By Steven Antill-Foundation Software Inc.
“Cash is king.” “Cash is the lifeblood of any organization.” These ubiquitous sayings explain what every contractor already knows: cash is one of the most critical components to a construction company’s success and stability.
In addition to developing cash flow forecasting at the planning stage of every contract, contractors also need a system at the corporate level to monitor cash flow in a proactive and timely manner. This system, known as cash flow reporting, provides the data necessary for analysis and decision-making. But what exactly constitutes good cash flow reporting?
In the world of construction, business owners should view and understand cash flow from two perspectives: across the entire organization as a whole and at the job level.
Company-Wide Cash Flow Reporting
Many contractors struggle to understand the peaks and valleys of cash flow as it affects the entire organization. Outside the Balance Sheet and the Income Statement, one of the most overlooked financial statements is the Statement of Cash Flow. This report is based on General Ledger activity and shows how changes in balance sheet and income statements line items affect cash. The information is generally broken down into three sections: Operating, Investing and Financing.
Why is this information so important to contractors? Mainly, it has to do with the fact that Income Statements are used to see company profitability, and Balance Sheets are used to satisfy creditors, manage inventory and collect receivables... but both miss the flow of cash in and out. A prepared Income Statement, for example, may show revenues that have been reported but not yet collected and expenses that have been reported but not yet paid. In the same sense, an increase in A/R billings does not necessarily mean in increase in cash, and the posting of an A/R invoice (which increases a company’s Income) has no effect on cash. A Cash Flow Statement, in contrast, identifies the cash that is flowing in and out of the company via cash receipt transactions: accounts receivable collections, A/P invoice payments, payroll liability payments, and so on.
Most good accounting systems that operate on an acrual method should offer a standard Cash Flow Statement generated within the General Ledger. When reviewed regularly, this report gives construction business owners a much clearer understanding of their company’s financial position than can be learned from the Income Statement and Balance Sheet alone. Negative cash flow from operating activities, for example, may raise a red flag as to why the reported net income is not turning into cash. Or a large increase in accounts receivables may uncover problems with billing or collection procedures.
Cash Flow By Job Reporting
Most construction projects are considered individual profit centers, each with its own cash cycle. Therefore, in addition to the Statement of Cash Flow that shows cash activity on a company-wide basis, contractors should also pay attention to cash flow by job to see how each project affects cash flow for a given period. Analyzing cash inflow and outflow by project allows contractors to identify profitable jobs that are funding themselves as well as underperforming jobs that are possibly being funded by other jobs.
Good construction-specific accounting software should make it easy, if not automatic, to prepare a Cash Flow By Job report. Some systems even incorporate this all-important report into their executive “dashboards” so that the information is displayed graphically and is available on a real time basis. (See Sample Report #1) At a minimum, the contractor should be able to see cash received or collected via cash receipts per job minus what was paid out of AP and payroll. It’s important to note that when defining Payroll Cash Paid to Date, the report should include not net payroll (employees’ wages) but rather gross payroll (employees’ wages plus FICA, FUTA, SUTA, Workers’ Compensation, prepaid insurance and other burdens).
For a more detailed look at cash flow by job, contractors will want a report that also includes a Revised Contract Amount, a Revised Estimated Cost, Gross Profit, Open Payables and Open Receivables per job (See Sample Report #2). Using this information – in conjunction with Cash Collected and Cash Paid to Date out of A/P and Payroll – construction business executives should be able to see the percentage of cash flow to contract and the percentage of cash flow to gross profit. Not only does this allow contractors to alter cash flow projections based on actual cash activity, but it also provides invaluable information on cash flow trends via jobs or types of jobs. In the long term, that can lead to better cash flow forecasting.
Proper cash flow management is essential for all businesses, but it is especially important in the cyclical, project-based world of contracting. To properly monitor cash flow activity, construction executives need to regularly view and understand reporting from two perspectives: the company-wide Statement of Cash Flow and the project-level Cash Flow by Job report. And with today’s sophisticated construction accounting applications, they can easily accomplish both.