Articles Written by Charles Vander Kooi

Gain control of cash flow

Cash flow not well-managed can put even money-making companies out of business.

By Charles Vander Kooi

Financial statements and cash in the bank are 2 different worlds. The first may show, that on paper, you have money even though your bank statement says you have little or no money. Why is this so??

Financial statements show you what money you would have if everyone paid you immediately, and you paid everyone you owed immediately. Because that doesn’t happen, they are never the same.

I have seen companies go out of business even though they are getting work, doing a good job of pricing and completing work within the estimate. Their problem is they ran out of cash. The saddest part of this is that the reasons they ran out of money were very preventable. I want to give you some of the reasons so that you don’t make the same mistakes.

Uncontrolled growth

The most common cause of poor cash flow is too much growth too fast. Growth costs money. Cash is needed to advance the payroll part of a job for 3 to 6 weeks before you are paid by the client. Growth requires additional equipment for which you need a down payment, initial purchasing costs (taxes, licenses, etc.), as well as monthly payments that are also paid 3 to 6 weeks before you are paid. You may also incur additional overhead costs (staff, rent, phone lines, cell phones) that will need to be paid before you are paid.

It is my opinion that any growth greater than 20% a year will cause you problems. Not only will it cause cash problems, but most contractors make nothing on any growth over 20%. They only trade dollars. This is mostly because the increase in people, equipment and overhead disturbs the continuity of how a company functions that makes them profitable. It takes 6 to 18 months for new people to fit into the company and iron out the changes to bring about profitability.

Insufficient credit

Another issue that causes cash problems occurs when a contractor does not have a sufficient line of credit at the bank for their existing work, or for their projected growth. A line of credit must be seen as the bank loaning you money to pre-pay your expenses prior to you being paid. We recommend that a contractor have a line of credit that equals 10% of projected yearly sales.

If you keep money in your company as retained earnings (a figure shown on the balance sheet) it should equal about 20% of annual sales in order to keep you out of the bank.

Paying bills too fast

Paying off your payables at a faster rate than you are collecting receivables can also lead to poor cash flow. It is recommended that for every $150 in receivables there should be at least $100 in payables. For example, a company with accounts receivables of $60,000 should have accounts payable of $40,000. If you pay down your payables faster than that rate, you will be dangerously draining cash flow.

Paying off debt quickly seems like a good idea, but in reality it can become a bad thing. Some contractors hate debt so much that they try to pay off their long-term loans on equipment too quickly. To maximize cash flow, borrow as much money as you can from the bank for equipment even if you have extra cash to pay down the loans.

Keep that cash in case you do have a problem, and then you will have money to carry you through. Otherwise, you will have to go to a bank with your hat in hand and ask for money. But at that point where you are having financial problems you will find the bank reluctant to give you a loan.

Steps to good cash flow

Here are some things you can do to keep out of cash flow problems:

Plan your growth proactively, keeping in mind the impacts that growth has on your cash. There was a bumper sticker going around that said, “Have you hugged your kids today?” I wanted to print one up that said, “Have you said no to a job today?” and put it on contractors’ bumpers.
Avoid paying cash as much as possible and always see what can be financed or re-financed to keep cash in your company.
Be creative in billings and collections. Get a deposit upfront, then a payment of 1/4 when 1/2 is done, then a check for the balance on the day you complete the job.
Be objective about your ability to handle money. Be realistic about your employees’ or partners’ abilities with money. There are people who simply cannot control their spending, let alone discipline their spending of the company’s money. As soon as they see money in the checkbook – whether it be a personal checkbook or a company checkbook – they spend it. Sound like you or an employee who has access to your company’s coffers?

Instill accountability

If someone in your company is a big spender, do everyone a favor: Set up a system of accountability that will keep you, the employee, and the company from being victimized by over-spending. You can do this in several ways:

Turn the checkbook over to someone else so you or they must go to another person for a check. The big spender can still sign these checks.
Have the accountant issue the payroll and monthly accounts-payable checks, and then set up another account from which the big spender can make minor and emergency expenditures. However, keep the balance in the second account as low as possible.
Set up a committee of level-headed people who will advise the big spender about expenditures which exceed a specific amount.

Some of these things may sound embarrassing, but they are less embarrassing than bankruptcy.

Handling big payments

Finally, I want to address the problem of large payments due at different times that can drastically hurt cash flow or catch someone off guard. If a bill comes in lower than expected or if your financial statement shows an unexpectedly high profit, you need to find out why before you spend the money.

If you find that someone may have under-billed you, you need to conserve cash to pay for a future re-billing. You also need to keep cash on hand to cover expenses for changes in your company that occur with growth. Unexpectedly high sales in a year come with unexpectedly high taxes due at tax time. Workers’ compensation costs go up as you add people, but you may not be charged for the cost until the end of the year.

You can prepare for future bills by setting up separate bank accounts for bills you pay at different frequencies – one for monthly payments, one for quarterly, one for annually, etc. Items that typically fit into long-term categories are certain taxes, insurance of all kinds, equipment maintenance expenses, licenses, yearly fees, dues, etc.

On a monthly basis, write checks for each of these items in the amounts you charge clients for those items in your overhead or general conditions. Deposit those checks in the separate savings account designated for each item. Monthly profit-and-loss financial statements will now include these costs because you wrote a check for them. Also, when the bill finally arrives, there will be money in an account to pay for it.

Remember, your long-term success will not just depend on your ability to make money but, also on your ability to handle the money well.

Since 1980, Vander Kooi & Associates has been helping business owners add more to the bottom line of their company’s financial performance. We would be proud to help you with budgeting, estimating, high-performance management, marketing, sales, productivity and field training. Visit VanderKooi.com or call (303) 697-6467.