Accounting | 04/26/2012
By Frank Hogg, CPA
Partner-In-Charge, RubinBrown’s Construction Services Group
While the overall economy has shown some signs of improving, the construction industry remains in very difficult economic times.
Though many agree that the recovery will be far from normal, the general consensus is a long and slow recovery of construction markets. Funding for many projects remains a challenge resulting in cancelled projects or delays in getting started.
In addition, increased budget constraints are expected to result in decreased federal, state and local government spending. This public spending had helped to sustain many contractors during the early part of the construction slowdown.
Cash Flow Management
As the construction economy slowly moves toward recovery, big challenges still face contractors. Maintaining a strong cash flow remains critical. Cash is king and it bears repeating that more contractors will go out of business because of poor cash flow than from a lack of work or fading profits.
During lean economic times, a natural tendency is to take work — any work — at little or no margins just to utilize company resources. Such practices may put serious strains on a company's finances if done on a regular basis. Effective cash flow management can actually occur when contractors decline to bid on certain low margin jobs.
Contractors should also be careful on bidding work outside of their "sweet" spots or areas of expertise. These challenges could include both technical and geographic. If a contractor is unfamiliar with certain types of work, they may not have the technical expertise to properly execute and safely perform the project, or leave important areas out of their bid. If a company is operating in an unfamiliar region, geographic hurdles could include labor and state/local regulatory approvals.
Customer and Subcontractor Health
In today's challenging economic environment, it is critical to carefully monitor doing work with others that may be on shaky ground and could still go out of business. For contractors, it is important to diligently research potential customers, looking at work previously performed, payment history, credit, character and ethics.
For general contractors, it is important to pre-qualify subcontractors and vice-versa. All parties need to closely scrutinize the financial stability of those that you will be working with - your success and profitability on the project is entwined with theirs.
Collections & Change Orders
Maintaining and improving cash flow also revolves around a strong collections function. Collections must be a daily mindset and not an end of the month activity. This mindset begins with the fact that collecting your accounts receivable is a right and not a privilege.
It may help delivering large invoices in person or personally collecting checks to help reduce excuses and delays. Although it may involve offending a customer, the rights of the company must always be protected. With already low margins, delays in receiving payments or failure to collect for all work performed could be disastrous to a company's cash flow.
Other cash flow areas to focus on include change orders and retentions. Change orders should be monitored closely. For scope changes, encourage signed authorizations in the field before beginning work to reduce subsequent disputes on billings arising from change orders.
In addition, the retention percentage and phase out period should be carefully negotiated. In order to speed up recovery of the retention as soon as possible, it is important that contractors focus on being great "closers." All punch list items should be quickly completed along with understanding and exceeding the final expectations of the customer.
Questions To Ponder
Although the recovery for the construction industry is moving along much slower than any of us would like, we should continue to plan for the time when this cycle finally arrives.
Will we have enough cash to support a rapidly expanding backlog? Have we established lines of credit and are they sufficient? Do we have adequate bonding capacity? After downsizing our workforce and cutting overhead expenditures, when and how quickly should we expand?
These are all critical questions that should be addressed with your accountant, banker, surety agent, and attorney to ensure that your company is in the best possible position to capitalize when economic conditions become more favorable.