Thomas C Schleifer, Ph.D.

During a recent interview I was asked what percent of the failed construction firms that I worked with for bonding companies had simply run out of money. My answer was, 100%. What’s more, they were all surprised that they ran out of funds. These contractors were not startups who didn’t know what they were doing. Most were successful contractors who had been in business for many years. The more important industry question is of course, how could this happen?

Inadequate Working Capital

The construction industry’s financial foundation rests on a chronic shortage of working capital. Inadequate working capital is a fact of contracting life, almost an essential part of the business model. Why does the construction business model rest on financial quicksand? Let’s take a look at how the model evolved and how closely each step might resemble your business.

Almost all construction companies begin as small closely held businesses. Relatively little capital is invested at start-up. Closely held family businesses resist giving up control to outside investors so capital needed for growth during the initial growth spurt is limited to internally generated funds. The day-to-day business of contracting is the acquisition of one new job after another. This constant growth requires abundant working capital. Because the contract acquisition model is based on multiple forms of bid processes, profit margins are slimmer than all other mature American industries. Slim profit margins produce inadequate capital for growth needs. Public equity markets are rarely accessible for growth capital. The small business owner and the company are virtually identical. Rarely do contractors retain substantial earnings on the company’s balance sheet. The remaining contractor earnings are reinvested in fixed assets and not left languishing in liquid form on the balance sheet to be used for working capital. Because of the resulting chronic shortage of adequate working capital, all growth represents substantial risk for contractors.

Putting Out Fires

Most contractors I have worked with over the years managed cash flow through a process of putting out fires. They would borrow from one job to temporarily finance the next; extend supplier payments beyond 30 days; front load a new job to complete payment on a previous project; approach the bank at the last minute to increase their working capital facility; or ask their cousin for a short-term loan. Few, if any, ever had an advanced cash flow management plan that avoided the perennial unexpected cash shortages.

Cash Flow Planning

Inadequate working capital is the highest risk factor in the contracting business, yet few contractors ever devise a cash flow plan in advance and make go/no-go decisions based on their ability to finance additional work. An effective cash flow plan is a highly complex, professional, ongoing financial projection based on your company’s history of collecting progress payments, supplier cooperation, adequate working capital lines of credit, and proper use of retained earnings.

Crafting and Utilizing a Cash Flow Plan

An updated cash flow plan should be a required monthly financial report prepared by your CFO. The purpose of the plan is to predict cash flow needs in advance and to decide if your current cash flow position will be adequate to take on new contracts under consideration. Most contractors believe that there are too many unpredictable variables in construction industry cash flow and that any static plan is rendered inaccurate the day it is put together. That’s why most don’t bother writing a thorough cash flow plan. Effective cash flow plans are fluid documents that are adjusted in real time as circumstances change. The ability to craft a baseline from the cash flow history of the company, to factor in real time variables, and to estimate adequacy when multiple simultaneous jobs are utilizing available cash must be left to financial professionals. Guestimates will result in surprises and, ultimately, put you out of business.

Next Week

Next week we will go through a step-by-step creation of a cash flow (working capital) plan. It is an intricate procedure with considerable variables, but it is not hard to understand and will serve your company well if crafted carefully. Don’t miss the exercise.

For more information on a cash flow plan, read more at: PLAN

For a broader view on working capital, read more here: CAPITAL

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Here we address some of the most frequently asked questions about the Simplar Foundation, our mission, and our impact on the construction industry.