Working Capital Q&A

Thomas C Schleifer, Ph.D.

Our current series of messages on managing working capital during this post pandemic disrupted economy has ignited questions from every corner of the construction industry. Today I will endeavor to answer a sample and encourage anyone who has a question to send it along to me at tschleifer@aol.com, and I will attempt to answer as many as I can as soon as I can.

Question #1 from the CEO of a GC in the Northwest – Your recent message on working capital woke me up to a mistake I have been making my entire career. I have never been aggressive demanding payment for extras but let the designers or owners delay or postpone change orders and payments while they decide what I’m due. That’s about to change in my organization. Here’s my question – The reason I always surrendered in the past is I didn’t think I could change anything, and I feared the cost of disputes and/or litigation. Believe me, I did an awful lot of work for free. That needs to stop. What can we do about payment for extras when they crop up as they always do.

TCS – Change orders and prompt payment for extras cannot be handled after the fact. Your team needs to make it clear during initial contract negotiations that your company is not interested in extras. Explain that you’re not looking for extras as the project progresses, and that in your experience extras are caused by project owners or their designers. Advise them before the work commences that if anyone alters the design or specifications during the project the extra work will be quoted as quickly as possible, and that extra work will not be initiated until a change order is issued in accordance with the contract. (This may be unrealistic in practice but is an effective position to take and to attempt to maintain. The excuse from owners and/or their designers that “we can’t get COs out that fast is equally unrealistic.) In addition, advise that you expect to be paid promptly in accordance with the contract. This is the short answer but only taking this posture at the outset will protect you from slowness or nonpayment for extras and the resulting negative impact on your working capital. I don’t advise trying this on work in progress, because you have already set a pattern. This only works when you establish the ground rules (which are already in your contract) before construction starts.

Question #2 from an Electrical Contractor in the Southeast – My CFO always calculates and secures our working capital line of credit one year in advance. However, halfway through the year we often must go back in for an increase or extension because the owner or GC is wrestling with their own financial problems and not promptly paying for work we have completed. Sometimes we get an increase in the line and sometimes we don’t. When we don’t secure an increase, we’re really squeezed. How can we correct this situation?

TCS – At the beginning of each 12-month lending cycle every construction firm should be attempting to raise their line to the maximum working capital line of credit their bank will extend based on their current credit status whether they expect to need it or not. To maintain an increased line of credit you will need to draw down a good portion of your line for a short time (15 to 30 days) each fiscal year even if you don’t need it. This will cost you a little interest but if you don’t utilize a reasonable amount each year your bank may want to reduce the amount available the following year when you may need it. Your line of credit is a “tool”, a business apparatus, and the easiest time to advance it is when you don’t need it. A prudent contractor attempts to increase and maximize their line every year.

Question #3 from a Road Builder in the Midwest – We work throughout the Midwest. My CFO has recently suggested leasing much of our heavy equipment and even renting some that we don’t utilize more than 50% of the time. Is he right?

TCS – Absolutely. Working capital management is different for every contractor, but you’re in a capital-intensive segment of the industry and owning your heavy equipment ties up enormous amounts of working capital that would otherwise be available if you leased your equipment. Although leasing and renting at first appears to have a negative effect on profits, your CFO’s analysis will reveal that when you calculate the all-in cost of repairs, limited utilization, and inflation impacted replacement costs; leasing and renting some equipment (even all) is very often cheaper in the long run. And certainly, has a net positive effect on available working capital and your ultimate cost of capital.

Question #4 from a Surety Executive in New England – You’ve been talking about managing working capital in this post pandemic disrupted economy. The recent failure of Silicon Valley Bank and other regional banks who failed to manage their book of business during the Fed’s interest rate battle with inflation has caused a credit pullback by regional banks that will have a negative effect on the construction industry’s ability to borrow working capital. What should we be advising our contractor clients?

TCS – Hopefully the credit shrinkage at the regional banking level will be both incidental and temporary. However, contractors should recognize that this credit pinch may affect their ability to secure larger lines of credit. They should not be ignoring or denying the credit environment you describe because the amount of working capital a contractor needs going forward depends on the amount of work they plan to contract for in the next year or two. The prudent contractor will adjust their growth plans to the amount their CFO tells them they can finance even if the bank temporarily shrinks their working capital line of credit. Everyone needs to recognize and accept that working capital availability is a limiting factor on growth. Credit management is a critical skill qualified CFOs should be utilizing continuously to protect the financial stability of their organizations.

Additional detail on these issues available in my book The Secrets To Construction Business Success. See you next week.

For a deeper look into working capital, read more here: WORKING CAPITAL

For a broader view into managing cash flow, read more here: CASH FLOW

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.