The unique complex nature of the construction financial transaction cannot be overstated. I make this point repeatedly because my experience working with contractors is they do not see the complexity of the business of contracting the same way I do.
The unfortunate contractors who suddenly ran out of cash and went out of business often asked what they missed in managing their business. Even if they had attended one of my seminars when they were actively in business and successful they often dismissed what I was saying as strictly academic.
Beyond Academics
Ask yourself these questions:
- How many hours a day do you spend worrying about getting paid on time, eager to get some cash flowing from the next job, or concerned about getting the retainage released from a completed project?
- How much time do you spend schmoozing your banker and suppliers to be certain they’ll be there the next time you need to supplement cash flow.
- How confident are you that you have ample cash to pay all current expenses?
- How certain are you that there will be enough cash next week – next month – next year?
As I have been pointing out this entire year, cash flow in the construction industry is a relentless day-to-day problem because of the complex nature of construction business transactions. In the same way that you need a team of superintendent and foremen to plan and execute a construction project, you need a team of financial professionals to plan and execute your finances.
Complex Does Not Cover It
Let’s take a journey from the inception of the construction business transaction to the conclusion of a project and final payment.
- The selling price of each project is estimated in advance with a downward pressure and bias applied by the competitive bid transaction. We need to be careful that our desire to get the work does not compromise the integrity of our estimates. We haven’t even begun to build the project, and we’re already at risk of underestimating expenses to lower the bid to win the work.
- The numerous expenses are almost breathtaking with fees, multiple subcontracts, payroll, materials, overhead costs, etc.–all estimated in advance. Only a financial professional could conceivably factor in inflation, the discounted future value of delayed payment, and the expense of financing the project without the customer reimbursing the value of the interest.
- Profit and loss must be tracked monthly after a complex project is underway, but it can only be estimated by the percentage of completion method required by construction accounting. Only an experienced construction Chief Financial Officer, devoting his/her complete attention to the methods used to estimate both revenues and expenses, could begin to even come close to an accurate monthly profit and loss statement.
- To accurately track the flow of cash through a construction company monthly, the CFO must assign the Statement of Changes arrived at through the direct method by accounting professionals on his team.
- The CFO must discipline daily the accounts receivable and the accounts payable process to ensure that all invoices are recorded on a real-time basis, and that accurate invoices are sent to the owners on the day allowed by contract.
- The CFO must also demand timely payment as stated in the contract. If cash flow lags due to slow, contentious payments on the part of the owners, or due to delayed billing on the part of the accounting department, the cost of capital balloons behind the scenes and can easily push a project into the loss column.
- The CFO must aggressively manage the payment of retention. Often the owner or designer will hold the retention for months after the time specified in the contract claiming they need to ensure the project is completed satisfactorily. Ten percent retention is a lot of money for any size contractor. (Readers may want to review Ch 5 Getting Paid for Your Work in my recently released book; (Construction Business for the 21st Century.)
- Finally, the CFO must manage these complex financial variables simultaneously on multiple projects at various stages of completion to come up with a consolidated monthly Profit and Loss statement, a Balance Sheet, and a Statement of Changes.
Need I Say More
If any of the thousands of failed contractors that I worked with had a team of financial professionals watching their money they would not have suddenly run out of cash and failed. The short summary above of the complexity of the construction financial transaction should be enough to convince any remaining doubters that without a team of financial professionals managing the business when a contractor has multiple projects underway, he/she is at continuous risk of sudden failure.
The complex financial nature of our industry demands that successful contractors employ an experienced Chief Financial Officer and include him/her in all top management decision making.
Next week we’ll go over a self-audit of your company’s financial competence.
For more information on getting paid, read more at: PAID
For a broader view of financial management & risk, read more at: RISK
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.
