This article is the final in a series addressing how to manage your custom building company using systems and reports.
I am sure that you have heard the old expression that cash is king. This is especially true in the custom building business where cash flow is more important than the bottom line because a builder without cash will never make it to the bottom line.
Many custom builders fail in their first several years as a result of poor cash flow management. They get into a rut of “robbing Peter to pay Paul,” taking the cash from a current job draw to cover the sins from a prior job. In the recent market slowdown I have run across many custom builders who have fallen into this track. With future jobs not filling backlog as quickly as in the past, they have run into cash flow problems.
Cash flow forecasting is a key component of a builder’s financial success. Long-term cash flow planning should be an integral part of the budgeting process so be sure to review your cash sources and requirements on a monthly basis. In addition to developing a monthly cash flow forecast, I suggest that you look at weekly cash inflows and outflows. I recommend using a six- to eight-week rolling schedule.
To develop their annual operating budget many custom builders identify annual expenditures and divide that amount by 12 in order to come up with a monthly operating budget. But budgeting this way doesn’t give a true picture of your monthly operations. When you prepare your annual budget, try to identify the month in which expenses will be incurred. For example, when you plan your advertising budget, identify when you plan to run ads and put the planned expenditures in that particular month. For instance, if you have a Yellow Pages ad, budget for the cost of the ad in the month that the expenditure is to be made.
Cash Forecast
After you have identified which months you expect operating expenses to occur, you need to adjust your total expenses for other cash flow items. Deduct items such as depreciation since this is a non-cash expense and add in non-expense-related cash items such as note payments (the interest portion should be considered as an expense while the principal payments affect cash flow), cash payments of other liabilities, cash purchases for equipment, as well as cash payments for federal and state income taxes. After completing this process you will have identified the amount of cash needed on a monthly basis in order to operate your company.
The next step in your annual cash forecast is to look at cash flow from jobs. Depending on the number of units you build, this budget can be prepared by home or by subdivision. There are four items you need when developing your job cash flow: your draw schedule (whether from the bank or from your customer), construction schedule, payment terms for your subcontractors and suppliers, and job estimate. With all of these in hand you should easily be able to predict cash inflows and outflows for your jobs on a monthly basis.
When you combine your cash flow from jobs with the cash outflows anticipated from operations you will be able to identify the months in which you will have excess cash and those in which you expect cash shortfalls. Use this projection to make strategic decisions for the year. Do you need to develop a line of credit to smooth out your cash flow? Should you start a spec home to provide cash flow from a construction loan? Should you renegotiate payment terms on a note coming due?
Just as you do with your other financial reports, your monthly cash flow projection should be reviewed and updated regularly. In addition to a monthly forecast, builders with tight cash needs should prepare a more detailed weekly cash flow projection. This projection should include information on what subcontractors and suppliers are to be paid on a job-by-job basis as well as weekly cash inflows such as draws and collections of receivables. By updating this forecast each week, you should be able to identify weekly cash flow problems and communicate payment plans with your vendors, if necessary.
Over the years I have seen more and more builders add nice amounts to their bottom line in interest income and discounts earned as well as reducing interest expense by proper management and projection of cash flow. The lesson is to keep an eye on your cash flow as well as on the bottom line.
Cash Management Tips
Following are some tips on managing your cash flow and making additional profits from it.
One of the advantages of the custom building business compared to spec building is that you can use the customer’s money to pay off your trades and suppliers instead of using internal funds or construction loans. You should try to always be ahead of the customer and maximize the use of your client’s funds by taking a deposit and front-loading your draw.
If you are front-loading your draws it is imperative that you manage your books on a percentage-of-completion basis. This will enable you to understand and account for overbillings on your jobs.
Try to set up benchmarks for payments that correlate to the start of a phase rather than its completion.
Take advantage of vendor discounts. A 2% discount for paying in 10 days is like 72% per year. Considering it would be due in 20 more days anyway, pay up. Where else can you earn that kind of a return?
Ask your subcontractors to take a discount if you pay them prior to the scheduled payment date.
Set up a systematic method of paying your bills (i.e., the 10th and 25th). Keep “hand checks” (issued outside of check paying days) to a minimum. You may also want to consider mailing checks on a Thursday in order to take advantage of the float over the weekend.
Use a sweep account to invest your excess cash. In a sweep account the bank will automatically move any amount that remains in your checking account over and above a specified balance needed to avoid bank fees into an interest-bearing account. Many banks will allow you to sweep excess funds into a money market or higher interest-bearing account than a normal savings account. With most banks, a builder having an average daily balance of greater than $35,000 would be able to earn interest income which would more than offset any bank fees related to having a sweep account.
Time your larger draws so that you can get money into the bank before the close of business on Friday to take advantage of earning interest over the weekend.
Explore the possibility of obtaining a line of credit. It is easier to start up a credit line when you really don’t need the funds. A credit line will also provide you with flexibility in taking advantage of discounts.
