Dennis Birch, a well-respected construction accountant, argued that “many US contractors are watchers instead of managers of their financial affairs.” He claimed that “they do a lot of responding to things that happen to them but don’t have much control over what’s happening or going to happen because they don’t have the appropriate financial information in the right place at the right time. To manage financial affairs properly, contractors must regularly analyze their historic financial data and gain a rearview perspective by carefully reading their financial statements.” (The Business of Construction Contracting, T C Schleifer, A B Cohen, Wiley, 2025)
Prior Preparation
For the last four weeks I have attempted to demonstrate how the scarcity of working capital in construction companies is not the result of management actions but rather is baked into the construction financial transaction recipe. This recipe cannot be changed after the transaction is in the oven. It can only be altered effectively before the transaction begins to bake. In other words, financial risk management hinges almost entirely on taking measures to mitigate financial risk before the contract is signed and work begins.
Proper Preparation
Effective financial management of a construction contracting business first recognizes the potential pitfalls built into the financial transaction and takes steps in advance to mitigate the negative impacts. Below find “Ten Steps to Liquidity” that can eliminate the risk of suddenly running out of cash and mitigate the negative impact of construction’s chronic shortage of working capital.
Ten Steps to Liquidity
- Avoid low bid acquisition whenever possible. The main reason contractors are perennially short of cash is that they capture work by bidding too low.
- Retain at least 50% of current earnings to serve as working capital for future projects. (That number should be 100% in the early going, gradually being reduced as the company increases in value.) The ultimate measure of performance is not what is earned, but how the earnings are used to increase company value. A firm’s increase in value is the true measure of financial performance.
- Conduct an in-depth credit analysis on every client before signing any contract. (The financial failure of project owners often causes the failure of contractors.)
- Discipline your project managers to submit accurate invoices on time – every time.
- Develop a close working relationship with your bank and bonding company. Never attempt to borrow working capital after the need arises. Always submit an intelligent business plan for each project in advance and borrow on the merits of the business plan. Bankers respond positively to in-depth forethought.
- Execute working capital budgets before every project is signed and integrate each budget into the company’s ongoing overall working capital plan.
- Evaluate potential project size based on your working capital capacity.
- Develop relationships with material suppliers based on mutual interests and not price alone.
- Insist on prompt payment according to the terms of each contract and stop work if payment is not forthcoming.
- Produce regular cash flow reports for use as a management tool.
Prevents Poor Performance
- When executed carefully the ten steps to liquidity can eliminate the surprise of sudden factors that cause construction companies to run out of money.
- If followed consistently the ten steps to liquidity eliminate the possibility of running out of money altogether.
- Managing cash flow prior to contract execution requires financial analysis and reporting systems in addition to traditional financial planning.
- An experienced construction CFO is indispensable for effective cash flow management.
- Working capital management requires unique analysis and forecasting because of the unique nature of the construction financial transaction.
Next Week
For the rest of the year these weekly messages will explain how to execute the Ten Steps to Liquidity to ensure that running short of cash mid-project will no longer be a nagging problem for contractors.
For more information on appropriate financial information, read more at: INFORMATION
For a broader view of liquidity, read more at: LIQUIDITY
To receive the free weekly Construction Messages, ask questions, or make comments contact me at research@simplarfoundation.org.
Please circulate this widely. It will benefit your constituents. This research is continuous and includes new information weekly as it becomes available. Thank you.
