28 May 2014

Financial Reporting Series: Cash Flow by Job

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Even if a contractor has a strong backlog of work, failure to monitor current cash flow and track financial data will be problematic.

It’s easy for contractors to focus the majority of their attention on running the jobs in the field, but they must remember that it’s cash that’s making those jobs possible. Monitoring cash flow is one of the most critical components of owning a construction business. Even if a contractor has a strong backlog of work, failure to monitor current cash flow and track financial data will be problematic. Not only will single jobs be affected, but the whole company will experience the effects. At the planning stage of every contract, contractors should develop cash forecasting. In addition, they must 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.

Construction business owners should view and understand cash flow from two perspectives: across the entire organization and at the job level.

Company-wide cash flow reporting. Many contractors struggle to understand the effects that “peaks and valleys” of cash flow have on the entire organization. The statement of cash flow, outside of the balance sheet and income statement, is one of the most overlooked financial statements. This report, based on general ledger activity, shows how changes in the balance sheet and income statement line items affect cash.

This information can generally be broken down into three sections: operating, investing, and financing. Income statements are used to illustrate company profitability and balance sheets are used to satisfy creditors, management of inventory, and receivables—but both miss the in-and-out of the flow of cash. For example, a prepared income statement may show revenues that have been reported but not yet collected, and expenses that have been reported but not yet paid. An increase in accounts receivable billings does not necessarily mean an increase in cash, and the posting of an accounts receivable invoice (which increases a company’s income) has no effect on cash.

In contrast, the cash flow statement identifies cash flowing in and out of the company via cash receipt transactions such as accounts receivable collections, accounts payable, and payroll liability payments.

Most accounting systems that operate on an accrual method 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 in conjunction with in and outflows of cash.

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, which shows cash activity on a company-wide basis, contractors should analyze cash flow by job to see how each project affects cash flow for a given period. By doing this, contractors can identify profitable jobs that are funding themselves and under-performing jobs that are possibly being funded by other jobs.

Construction-specific accounting software should make it easy, and possibly automatic, to prepare a cash flow by job report. These reports can be customizable and should, at minimum, give a contractor the ability to view cash received or collected via cash receipts per job minus what was paid out of accounts payable and payroll. When defining payroll cash paid to date, the report should include gross payroll (employees’ wages plus FICA, FUTA, SUTA, workers’ compensation, prepaid insurance, and other costs), not only net payroll (employees’ wages).

Contractors need a report that includes a revised contract amount, a revised estimated cost, gross profit, open payables, and open receivables on a job in order to get a detailed look at cash flow by job. Using this information—in conjunction with cash collected and cash paid to date out of accounts payable and payroll—construction executives should be able to see the percentage of cash flow to contract and the percentage of cash flow to gross profit. This allows contractors to alter cash flow projections based on actual cash activity and also provides valuable information on trends for certain types of jobs.

Managing Cash Flow

Contractors cannot solely manage their jobs—they must also properly manage their cash flow. In the cyclical, project-based world of contracting, it’s extremely important to keep tabs on cash flow at all times. Today, sophisticated construction accounting applications make monitoring cash flow easy and give contractors the ability to view cash flow reports on a company-wide and project-level basis.

*Published in Builders Exchange Magazine