The process of estimating and preparing bids is one of our most essential management tasks, including direct and indirect costs. Professional estimators have a detailed knowledge of construction materials, specifications, techniques, codes, and pricing trends as they go through the following procedures:

  1. Review bid package.
  2. Conduct a site visit.
  3. Perform a material takeoff.
  4. Solicit pricing from suppliers and vendors.
  5. Evaluate labor requirements.
  6. Determine insurance and bonding costs.
  7. Calculate overhead and indirect costs.
  8. Account for profit and contingency.

Most contractors have replaced the business functions of budgeting and planning with job estimating. After pricing, winning, and the work is underway; they see little need to overlay a thorough professional estimate with additional budgeting. This is a primary reason cash flow capacity is overlooked and why contractors are exposed to running out of money in the middle of profitable work. Few estimates include a cash flow plan.

Cost vs. Capacity

Contractors depend on accurate estimates to be competitive and profitable.

  • Underestimating the cost of a project forces us to cut into our own profit margin to cover project costs. 
  • Overestimating project costs prevents us from getting the job. Even in negotiating scenarios, our estimates need to be accurate to strike a balance between the owner’s budget and our profit. 
  • However, our capacity to finance an ongoing project is not addressed in either case. 

The Ability to Finance the Job

For the past three weeks we have been discussing the unseen burden imposed on contractors to not only build a project but also to finance it. Estimators assess our capacity to build a project for a profit but are not given the responsibility to assess our ability to finance the project during construction. Once we have signed a contract, we consider the ability to pay the related costs as given because the owner pays us and we pass payment along to subcontractors, workers and suppliers; simple and self-evident.

Not So Fast

As the expression goes, timing is everything in life. As we discussed last week, the contracting financial transaction is complex. 

  • It is not simple cash payment as in most commercial transactions where at the point-of-sale payment terms are generally sufficient to finance ongoing expenses. Our construction accounts payable are offset by our accounts receivable and any mismatch must be financed by our cash on hand or credit. 
  • We must also finance immediate costs in advance of the owner’s progress payments (wages, fees, ongoing overhead, equipment payments, taxes, etc.)
  • Our progress invoices are estimates of work partially completed, not funds expended, or costs incurred. And during the second half of the project (when front load runs out) they rarely match the actual cash expenses, and the variance is paid out of cash on hand, borrowing, and/or delayed payment of accounts payables.
  • We regularly finance this cash mismatch with a working capital line of credit. These credit lines must be fully repaid to the bank annually and have a predetermined limit based on our credit worthiness rather than our cash needs to finance multiple ongoing projects.
  • This gap between capacity and need is why I constantly caution contractors about growing too fast. Our financial capacity is determined by the size of our current business, not the potential size AFTER we take on larger projects.

Estimating Cash Flow Capacity

The only protection a contractor has, large or small, is to continuously calculate their ongoing cash flow capacity, particularly when considering going after a larger project. This is a simple calculation added to the already highly complex computations that competent CFOs produce. A simple cash flow capacity estimate might include:

+ Cash on hand

+ Other current near cash assets

+ Unused portion of accounts payable

+ Unused portion of working capital line of credit

– Increase in accounts receivable

– Current wages due

– Current overhead expenses due

= capital available for ongoing operations

A calculation like this is only useful if it is done in advance. As a report many contractors may see this as limited value and even an unnecessary constraint. CFOs can pull a simple calculation like this together every 30 days or even more often in a highly volatile, complex company running multiple jobs simultaneously. 

Too few contractors follow budgets or even have one. Somehow getting the work and growth has become more important than the primary responsibility to protect the business (particularly in an industry with the second-highest failure rate). Next week we will inspect this unique business through an even closer lens. 

For a deeper look into cash flow,  read more here: CASH FLOW

For a broader view into business failure, read more here: FAILURE

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