Step back in time, and there’s a good chance that most of the names in the construction business no longer exist. Of the more than 43,000 construction companies that started in the spring of 2011, less than 38% managed to stick around a decade later, according to data from the U.S. Bureau of Labor Statistics. More often than not, the closures boil down to one simple reason: money.
Avoiding money issues starts with having a solid understanding of where the cash is coming from. Milton Graugnard, executive vice president of Louisiana-based Cajun Industries, says the company is likely to take a different approach to a contract with an established industry leader that has a heavy balance sheet than the firm will with a client that isn’t as well-capitalized or is counting on a substantial chunk of outside investment to fund the project. The latter will likely be put under the microscope with additional questions to instill the necessary confidence to break ground.
In addition to evaluating an owner’s creditworthiness, Graugnard, who previously served as the company’s chief financial officer, highlights the need to consider some critical distinctions between lump-sum projects and cost-reimbursable work. “There’s a bit more inherent risk on lump-sum work,” he says.
When the firm is doing lump-sum work with a fixed number attached to the project, Graugnard says the key to cash flow is establishing a schedule of values and determining billing frequency. Some projects involve weekly billing, while others may be monthly. Payment terms may vary between 30 and 60 days. Despite all those differences, Graugnard says there is one commonality: Cajun is always aiming to avoid the need to dip into its own funds.
“As a contractor, it’s imperative to know how much cost you will have out in any month or two prior to getting paid to protect yourself,” he says. “You want to work on the owner’s money rather than yours.”
GETTING PAID ASAP
Part of working on that money relies on identifying every opportunity for upfront cash infusions. “A lot of times, you try to bill some mobilization costs to cover materials, bonding insurance, permits and other early-stage costs,” Caryl Coronis, chief financial officer at Texas-based NAPCO Precast and chair of the Construction Financial Management Association, says. “You need to think about the timing to recognize the revenue, though. You might have the cash, but you’re going to have additional expenses that might not come in until late in the project.”
In addition to getting those funds in the door as early as possible, Coronis often aims to find a way to bill for stored materials. Once NAPCO signs a contract, Coronis says the company will aim to buy out supplies to mitigate potential price escalation issues while getting paid for holding on to them. “We might not be able to bill for the full materials until reaching a certain point in a contract, but if we can get some money for material that we have purchased for the project, it helps our cash flow,” she says. “It can create some storage issues from time to time, but it’s worth it.”
CONTRACTUAL CONSIDERATIONS
While firms can take plenty of measures to know exactly what they’ll be spending and when, they typically lack control over one big potential problem: What if they aren’t getting paid on time? Data from PYMNTS.com’s Working Capital Tracker shows it’s a question that pops up for every construction leader: According to the research, 100% of construction companies report payment delays, and 27% of firms report that payments are received between 31 and 60 days past their initial due dates.
Graugnard recommends accounting for these delays when putting a legal framework in place for the work. “If you are not getting paid, the only way you can stop the spigot is by stopping work,” he says. “But in most cases, that’s a breach of contract.”
With that in mind, Graugnard says that the conditions inside a contract need to be carefully studied to empower the company with additional negotiation tactics. “If they aren’t adhering to the 30-day or 60-day payment requirements,” he says, “it’s important that the terms of the contract give you the option to press pause on the work.”
NAVIGATING RETAINAGE
While every contract is different, most will involve the waiting game of retainage. At NAPCO, Coronis says the firm operates as a first-tier subcontractor, and one standard arrangement means that the general contractor will withhold 10% of each invoice while NAPCO will withhold the same amount from its subcontractors’ invoices. However, Coronis highlights that she aims to avoid dealing with full retainage through the entire project cycle.
“When we build a parking garage for a multifamily building, for example, we’re one of the first groups in after the site work is done,” she says. “We put forth the argument that we shouldn’t have to wait until the very end—when the apartment building is done—to get our retainage. Instead, we like to negotiate to release at least a portion of the retainage after we have finished the majority of our duties.”
The full amount may not be released early—NAPCO still has to come back for finishing work—but something is much better than nothing, particularly for any company working on a project with a relatively small margin. “For some smaller firms, the entire profit might be in the retainage,” she says. “If your projected gross profit on the job is 8% and they’re withholding 10%, finances get upside down.”
And if a company winds up waiting too long to get those funds released, Coronis says it can lead to an precarious position. “You want to close out the project as quickly as you can, especially if you’re a sub[contractor],” she says. “At the end, the sub[contractor] starts to lose leverage. You don’t want to be in the position of having to agree to something that isn’t ideal for your business just to get some payment.”
CONSTANT MONITORING
Effective financial management is less about thinking of the end date on a calendar when a project is supposed to be completed and more about focusing on the status of overall costs versus estimated expenses. “We primarily look at a project based on a cost-to-completion basis from our financial reporting perspective,” Coronis says. “For example, if you estimated that the cost would be $1 million and you have incurred $500,000, you’re 50% complete on the project.”
That may sound fairly simple, but Coronis points out that trying to reconcile revenue can wind up looking like a complicated maze. “When you look at your cash flow you have to consider it from a different perspective,” she says. “You may have sent out a bill, but that isn’t going to collect the money. And on the cost side, you have to look at the invoices you’ve received versus the dates you are actually paying them.”
And while the CFO may be the ultimate authority on all those dates, bills and invoices, Graugnard sees being a good project manager as synonymous with being a good business manager. With that in mind, he says that executive management at the company conducts monthly reviews of every contract’s current financial state. It’s no small task, either; typically, the company has approximately 300 contracts to analyze, ranging from as small as $5,000 to as large as an $800 million, three-year contract. While the review doesn’t involve diving into the nitty gritty details of each project, Graugnard says there is plenty of scrutiny for any project that manages to slip into a negative cash-flow basis.
What causes one of those projects to fall into the red? Graugnard points to a number of reasons, including a poorly drafted schedule of values, an owner that fails to live up to their payment terms and cost overruns. And in some cases, it could simply be due to the reality that every project isn’t a slam dunk. “From time to time, we have projects that go bad,” he says. “It could simply be that it’s not a good contract, and it’s not going to wind up making money.”
While those lemons aren’t common at Cajun due to the company’s focus on its cost system, they are a recurring feature of the larger industry. And as the costs of materials and labor continue to increase, it’s imperative for every firm to keep a laser focus on the bottom line. “There are an awful lot of superb contractors that go out of business because they don’t manage the financial side of things well,” Graugnard says. “Being in construction is a wonderful lifestyle, but if you don’t have a handle on your cash-flow management, you can find yourself in deep trouble.”
