Cash is Slippery
For the past few months we have been dealing with the risk factors hidden in growth markets and the risk mitigation techniques that construction management might employ. Now it is time to cut to the chase and identify the mother of all risk –
RUNNING OUT OF CASH.
When your company runs out of money you are finished. Nothing could be more obvious yet in all the project and company failures we have analyzed over thirty years of research, the most surprising and inexplicable factor was that in most cases management didn’t see the failure coming. They were genuinely surprised when their company collapsed. Suddenly there was no money left to meet the payroll and they had to throw in the towel. How could businessmen of this caliber not realize that they were about to run out of cash?
At first, we believed that managers must have known that they were about to run out of money, but they chose to stay in denial. However, countless interviews with departing management revealed that most of them were completely surprised when the end came. They either didn’t believe their CFO or didn’t know how to read the financial information they received. In some cases the CFO did not produce timely financial statements that would red flag a working capital crisis. In any event, much to our surprise, senior management was frequently caught off guard and shocked when the coffers were emptied.
In a recent book from the Harvard Business School, How Finance Works: The HBR Guide to Thinking Smart About the Numbers, April 23, 2019, Miihir Desai sets out to demystify finance and instill both curiosity and confidence in managers to ask fundamental questions like: What do financial ratios reveal about a company? How much value does a particular company create? And, what’s the best way for CFOs to communicate critical financial information to management?
Desai says, “People think finance and accounting are fundamentally the same when, in fact, much of the finance approach is a reaction against accounting. If you take the information problem as central, then measuring cash becomes important, as profits can be manipulated. Moreover, many of the central principles of accounting, including accrual accounting, effectively smooth out performance and deliberately obscure the inflows and outflows of cash. The modern finance approach is to return to cash via various metrics that have grown ascendant over the last three decades—EBITDA, operating cash flow, and free cash flow” … Finance is often talked about in an overly complicated way. This serves the interests of those in finance as they benefit from the obfuscation; it creates more mystery about what they do.”
The book makes the point that, rather than seeing finance and accounting as a tool they can use to better manage their company, managers tend to ignore the CFO because he is not speaking their language or telling them what they need to hear. Desei is speaking, of course, to management across all industries not just the construction industry, but he certainly explains how construction senior management could be surprised when their companies fail for a lack of adequate cash.
Construction Company Self-Analysis Program
During the many years of completing failed construction projects for sureties who were on the hook for completion bonds, I analyzed the construction companies I worked with to discern the individual management practices (or the lack thereof) that seemed to contribute to their failure. From that data I designed a Construction Company Self-Analysis Program that, through a series of yes or no questions, enables construction management to analyze their own management practices and take steps to mitigate their risk of failure. Note the questions that are right at the beginning of the program:
1.1 – Does senior management have a positive working relationship with the firm’s CFO?
1.2 – Is the CFO knowledgeable/qualified in construction accounting?
1.3 – Does management trust the financial information produced by the CFO?
1.4 – Is the CFO regularly included in top management meetings?
Cash Flow Management
3.1 – Is cash flow a major consideration in all corporate planning?
3.2 – Is cash flow a consideration in all project planning?
3.3 – Does management use three to six-month cash flow projection?
3.4 – Is impact on working capital considered in accounting and management decisions?
Don’t YOU be Surprised
The entire Construction Company Self-Analysis Program is available at no cost here on the Simplar website. Feel free to take a look and confidentially analyze your own risk of catastrophic failure.