HOW CAN A CONSTRUCTION FIRM MAINTAIN HEALTHY CASH FLOW YEAR-ROUND?

Todd A. Feuerman, CPA, CCA, MBA
Director, Chair of Construction Services Group
Ellin & Tucker

The construction industry is a very demanding, challenging and somewhat unpredictable business environment. Not only is the work sometimes difficult, but collecting bills takes tireless commitment, and paying subcontractor bills is equally challenging. Maintaining healthy cash flow centers around a few key concepts:

1. Protecting the balance sheet. As with personal finances, it’s vital to ensure a company’s balance sheet can handle the ups and downs of the construction industry. Be sure to build cash reserves, have access to available credit lines, and implement aggressive billing and collection programs while closely monitoring the outflow of cash.
2. Protecting the workforce. It’s no secret the construction labor market is tight. With this is mind, be mindful of protecting your workforce through proper compensation programs, and realize that paying a slightly-higher-than-market rate is much more cost-efficient than having to find and train a new employee.
3. Monitoring key financial cash flow metrics. A wise and attentive contractor pays attention to several key financial indicators very closely in order to protect the financial health of the company:

• cash position greater than 5% of annual revenue;
• minimal net under-billing on work in progress;
• tangible working capital greater than 8% of annual revenue; and
• equity greater than 10% of annual revenue and a proper bank line of credit availability of at least 10% of annual revenue.

“Cash is king,” and ensuring healthy cash flow throughout the year takes hard work, commitment and a focus on prudent financial operations and oversight.

Larry May
Partner
Carr, Riggs & Ingram CPAs and Advisors

To maintain a healthy cash flow, construction companies should consider the following:

• Bill as aggressively as possible within the contract terms. This allows the construction project to cash flow itself. The sooner you bill, the sooner you get paid.Work your receivables—as with all things, the squeaky wheel gets the grease. Make sure you are continually calling about old receivables.
• Follow the “pay when paid” clauses of your contracts. Often contractors have good relationships with subcontractors or suppliers and pay as billed to keep them. However, it is always a best practice to follow the “pay when paid” clauses to keep the cash that is yours.
• Finance equipment and vehicles for three or more years and follow the payment schedule of the note. Due to the general belief that debt is bad, contractors often pay cash for equipment or pay off loans earlier than required. By doing this, they are diminishing their working capital and cash reserves.
• Avoid prepaying for insurance or other expenses that you can pay over time.
• Exercise caution when investing in equity securities. Due to volatility in the stock market, you could lose a portion of your investment. Bonding companies usually discount equity securities by 20% or more in calculating discounted working capital.
• Bypass purchasing non-operating assets in the construction company. Although many contractors enjoy deep sea fishing, duck hunting and other hobbies, funding these activities within the construction company depletes cash while not contributing to earnings.

Joseph Natarelli
National Construction Industry Group Leader
Marcum LLP

For construction companies, management of cash flow may just be the deciding factor between your continued success and stagnation. Typically occurring in the later stages of projects, cash flow mismanagement can be extremely difficult to recover from. Strategically managing cash flow should be top-of-mind at the leadership level of your organizations with systems in place for consistent monitoring. That said, here are our top seven steps to get you started:

1. A strong accounting department and/or a partnership with specialized construction accountants can yield strategies to defer tax payments in order to free cash for project completion or growth.
2. Tracking the status of overbilling and underbilling in a timely manner on a job-by-job basis will catch issues early.
3. Routinely monitoring project and company cash flows can reduce project completion cash flow deficits.
4. Key ratios such as days sales outstanding, accounts receivable turnover, retainage balances, working capital, debt-to-equity ratio and project gain/fade can help identify significant and potentially negative issues early, enabling resolution before real damage occurs.
5. Investing in the proper infrastructure internally is necessary to ensure the availability of accurate and timely information.
6. Strong internal controls should include timely communication between project management and accounting department.
7. Working with other experienced professionals such as CPAs, attorneys, sureties and bankers who are experts in the construction industry can assist in identifying potential problems before they become critical.

By implementing these steps, you can identify red flags promptly, thereby increasing your chances of a healthy cash position.

WHAT ARE THE TOP THREE ACCOUNTING PRACTICES A CONSTRUCTION FIRM SHOULD ADHERE TO?

John Rosch
Regional Sales Manager
Explorer Software

The top three accounting practices a construction firm should adhere to are budgeting, buyout and pay when paid.

With budgeting, for every project there should be a standard practice for the estimator to review the estimate with the project manager. The project manager should take the detailed estimate and build a project budget broken down by phase and/or task. This allows you to run weekly budget vs. actual reports to determine your profitability. Actual results should be shared with the estimator for future bids.

Every project should be bought out as soon as possible to lock in pricing for materials and subcontractors. Purchase orders and subcontracts should be issued. These commitments can ensure timely delivery and on-schedule performance by subcontractors. The buyout portion is not complete until a purchase order has been acknowledged and the signed subcontract has been returned.

Your major vendor project invoices and monthly subcontract payment applications should be tied to your billing to the customer. Payments to vendors and subs should only be made when the payment from the customer has been received. This practice will help you improve cash flow, and it also guarantees the customer has not short-paid your billing for a portion or all of a vendor’s material or a subcontractor’s work.

All three practices provide a measure of control for every project, which will lead to higher margins.

Mike Ode
CEO
Payroll4Construction.com

For the top accounting practices, contractors should prioritize the “ABCs”: allocating overhead, budgeting projects and cash flow reporting.

First, contractors need to get a true picture of their project profitability by applying overhead costs to their jobs. These include indirect expenses, which go into project operations, as well as the costs of operating the company as a whole—known as general and administrative costs. They’re the hidden costs of running a construction business, and by applying them to job cost measurements and bidding, contractors can be sure that they’re fully accounted for in each of their profit centers.

Of course, one of those key job cost measurements is a detailed job budget maintained for each project. Tying costs, labor and productivity to individual projects and specific cost areas is the only way to reliably measure where your profitability and productivity is being affected. Budgeting out your jobs to cost codes and cost types helps to monitor progress, control costs and protect against profit fade.

Finally, cash flow reporting is essential to ensure you have enough operating capital to get through each of your projects. It’s not enough to know you’ll make a profit at the end if you subtract your total costs from your total billings—you need to know you’ll have cash on hand every week to make payroll and finish. Cash flow reporting in construction should be done at both the company and job level. With long billing cycles typical in construction, it’s imperative you know at every point both where cash is going out and when it’s coming in.

All of these work together to give contractors the foundational practices they need in order to keep a basic handle on the success of their business. And while there are numerous additional practices contractors can implement, everything begins with the ABCs.

Louis Sandor III, CPA, CCIFP
Partner, Practice Leader of Construction Services Team
WithumSmith+Brown

Construction companies should:

1. follow the percentage of completion method of accounting under the new revenue recognition standards;
2. allocate bid estimates correctly across performance categories; and
3. establish and operate under sound internal controls and cybersecurity measures.

First, and most importantly, the company should follow the percentage of completion method of accounting under the new revenue recognition standards, effective Jan. 1, 2019, for private companies. Accounting for job phases, claims, extra work orders, inventory, change orders, mobilization and startup costs should comply with the new standards. Consistent and standardized procedures among all jobs help project managers understand the importance of their role in financial reporting. Additionally, accounting principles require company job costing, billing and internal accounting processes to match the cost codes for each budgeted construction line item and performance obligation.

Second, the company should accurately break down awarded job bids into performance categories. Costs in the system are then easily comparable to budgeted amounts. This process makes field supervision and project managers accountable and responsible for job performance. It also enables them to easily defend claims and obtain additional work approvals.

Third, the company should establish sound fraud prevention internal controls and cybersecurity measures. As technology is introduced rapidly into the brick and mortar industry, fraud and cybersecurity breaches are becoming more frequent and should be top of mind for owners as the fallout is costly.

Companies should approach their CPA firms for advice with these types of challenges.

Joseph Gleba, CPA, CCIFP
Partner
Porte Brown LLC

Cash is King
Having an abundance of cash can make running a construction business that much easier. Some ways to accelerate and maintain positive cash flow include:

• timely billing and collection of receivables;
• utilizing electronic billing means to accelerate payment submittal requests;
• modifying contract terms to allow for advance paydowns on retentions as jobs near completion;
• monitoring equipment operating and repair costs and identifying idle or obsolete equipment that is incurring ongoing cost;
• negotiating financial debt to the most favorable terms by lowering interest rates or modifying payment terms to preserve current or future cash outlays;
• structure liability payments to stretch out due dates; and
• avoiding late payment penalties or interest.

Close Out Jobs in a Timely Manner
Jobs are competitively bid, resulting in low or tight margins. Don’t let profits slip away by not closing out jobs in a timely manner. Finish and submit final change orders and pay requests.

Communication, Communication, Communication
To be successful, all team members need to be on the same page. Accounting, estimating, project management and field supervisors all need to be working with the same up-to-date information and resources. Utilize technology and each team member’s expertise to achieve management’s goals and ultimate success.

Bryce Wisan
Partner
Eide Bailly LLP

A strong accounting function can provide valuable information about a construction company and can help minimize risk.

1. Keep a current WIP schedule. This requires regular, meaningful communication between operations and the office about how projects are going in the field. This communication will help keep billings current, help prevent billing mistakes and missed billing opportunities, and help the office track change orders. Consider also using the WIP as the starting point for a cash projection.
2. Track project activity versus estimates. Doing so can identify project performance issues, help prevent theft and other wasting of resources, and help office staff identify and properly track change orders.
3. Monitor project level cash flows. Many successful contractors work to keep cash flow positive throughout the life of the project. Some contractors carry excessive project costs for the owner or prime contractor due to poor billing practices, inaccurate accounting records and incomplete payment applications, which often cause margin erosion and cash flow stress.

Linda Roberts
Principal
BerryDunn

Our top three accounting practices for construction firms focus on keeping your business healthy, both today and well into the future.

1. Develop a robust process for a period’s close that drives accurate reporting throughout the year, eases your year-end time crunch, and avoids surprise material adjustments at or after year-end, which banks and sureties dislike. Knowing where you stand here and now is critical to properly planning for your future tax concerns, cash demands and recruiting needs. Our teams visit client jobsites during our audit procedures to gain an on-the-ground understanding of our clients’ business challenges.
2. Build contract schedules with input from the estimating, project management and finance departments. As the saying goes, “it takes a village” to assemble optimal cost-to-complete estimates.
3. Conduct comprehensive industry benchmarking assessments. Benchmarking that is baked into budgets and consistently applied can help your management team set useful mile-markers that enable them to measure the progress of pivotal business improvements.

Of course, countless other areas demand close consideration—from strategic planning and contract review, to joint venture planning and revenue recognition.

Getting an informed, 360-degree view of your financial environment is key, with an eye on understanding and planning around emerging industry trends, new regulations and shifting economic forces.

WHAT KIND OF FINANCIAL DISASTER PLAN SHOULD A CONSTRUCTION FIRM HAVE IN PLACE?

Fred Ode
CEO/Chairman
Foundation Software

The single most important financial disaster plan is cash. Looking at typical market cycles, the economy is poised to shrink again anywhere in the next six months to three years. Few people will agree on when exactly to expect it, but no one can doubt that it will affect construction. And in lean times, you can’t beat having cash reserves to be able to draw on, both to carry you over into better days and to keep you competitive when others pull back.

When 2008 hit, we saw firsthand as well as any contractor how the recession decimated sales. A lot of competitors began cutting back. But because we had built up cash reserves for just such a time, we accelerated our R&D spending and seized an opportunity handed to us by a challenging economy. By the time the market lifted, they were limping and we were off at a sprint.

That said, cash isn’t easy to come by in construction. Thin profit margins and common cash flow issues mean that a lot of companies depend on the next project for billings they may not be getting on the last project. Contractors should be reviewing cash flow statements with their CPAs to make sure they’re not overextending themselves with the economic expansion, because if they’re not able to squirrel cash away, they may not survive the next financial winter.

Preparing for the economy to slow has to be a first-order priority for contractors today. It’s tempting to go after any new business you can get. But being selective on the contracts you bid and ensuring you have the estimating, billing and cost control processes in place to keep a healthy cash flow and profit margin can put you in position for a much bigger opportunity down the road, however the economy turns.

Jill Bosco
Managing Principal of Construction
CLA (CliftonLarsonAllen)

A construction firm looking to avert financial disaster should create a contingency plan while economic times are good. Creativity amid a crisis is challenging.

The contingency plan needs to be guided by the strategic goals of the organization. Planning begins by researching how, why and when the contingency plan will be put into action. Leaders should consider the cumulative effect of changes when evaluating operating costs, discretionary spending and personnel costs. The order in which actions and changes will take place is best determined before a crisis.

The plan should also consider the reliability of vendors and the availability of material resources during an economic downturn. Leaders must identify alternative material suppliers and consider their contractual obligations if materials are delayed.

One of the key elements of a contingency plan is prioritizing capital expenditures. Reviewing and forecasting cash reserves will help determine the most critical expenses. A 12-month financial model built out for various “what if” scenarios will equip organizational leaders to make informed decisions.

A well-developed plan establishes project teams that are responsible for communicating and implementing decisions. Coordination and solid communication among the teams is imperative.

Finally, a contingency plan is not static. Plans should be reviewed, refreshed and revised as business circumstances evolve.

HOW CAN ACCOUNTS PAYABLE AUTOMATION IMPROVE A CONSTRUCTION FIRM’S ACCOUNTING PRACTICES?

Bill Gustaw
Team Leader, Solutions Group
CMiC

In the last decade, “going paperless” has become the anthem of digital transformation. Although the construction industry was not—and in many regards, still is not—an early adopter of technology, forward-thinking AEC firms are now realizing that the viability of projects depends entirely on the ability to anticipate and prepare for variances in costs and schedules.

To accomplish this, the accounting departments of construction firms must indeed go paperless and begin automating their business processes to deliver real-time data and insights. Thankfully, the increasing adoption of cloud-based ERP software solutions—purpose-built for construction—is redefining how construction firms deploy best practices to manage their financials.

Introducing accounts payable automation will not only drastically improve a construction firm’s accounting practices, but boost its productivity overall. With paper invoices, the likelihood of working with outdated information from redundant data entry; the physical paper shuffle between desks; and the manual printing and copying of checks collectively introduce avoidable inefficiencies and unnecessary risk.

With a system that automates AP, construction firms can gain full visibility into their organization’s live spend patterns and the processing status on every invoice. Specifically, they can know—on a real-time basis—when invoices come in, where they are and which balances are outstanding—and validate that the relevant costs appear where they’re supposed to in their budgets and estimates.

Construction firms can only begin to take control of their financials once they learn to fully trust their data. After all, there is some truth behind the notion that construction companies are really accounting firms that just happen to build buildings.

WHAT ARE THE TOP OPPORTUNITIES FOR CONSTRUCTION COMPANIES TO PURSUE FOLLOWING FEDERAL TAX REFORM?

Phillip Ross
Partner and Practice Leader, Construction Industry Group
Anchin, Block & Anchin LLP

While the Tax Cuts and Jobs Act of 2017 (TCJA) has had a significant impact on all businesses, construction companies in particular are in a strong position to potentially benefit from the changes. Companies within this highly competitive industry need to be proactive and strategically plan for their future to address project cycles, cash flow, financing, bonding and operational issues unique to each company.

Some of the top opportunities for construction companies to consider include:

• Beginning in 2018, the average annual gross receipts exception to the requirement to use the percentage-of-completion accounting method for long-term contracts has increased from $10 million to $25 million for contracts entered into beginning in 2018. Businesses that meet such an exception would be permitted to use the completed-contract method (or any other permissible method).
• Under prior law, net taxable income from construction pass-through business entities (such as sole proprietorships, partnerships, S corporations and LLCs) was passed through to owners with a 9% deduction based on their activities. It was then taxed at the owner’s tax rates. For tax years beginning in 2018, construction company owners could be eligible for a new 20% deduction, based on their qualified business income (QBI). QBI does not include compensation paid to an owner for services rendered to the business, or any guaranteed payments to a partner or LLC member. Those compensation levels may be reassessed to maximize the QBI deduction for profitable pass-through entities.
• Construction companies can have difficulty managing and strategizing cash flows. Under prior law, taxpayers had several requirements and limitations related to the use of the cash method of accounting. Many of these limitations have been loosened or removed for companies with less than $25 million in average annual gross receipts under TCJA, resulting in a major potential.

IN WHAT THREE AREAS SHOULD CONSTRUCTION COMPANIES FOCUS THEIR ENERGY TO OBTAIN HIGH GROWTH?

Brian Bohman
Partner
Wipfli LLP

Labor Shortages: Attracting, acquiring and maintaining talent has become a challenge due to fewer individuals entering the trades. Contractors are developing deeper relationships with schools and trade organizations, investing in training and apprenticeships, and even hiring recruiters to address shortages. They are also looking at their compensation and benefit plans including incentive arrangements.

Technology Adoption: Technology is and will continue to change the construction industry. Technology applications are available to help contractors access information on-demand, eliminate paper-based processes, conduct training, improve communications between technologies and collaborate more efficiently between field and office environments. Those early adopters of technology will obtain a competitive edge.

Succession: Proactive succession planning is key to ownership transition. Whether it is to family or key employees, owners need to know available options, how to value the business and what structure is most advantageous without burdening the business with debt. The more proactive a contractor is, the more successful the transition will be for both parties.

WHY SHOULD A CONSTRUCTION ACCOUNTING PROFESSIONAL REVIEW DOCUMENTS SUCH AS CONTRACTS AND EMPLOYEE BENEFITS PLANS?

Michelle Eastman
CFO
North Mechanical Contracting and Service

When it comes to contracts and employee benefits plans, it’s a good business practice to have a construction financial manager (CFM) review these documents. With their vast experience and knowledge of accounting standards, cash management and risk management, CFMs bring a unique perspective to the document review process.

As the company’s financial expert, the CFM can thoroughly analyze how proposed contracts and employee benefits plans will impact the company.

For example, a CFM reviewing a proposed contract may note a proposed net 90 turnaround in payment terms. Having a high-performing CFM on staff who reviews this contract can address if the net 90 terms proposed can be negotiated down to net 30. And should net 90 be non-negotiable, the CFM can assess the ability of the business to fulfill all contract requirements under the net 90.

After the CFM has reviewed a contract or benefits plan, the implications of the contract terms (both positive and negative) can be shared with the company’s executive team. The CFM can advise the team of all financial risks so an informed decision can be made.

It goes without saying that because the negotiation of contract terms is, without a doubt, always easier when addressed prior to contract execution, the earlier a CFM is involved in the contract review process, the better.

WHAT ADVICE WOULD YOU GIVE A CONTRACTOR REGARDING THE NEW REVENUE RECOGNITION ACCOUNTING RULES?

Tony Hakes
Lead Managing Director and Shareholder
CBIZ & Mayer Hoffman McCann P.C.

If you have not started the implementation process, you need to as soon as possible. The new revenue recognition rules are effective for 2019 and will need to be reflected in your year-end financial statements that you give to your bank and surety.

If you wait until year-end, the implementation process will be piled onto your other year-end procedures such as providing financials to your surety and banker, and filing tax returns.

In my experience, while the implementation process is time consuming, generally it will not result in significant changes to how revenue is recognized, although it may lead to changes to internal controls and processes. The key is to get started now.

HOW MUCH OF A PRIORITY IS DIGITAL TRANSFORMATION?

Robert G. Nagle, CPA/CGMA
Principal
Rehmann

As a professional advisory firm, we strive to keep businesses in step with current trends, and digital transformation of processes continues to expand throughout business operations. Cloud and subscription-based software and new digital solutions continue to emerge and improve. This is true in accounting, time and attendance, human resource management, payroll processing, jobsite safety and many other software tools critical to an organization’s operations.

There are often surprising financial and efficiency benefits of engaging in transforming an area. Transformation requires documenting and understanding every step of existing processes, which are scrutinized for unnecessary steps and for where critical controls exist or are needed. This leads to streamlining and building a secure digital process, which provides for documented performance, approvals and secure digital document retention, eliminating paper storage and providing instant access to documents when needed.

Think accounts payable or payroll to start. Does your field labor enter time with mobile devices? If this is not already in place, you are behind some of your competitors. And chances are your organization is incurring needless hours manually compiling hours and job costing details, with risk of error. Younger workers embrace automation and feel confident the organization is investing in the future.

Many construction projects now work from inception to completion with no paper documents produced. Beginning with the bid process, if you are not planning for a technology-based approach, what happens to your sales when these requirements face your organization for the first time?