Cash Flow, Part 2 from page 16
Your focus, then, should simply be to satisfy the customer. This
includes not only managing a successful completion of the project (including all punch list items), but also ensuring that all
required paperwork is submitted accurately and on time.
Operational Links to Cash Flow
Project management and field staff usually understand all of
these operational practices; however, these professionals are
not always able to connect these practices to the effect they
have on cash flow.
Here’s a simplified method for managing A/R: Each month,
collect as much (if not more) than was billed for the month.
The actual figure collected will depend on whether volume is
increasing or decreasing, and on whether the current status of
the DSO is acceptable when compared to industry averages.
For many contractors, inventory is not a significant item on
the balance sheet; nevertheless, even small efforts can have
a positive impact on cash flow.
I generally tell CFMs that adhering to these practices will
mean that their company’s cash flow is moving in the right
direction. However, this answer is
rarely adequate. Accordingly, I have
developed the following guidelines
for each component of the cash flow
The goal here is to maintain as low an inventory as possible,
while still meeting construction needs. So, use suppliers that
can provide quick delivery of materials for the best prices.
Another strategy is to use vendors
that will hold materials on consignment until they are needed.
EBITA, OR EARNINGS
This is the first component of the
formula and arguably the most
important, as it is the only income
statement component. All of the
others are balance sheet components. So, what does that mean?
(OVER- OR UNDERBILLINGS)
Generally, this component is the
second most controllable by operations. Although WIP may consist
of both over- and underbillings,
the net balance should be maintained in an overbilled status.
Without earnings, cash management would be nothing more than
shuffling cash between the various balance sheet components.
Earnings are what provide additional cash (when cash is defined as spending power) to the cash flow formula.
Remember that we are trying to increase liabilities. Therefore, the
objective of operations should be
to maintain a reasonable overbilled
status. In fact, a construction company can be managed on an excep-
tions basis by monitoring debit WIP or underbillings.
This component of the cash flow formula is the one most easily controlled by operations. The key is to keep the focus on
achieving and maintaining profitable operations.
Since A/R is an asset, the objective is to reduce it as much as
reasonably possible. However, the answer is not to bill less,
but rather, to increase collections.
The easiest measurement is “days sales outstanding” or DSO.
This measurement can be calculated at the project, individual,
department, location, or company level. Aging of receivables,
and the related DSO, should be reviewed by operations management at least monthly.
An overbilled status can be maintained if billings keep pace
with progress on the job and the schedule of values is appropriately front-end loaded. An inability to achieve and maintain an overbilled status is generally the result of cost overruns, which means that your company is going to lose money
on that job.
This component of the cash flow formula is a combination of
the net additions and disposals of fixed assets and the depreciation (an expense that does not represent an outlay of cash)
on total fixed assets. Generally, project management has little
control over this number; top management sets the guidelines
for purchases and disposals of fixed assets.
continued on page 20