies Contractors Can Use to Maximize Cash Flow Now

Business in every sector is far from normal right now, and considering the various ways that contractors are exposed to risk right now – from supplier shortages and disruptions, employee layoffs, and government-mandated project shutdowns – it will be imperative for contractors to maximize every dollar. These are additional strategies contractors can use to save cash now and set themselves up for a profitable future once the economy turns around.  

  • Request money up-front before beginning a new project or continuing with an existing one.
  • Enable online payments and credit card processing.
  • Establish a rainy-day fund with any surplus money to weather the current economic storm.
  • Process change orders immediately. This will have a positive impact on cash flow and needs to be realized as quickly as possible.
  • Send invoices digitally, if not already doing so. It will speed up the collection cycle.
  • Avoid excessive over- and under-billings. These cause swings in cash flow and are difficult to track.
  • Strategically manage retainage.
  • Evaluate the possibility of refinancing assets and investing the equity back into the business.
  • Consider leasing new equipment rather than making large purchases right now.
  • Work with the lender to temporarily lower interest rates on outstanding debt or possibly make interest-only payments on mortgages or equipment loans.

Common Cash Flow Problems for Contractors

In any business climate, contractors can cause issues for themselves and end up sending more money out the door than is necessary. Now more than ever is the time to identify cash flow deficiencies and improve business practices. The result will be a healthier bottom line and a company able to withstand the challenges of extreme economic pressure.

  • Failing to close out completed projects, resulting in final change orders going unresolved and delayed payment of final requisition and retainage.
  • Lack of standard protocols for collections, which causes delays in A/R. Sometimes a simple change of ‘net 30 days’ or adding a finance charge to outdated invoices can make a big difference in collections. But, make sure to clearly communicate any changes to customers and suppliers.
  • Not following up with customers or suppliers about past due bills. This is an area completely within the contractor’s control. Persistence and frequency combined with varied forms of contact – phone and email – might be necessary to collect on outstanding debts in a timely fashion.
  • Failing to have an adequate contract in place or using generic contract terms, which can open up the contractor to undue risk. Avoid the easy route of using the same or similar contract terms for all jobs and customize the contract for the job. Regarding cash flow, ensure that terms are clearly specified for requisitions and what documentation is required.

Last but not least, talk to a PBMares tax professional about other ways to utilize tax planning to conserve short-term cash, such as accelerated deductions and the impact of various activities on tax strategy. Contractors are experiencing the beginning of a recession that will change the way business is done for most in the industry. Take the time now to prepare and adjust course and take proactive steps to protect cash flow.