Working Capital Engineers
Thomas C Schleifer, Ph.D.
No sane construction professional would prepare a bid or start a job without input from the estimators, designers and/or engineers, and project managers. After scrutinizing specifications and understanding quality standards, this team supervises the work and polices it for compliance. No construction project would get from conception to successful completion without their efforts.
Working Capital Engineers
An oft forgotten team member that is, nonetheless, essential to the construction firm’s success as the company takes on new projects is the “working capital engineer”. Who? The “working capital engineer,” better known as the Chief Financial Officer. CFOs can engineer the working capital of a construction firm to ensure an adequate supply of working capital is available to complete impending projects. They should be working side by side with the estimators, designers, and project managers to supervise the cash flow required to fuel external growth.
Not a Normal Business
Normal industrial companies finance external growth with equity capital provided by stock investors. Unlike these common publicly traded companies, who have an abundance of cash on hand in the form of equity capital to fund growth, construction companies must generate working capital from ongoing business activity. This is a tricky, complex balancing act that can only be performed by a financial professional who manages a construction company’s working capital flows from a variety of interrelated, fluctuating business activities. As I noted last week, a typical construction company’s working capital formula is:
Initial owner ‘s equity + current assets + retained earnings + bank lines of credit + front load payments + progress payments + vendor’s and supplier’s payment terms – cost of extras in dispute – retainage – delayed progress payments – net loss on recently completed projects = working capital available.
No Easy Answer
Construction’s ongoing business activity typically includes growth. Since there is not a big pot of public equity capital sitting on the balance sheet, all new business must be financed through cash flow management, and this is where the experienced CFO comes in.
Over the years, I have been asked what I thought was a safe working capital to growth ratio for the average construction company. I have never been able to come up with an industry-wide metric because working capital requirements vary from company to company – from job to job – from element to element, such as size and type of project, etc. Only the construction organization’s experienced CFO can estimate the contribution of each working capital element to each impending job going forward.
Even the Variables are Variable
Every element of working capital varies from company to company, from job to jo, and must be assessed by the CFO individually.
- Initial owner’s equity + current assets + retained earnings: These three elements are fixed at any point in time and can be used at face value.
- Bank lines of credit – The CFO needs to establish a close trusting relationship with the company’s lenders and be able to present the company’s credit status in a positive light to ensure that they can secure the amount of working capital their analysis of the working capital elements tells them the company will need to safely complete projects going forward.
- Front load payments – This important source of working capital should not be overestimated. Its quality depends on the timing of future progress payments.
- Progress Payments – Every owner represents a different payment profile. The CFO should analyze the payment history of every prospective client as well as ensure that the accounting department bills accurately and on-time, and that they demand payment according to contract terms.
- Supplier’s Payment Terms – A close relationship with the company’s suppliers can enable a savvy CFO to negotiate favorable terms if their cash flow is endangered by slow or interrupted progress payments.
- Cost of Extras in Dispute – Every job involves extras. Often completion and quality are in dispute and payment is delayed or evaporates. The CFO should analyze his company’s performance history in this area and the project owner’s history of contention and litigation. A realistic appraisal can provide a working capital safety net.
- Retainage – This amount is often unreasonably large with payment delayed for an extended period. The experienced CFO will carefully calculate the cost of this element and recognize its impact on working capital in advance of contract execution.
- Recently Accumulated Net Losses – Often overlooked because the final bills on the jobs wrapping up have not been accounted for. The experienced CFO will carefully estimate this negative impact on their ongoing working capital.
Your team is on the field without a safety net if you do not have a “Working Capital Engineer” (expert) on your side.
Next week some important data points.
For a deeper look into strategic project planning, read more here: STRATEGIC PROJECT PLANNING
For a broader view into the role of CFOs, read more here: CHIEF FINANCIAL OFFICER
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