Last week we discussed the irony of the construction industry’s traditional low-bid acquisition system. It seems you can’t win the game of making money if you pick up all your work by being the cheapest price. On the other hand, you can’t even play the game if you don’t get jobs by being the low bidder. Ironic.
Working Capital Dilemma
When you think about it, it’s insane to sign a year-plus performance contract for the lowest price the buyer will pay, then invest your own capital in the buyer’s asset as it emerges over the contract term, all before the buyer will grudgingly pay your costs. It may not be insane, but it’s a tough way to make a living.
This low-bid irony leads to an accompanied working capital dilemma that is not confined to start-ups but persists throughout the growth stages of all construction companies. While you’re putting up your own money to build the current project, the next job you acquire is going to require more working capital. As you stack one project on top of another, the working capital requirements begin to compound at an almost geometric rate. It is not surprising that busy contractors lose track of their working capital and have to scramble to stay afloat. This happens even after being successful for decades.
Some History
For many years I owned and operated the largest national consulting firm assisting sureties to complete projects interrupted when contractors ran out of money. My firm completed projects from thousands of failed contractors. During a recent interview I was asked the following questions:
Interviewer: “What was the main cause of the contractor failures you encountered when your firm worked for sureties?
TCS: “They simply ran out of money and could no longer make payroll or pay their subs and suppliers.”
Interviewer: “What percentage of all these contracting companies failed solely because of a shortage of cash?”
TLS: (My immediate answer) – “100%”.
Interviewer: “Wow! I’m surprised.”
TLS: “So were they. And that’s what surprised me.”
The Problem with Profit
Last week we discussed the erosion of construction industry profit margins through the persistent use of low-bid acquisition and the dilemma contractors face, who are trapped in that traditional business model. When profit margins are dangerously low from one low-bid job to the next, contractors cannot retain enough earnings to build up capital reserves. With low margins going in, too many projects end up using cash rather than supplying it. Some have ignored the reality that the low bid process can slowly put them out of business without them even realizing it. Therein lies the element of surprise.
Heads Up
Every time my firm was sent in by a surety, we would meet with a demoralized contractor lamenting: “How could I not know we were running out of cash? Who is responsible for this disaster?” Sadly, one contractor screamed at his accounting manager: “Why didn’t anyone in my company give me a heads up?” The accountant said: “I tried to tell you, but you wouldn’t listen.”
Running out of cash is a symptom not a cause. Being unaware of the true financial condition of your own company is the disease. Until we cure the disease, the symptoms will never go away.
A Widespread Disease
Ignoring the science of business management is a widespread disease in the construction industry. Contractors pride themselves on being builders, but few are trained business managers. Many don’t even recognize business management as a science. But as they advance their organization across the construction marketplace their company emerges in the background as a complex business organization. At that point, continuing to ignore business management principles can become fatal.
Is There a Doctor in the House?
I am convinced that the first management position that a contractor should hire is Chief Financial Officer. The CFO is the ‘doctor’ who can cure the disease of ignoring business principles and prevent the slow spread of capital erosion. In a successful construction organization, the contractor oversees the top line (revenues) while the CFO oversees the bottom line (profit). Without one, the other is at risk. Together they are almost unbeatable.
Next week we will discuss how the CFO prevents the fatal cash shortage surprise.
For more information on working capital dilemma, read more at: CAPITAL
For a broader view of the low-bid irony, read more at: LOW-BID
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Please circulate this widely. It will benefit your constituents. This research is continuous and includes new information weekly as it becomes available. Thank you.
