Analyzing and Managing Cash Flow


Maintaining a strong cash flow in the construction industry can be especially challenging.

Having cash available to cover expenses or expansions is important for all businesses. But for contractors, subcontractors and other construction companies, maintaining a strong cash flow can be especially critical and challenging.

For the construction industry, the majority of cash inflow comes from projects currently underway. This can pose a challenge as ongoing projects also have expenses. The construction company or contractor must be able to cover spending that allows for the completion of the project, while relying on customer payments to cover payroll, vendor expenses, promotional materials or other business expenses.

"Many companies don't realize their cash flow balance is misaligned until it's too late."

If outstanding invoices are not paid in a timely manner, or the company lacks working capital to manage expenses, the company may be forced to put off paying bills or taking on new jobs. For this reason, it's important to maintain a healthy balance between funds going in and out of the business.

Unfortunately, many construction companies don't realize their cash flow balance is misaligned until it's too late, and they find themselves unable to cover an expense. Many businesses rely on monthly balance sheets or income reports, but these methods may not provide adequate or advanced warning of a cash flow problem.

How to assess the strength of cash flow
While cash flow can be defined simply as the amount of payments received minus payments made over a set period, maintaining a healthy cash flow involves more complex calculations.

Analyzing cash flow involves several key indicators. These may include looking at the working capital percentage, meaning funds available after debts and expenses are settled. Ideally this percentage should be 8 to 12 percent of the total revenue.

Cash flow must also factor in how liquid the company is, and the company's ability to meet financial obligations. Examples of common ratios used to determine this include the current ratio and the quick ratio. The current ratio is determined by the ratio of current assets to current liabilities, and the quick ratio is the ratio between cash, short term investments and net accounts receivable to current liabilities. The higher these ratios, the healthier or stronger the company. Other factors to consider may include cash demand and ratios such as working capital turnover and the average number of days it takes to settle outstanding accounts.

Why cash flow is important
In addition to allowing a business to cover its expenses, the ability to successfully manage cash flow can impact the relationship a company or contractor has with sureties or other lenders.

"Cash flow can impact the relationship a company has with sureties or other lenders."

Many businesses will need to borrow funds in order to meet their business's needs, and this may be especially true in the construction industry, where purchasing and labor often precede customer payment. Maintaining a healthy cash flow becomes even more important as lenders will analyze a contractor's or company's ability to maintain sound financial practices.

A surety underwriter will examine several factors when deciding if a borrower is a strong candidate for a loan or bond. Some of these factors include:

  • Debt-to-equity ratio
  • Whether bills are paid on time
  • Accurate in-house financial tracking
  • Any existing borrowing or overbilling

A strong, well-managed cash flow allows construction industry professionals to demonstrate their financial security and surety capacity.

Best practices for cash flow management
There are several ways to strengthen a contractor or company's cash flow. One method is to set up progress payments by creating a schedule of values. This method will allow the company to be covered for the cost of startup activities before they are incurred without the appearance of frontloading the bill. The schedule of values will also enable project managers to control costs by timing phases of the project to align with customer billing.

Setting up a standardized billing and collection policy can also aid in cash flow management. This includes ensuring timely invoicing from the project managers as well as efficient collection from customers. Construction companies and contractors should also establish collection policies, including escalation actions for late payments. Additional strategies may involve negotiating better contract terms or factoring some portion of accounts receivable.

In order to better understand cash flow needs and how to manage cash flow projections, construction companies and contractors should work with certified public accountants who are able to provide best-practices advice on cash flow management. LaPorte's Construction Industry Group has more than five decades of experience in accounting services for the construction industry, including leadership and participation in trade organizations and associations in Texas and Louisiana.

Contact LaPorte for more information on establishing practices to strengthen cash flow and enhance their financial flexibility.