The DIY Construction Cash Flow Formula For Contractors Under $5 Million.

Simplifying the solution to the problem nearly every contractor faces.

I hardly ever work with contractors who have never done something to protect cash flow that cost them more in the long run. It's such a pervasive issue, in fact, that I work with a set of contractors who would make these decisions every single week.

They constantly draw from revolving lines of credit to pay their crew or their subs. They max out credit cards and hold balances to pay operating costs. They check their bank account balance every single day hoping they're not about to overdraw.

And in the end, it costs them more in interest and fees than it would have cost them to implement a better system in the first place. If you've done something like this, I have a solution for you to try.

Understanding the Construction Cash Flow Problem

You might be wondering "why does this happen to contractors?" While this certainly occurs in other businesses, it is particularly widespread for construction businesses.

Let's simplify this by comparing construction to two other types of businesses: selling a physical product and providing consulting services. The driver behind the issue comes from the sales cycle of each type of business.

Let's say Paul's Hardware sells screws and nails. They buy their products from a manufacturer for $0.01 per unit and they sell them for $0.04 per unit. They buy a box of 100 for $1.00 and sell it a month later for $4.00. Their manufacturer let's them pay on credit, which means they don't pay until a month later.

This means that if Paul's Hardware sells 100 boxes, they made $400, and right when they sell the $400 of product, they pay the manufacturer $100. This primarily works for cashflow because Paul's customers pay before they get the product. They can't leave the store with it and pay for it a month later.

John's Construction, however, has a much slower sales cycle for many contractors. They complete work throughout the month and then bill the next month or when the job is complete. This means their payment might not come in until six or eight weeks after they front a cost. With that in mind, we can say the first problem is contractors often pay subs and suppliers before they get paid by their customer.

Now let's compare John's Construction to Roger's Architecture. Roger's Architecture charges once per month for design services to their clients. They have expensive labor, but their other expenses are relatively small. They charge hourly with a 60% markup on their true labor costs. Since they pay their employees semi-monthly, and they get paid monthly, they only need to front half their monthly labor cost before getting paid.

Since they don't have to pay many costs in advance, they carry far more cash as a buffer, and never worry about bouncing a payroll.

John's construction, though, offers a more complex service with more moving pieces and more overhead cost. John's has to wait the same time for payment without the added benefit of a simple cash buffer. That makes the second problem contractors have complex costs and small margins.

If you put these two problems together, you have a blueprint for a house with a shaky foundation. Naturally, these two problems can be resolved with income-related solutions. If you charge more up front, you're less likely to pay subs and suppliers out of pocket. If you charge more altogether, you have larger margins.

But I'd like to make a different argument.

Why Spending Matters Before Income

Don't misunderstand me - Income is a useful and underutilized lever for construction companies. Too many contractors never raise their prices and fight endlessly to be busy with unprofitable jobs. But if you do it out of order, as your income grows, so will your spending.

At any revenue level, you have the power to control your profit to a degree by being intentional with spending. Most contractors caught in a cash flow cage are not being intentional with their spending. They spend reactively, or on gut feeling, neither of which provide maximum benefit to the business.

With that in mind, I only wish to say that if you learn to control your spending first, those habits will carry over to higher top-line revenue. It doesn't work in reverse.

The Formula

So what does this look like practically and, more importantly, how do you fit it in your already busy schedule?

Well my formula is very simple. It goes like this:

Current Cash + Current AR - Current AP - Estimated Expenses - Estimated Debt Payments = Your Current Cash Position.

Every week, you calculate your current cash position and you will get a quick and reliable approximation of how cash flows through your business. Here's what each of these terms means.

Current Cash: Add up the balances of all your checking and savings accounts.

Current AR: Add up the balances of all of your open customer invoices due in the next seven days.

Current AP: Add up the balances of all of your vendor bills due in the next seven days.

Estimated Expenses: Go to your profit and loss report and set the date range for the last 28 days. Add up all of your expenses and Cost of Goods Sold and divide that number by four. Subtract Current AP (AP ends up on the profit & loss!)

Estimated Debt Payments: Add up the minimum payments (or the amount you plan to pay, if more than minimum) of all debts in the business name. Include credit cards, loans, lines of credit, and any payment plans you're on. Divide by four.

It's not a perfect calculation, but it gets you 80% of the way there. With these five simple figures, you get a decent picture of your cash flow, and after a few weeks, you'll begin to notice patterns you didn't know existed.

You'll notice that every third week your cash gets very low when you make payments to vendors. You'll notice if your average expenses slowly climb. You'll certainly notice if your cash position is negative.

To top it off, this is only scratching the surface.

Maximizing Your Cash Position Report

Here are just a few things you can do if you want to weather just a little more complexity to get value out of your financial analysis.

Add your top five largest outstanding invoices: Sort your overdue invoices by the largest balance. Pick the top five and chase those payments this week! Any outstanding balances are money you should have already been paid: missing that cash adds pressure where it doesn't belong.

Break out your largest expenses into their own estimated categories: It may be helpful for you to split Estimated Expenses into KPI categories like Estimated Subcontractors Cost or Estimated Material Cost and backing it out from the overall Estimated Expenses. This lets you get crystal clear visibility on categories that might quietly inflate over time.

Track total debt: Add a figure for the total debt your business has. Then, week over week, you can compare your cash position to your total debt. Over time, you'll learn how much debt to cash ratio you can weather and still make payments on time.

Conclusion

Now you've got a tool that will keep things simple for you and will give you valuable data on the go so you can run your business ready to tackle the cash flow cage.

Get out there and sell.

Need Quality Bookkeeping to Rely On?

This report is most helpful if you have accurate data underneath it - It might actually be unhelpful if the profit and loss is wrong or out of date. I can help with that.

To get started, click here to book your free discovery call. It takes 30 minutes, and you'll leave knowing how I help contractors like you make everything make sense.