The Payoff: Understanding and Monitoring Cash Flow

The Payoff: Understanding and Monitoring Cash Flow (All Business.com's Chris Bjorklund interviews construction business experts Matt Stevens and Kia Ricchi on the importance of properly managing your cash flow. )

Chris Bjorklund: You're listening to the AllBusiness podcast. I'm Chris Bjorklund. If you're getting this through iTunes and RSS feed or an on-line streaming media player, you have the opportunity to hear a more valuable advice from top business experts right here on AllBusiness.com. We'll be right back after this brief message from our sponsor, comcast.

Chris Bjorklund: In today's AllBusiness podcast, we'll be talking about better ways for businesses to manage their cash flow. My guest, Matt Stevens, has more than 30 years of experience in business planning. He's the author of Managing a Construction Firm in Just 24 Hours a Day and a formal general contractor. He's a president of Stevens Institute, a management consulting practice. He got his start in business in high school when he had his summer job hauling trash from construction sites. Matt Stevens, thanks so much for joining me today on the AllBusiness podcast.

Matt Stevens: Thanks for inviting me, Chris

Bjorklund: Matt, in your 30 years of experience as a business consultant in the contracting industry, you've seen that many companies succeed and many many fail. How big a factor is cash flow, when you look at the businesses that did fail?

Stevens: Well, its/couple things to add to that is on the failure side. It is a top five economic issue to the success or failure of a firm. You know, if you talk to the sureties, you talk to people that study business failure almost exclusively like banks that guard against it. It's a leading indicator of future bankruptcy that is they see that cash flow going down or being negative as a precursor to bankruptcy. Well, it's, it's you know, hugely important. I don't know if we can say that as a top issue, that certainly profitability is, but it's a top five, top three issue.

Bjorklund: What is a good way to explain cash flow?

Stevens: Well, the way I explain it is that it's quite simply like a foot of water in the bottom of your boat or your ship causes the boat to ride lower and move slower. You know, you're just a foot closer to sinking. So the/that parable tends to resonate with a lot of people especially in Florida here you know, where in the sea of water we have. But it's a good way to say you want to keep that water out of your ship as much as possible. In another way, if you look at the way we identify our study profitability, we really don't look at profit margin as the best indicator. It is return on investment that is in construction, many contractors if not all contractors really finance the project in some way. They pay their payroll. The job gets built, they send a schedule of values that actually are application for payment in. It gets paid. They've given some money back. Somewhere in there, they are reimbursed for their expenses. But the next week, they're going to have to pay the payroll again to pay for those material invoices. And so if you look at that financing, or that working capital they're investing in that project, that's one of the two calculations you have to make to make return on investments make sense. That's a little awkward maybe to talk about with some people because most people like I, like myself, was brought up to believe, you know, if you've got lots of backlog, and if you've got lots of more than a margin in your backlog, you're good. Well, the businesses, the second riskiest business in the United States. So we have to look harder at this profitability issue. We have to say, you know we really want to make sure that we have a very high return on investment. Of the working capital we lent the project, where there's a mildly complex calculation that we go through. And it really tells contractors how they're doing financially on the project and overall in their business.

Bjorklund: Should they be looking at the cash coming in and then the cash going out? And when that cash is going out, the timing issues?

Stevens: Absolutely. And you know, there's no great change you're going to make over this short term. But the long term, if they look at this cash in-cash out or what I'd like to call the cash to cash cycle. You know, the industry average is about 47 days if you follow this kind of thing. 47 days is a, you know, analysis done by the banks and it's very accurate. Somewhere less than fifty is a pretty normal cash to cash cycle. Well, if you've got people telling you that 70 and 80 is normal, I will argue with that. And I will say to you that there's things that you could be doing right now to bring down at least to 47. And of course the better contractors financially will each other to figure out a way to bring it down to 45, and 40 and 30.

Bjorklund: So that's the gold standard so to speak.

Stevens: Yeah. The best guys in the industry to be absurd are the handymen, you know. They walk in one day, and they had their hand out when they walk out. They pay me for the day's work and so their cash to cash cycle is zero or one day. And don't forget when they buy a material, that material might be due or that invoice might be due in 30 days and/but they're still paid today That's a ridiculous example but you can see the logic in it. Now, on the other side of the coin, you know, certainly when we talk about retention in construction that/that's a huge issue. And if you look at the studies there, retention being, you know,that 10 percent that's held back to assure quality to assure warranty issues are taken cared of properly. It's actually gotten worse in the industry. The percentage of debt as part of retention which is a fancy way to say how hold/how long they hold in retention is has grown by about 90%. So that cash flow, that retention sitting out there longer, we're not getting it into our bank account. It's really a huge issue.

Bjorklund: And how is your cash flow different from profit?

Stevens: Well, they both work together. Certainly if you charge somebody let's say 20% profit but can't collect it, there is no profit. If you can collect money very quickly in one day and your margin is 1 percent that might be better financially but the idea is that you certainly got to be able to get the cash back in including the profit to have any kind of profit.

Bjorklund: Your timing of cash flow seems to be critical to as you keep referring to you say money is collected, bills will have to be paid. And then depreciation factors in. So, this is now getting increasingly complex is what you're talking about?

Stevens: Yeah. If I could break it down to maybe a couple of small factors. You know, we talk about cash flow, to me you have to look at what's honored, there's cash and non-cash items. Now, cash items are those that we pay money for, you know, a check or actually a wad of cash goes out the door. And that would be something like payroll or material bill. Non-cash items would be something like depreciation, you know. You bought a truck, but it was a $20,000 truck, you drove it for a year, year-end it's worth $15,000. Well, you know, poor for the $5,000 depreciation, although you do realize a tax benefit for that. That's something you have to talk about in cash flowers, identify cash and non-cash items.

Bjorklund: Every small business has/has both components?

Stevens: Well, they certainly do. And then the other part of cash flow that I think it important is known as negotiable and non-negotiable. Non-negotiable items in cash flow are things like payroll. You know, you just can't negotiate that you're not going to pay somebody their thousand bucks this week. You know they work for you. They've done the work. You know that's non-negotiable, you better have the check ready on Friday, or otherwise somebody's not going to be there on Monday. The negotiable items are things that you and I have run into on everything. You know, we go to the rental store and we haggle a little bit on equipment. We get a discount based on that. You go to your doctor, and you say, well, I'm going to pay today cash. I'm not going to let you/I'm not going to allow you or I'm not going to make you go to the insurance company and get reimbursement for my medical bill. I mean my deductible, so I'm going to pay you cash. What's my bill? I've done that. You've done that. And the doctor comes back with a discount of 40% because those kinds of things, you know, there's some contracting examples also are negotiable. Well, taking advantage or knowing those negotiable items and obviously. We know what the non-negotiables are. Very important to keep cash in our business, you know. I didn't tell you this at the beginning, but maybe I should now. There's an old saying. It was said by old people rough riders and me. But I'm going to steal it right now. They used to say this, there are ten rules to business. The first rule is don't run out of cash. The second rule is don't run out of cash. The third rule is don't run out of cash. And rules 4 to ten are not that important.

Bjorklund: That's excellent. Now, your experiences primarily working with contractors and yet much of what you're saying is applicable to any small business. But you're trying let them look at their business differently through your some of your articles, blogs, and some of your workshop seminars, your consulting. Do you find that many of them, they know their trade. They have a passion for what they do. But they just don't want to spend that much time on the money end of the business.

Stevens: That's true. One of the comments I try to bring forward in the first, you know, half the day or first hour of any seminar or any discussion, is what do you wanna do when you're 65? do you wanna be independently financially or dependent financially? And that usually gets their attention.

Bjorklund: Yes. Hello.

Stevens: That's a wake up call.

Bjorklund: Yeah. That's a wake-up call.

Stevens: And/and so then we start talking about you know this business is not one that we do for prestige or for possessions. You know, a lot of us do it because we like it, but also a lot of us just want to be financially independent. The business portion of it, you know, becomes even more important after the discussion.

Bjorklund: You know, I'd like to bring into our discussion now one of your past clients. Let's bring her on the line, Ricchi. Kia is the president-owner of Centerline productions. It's a general contracting firm that does commercial tenant build outs and duplex remodels. She has been in business since 1989. And Kia welcome to the AllBusiness podcasts.

Ricchi: Oh, thank you, Chris.

Bjorklund: Why did you go to Matt in the first place on cash flow issues and other business concerns?

Ricchi: Well, I met Matt during one of my continuing education courses that we take annually. And he was doing a presentation on cash flow and other financial issues. And during the presentation, there were several contractors in the classroom that were relating their problem with the financial issues and primarily rolled back to cash flow problems. And that's when I became aware that it is a very realistic problem. I hadn't experienced it but I saw that many of the contractors had. And that motivated me to talk to Matt further about this and to educate myself so that in the future, I wouldn't encounter this hardship.

Bjorklund: When you talked to Kia, Matt in the beginning and kind of did an assessment of her situation, where do you begin with a client like Kia, a small general contractor?

Stevens: Well, this is something important I think that all consultants should consider. You really talk to the client about their goals, what's important to you. You know, we come down to the business, the business is supposed to serve us our goals, our family situations, you know, our desires to do whatever, whatever that might be. And I talked to her about that and it was clear that she wanted to do good work and become financially comfortable doing it. And so, that's pretty easy to work with, you know. We don't have any real big/you know, the son-in-law coming into the business issues or somehow somebody wanted to be the biggest in the country. That's a very naughty one. It was very straight forward. I wanna be good at what I do and I wanna do well and I wanna be financially comfortable.

Bjorklund: So Kia, what kind of changes did you make based on your work with Matt?

Ricchi: Well,one of the things Matt help me do was create a spread sheet that I would apply to each individual job. I had a bad habit that I would estimate a job, go to contract. And when I was out in the field often and I was addressing the financial situation as the job was progressing. Let's say I would have three jobs, running at the same time. Well, I haven't been separating them. And I think that it's very important that you have to keep the jobs separate. And you are able to see what you're doing right and wrong on each job, so you're not taking money from one job to pay on another job. And knowing what your problems are on the individual job makes you look at it closely and then remedy that financial problem that might be happening on that particular job, so that was very helpful. And the other thing Matt had pointed out was since I often pay my subs on a two-week basis, that it was important that my customer is paying me at that amount of time also. So that I'm not reaching into my pocket and paying my subs and my materials and going in the hole. So that was also something Matt helped me look at and addressed.

Bjorklund: Matt are these the kinds of changes that are pretty easy for many different sized businesses to implement?

Stevens: Yeah, it's a/to me it's a merchant mentality. You have to look at the businesses high stake financially conservative. Let me/let me expand on that definition. I think everybody knows what financially conservative means about. I wanna tell you something else about it. You know, you look into your expenses and you say, are those expenses correct? Is there a way to lessen those expenses? But financial conservatives are also about on the revenue side that you collect those bills due you. And that's you know that's a little bit of conflict for some people in our industry to sit in somebody's office or to call them. And pointly call out that you know, they're supposed to pay you when those mike check ready. You know holding out estimates to customers who're not paying you. "Look I'm not going to bid you anymore because you're not paying me". But that financial conservatism attitude sometimes needs to be learned or embraced by some people because it's a source of conflict. And certainly people don't wanna pay and they wanna give you an excuse. And you wanna believe that they're doing the right thing. But also on financial conservatism, you certainly wanna build people the market pricing. And Kia does that. You know, certainly you're going to give people a great job. But there's no discounting, there's no call for discounting because she does great work and so the financial position that puts her up herself in is very strong. She gets paid. She gets the market price. She keeps a close eye on her expenses. You know, you look at that and you say, her business has a very certain future.

Bjorklund: Do you find that some companies do work backwards and find that their profit is just whatever is left over? When all/ when the project is done or when the year is done?

Stevens: Yeah, again I go back to that comment about you know, people who look at their businesses. I've got good backlog. I've got plenty of work this year, maybe next. I've got good margin. I should be fine financially. It looks good kind of have a quick look. And that, you know, can bite you in this business. You know our business, contracting, is the second riskiest business in the United States. Which means a lot of people work very hard at it and fail. This is not an easy business at all. There's a hundred ways to get big in our business. Poker players say this. They say, it's called a bad beat, and a bad beat is when you get all the cards on the table except one and looks like you're going to win and all of a sudden that last card is drawn. And you're/and it comes out of the blue and it's your 1 percent chance, but it beat you. Well, that's construction to a tee. I've got to be very careful. You know, meticulous about some of the issues here. It's not something that you can just brush off and save it yet for tomorrow. You want to continue for 30 to 40 years in this business and manage yourself into a recession. You've got to have that merchant mentality that financial conservatism attitude.

Bjorklund: Well, it sounds like Kia has adopted. Well, she's been drinking your "Kool-aid" so to speak. Kia what impact have the changes that you've made had on your company?

Ricchi: Well, I have to admit prior to meeting Matt, I was actually waiting to the end of the job to pay myself. So I was fortunate not to get stung and/but that made me very uneasy. So that was not the way to go about running my business. Now, I know what I'm going to make. It goes as planned, as estimated.

Bjorklund: Matt... Oh, go ahead, go ahead.

Ricchi: It was very comforting to you know, have in my pocket.

Bjorklund: So you think you can weather the next recession?

Ricchi: We'll see won't we.

Bjorklund: Alright.

Stevens: I have a lot of confidence that she can.

Bjorklund: Now, we haven't touched on negative cash flow. And what are some of the ways businesses get themselves into that situation?

Stevens: Well, certainly, one of the ways that begin trouble is that they start out on a job with you know, the upside down of the building. They don't build a lot upfront. They build something upfront. You know, there's a lot of different ways to get upside down. Another way is/this is common to everybody that listens to you, Chris. You know you get a client talking to you and says, you know what, I'm want to use you. I think you're very good at what you do. Here. This is the kind of work I want you to do. And you go out, you do your training. You get yourself/you invest them in some equipment. You sit there and say, "gosh this person is going to give me this great work". And all of a sudden, you do all this preparation, all this expensive investment. And the project goes to somebody else. And your left holding the bag for thousands of dollars of investment. And you're upside down in cash. Well that's what happens to every contractor being promised work but it never came through. Another one, is that we tend to overpay on salaries. Where we should say listen let's give everybody a decent salary, an average salary, a market salary, or maybe below average market salary, but we'll make up for it based on a performance bonus that's paid out at the end of the year. Or your bonus is deferred. You get a lot of your bonuses you know, in the first year, some on the second year, some on the third, defer it to keep people around. To place them or to even randomly say, I'm going to do the right thing for me and for you on cash. But it's really watching those cash expenses that we all can make and we're believing that something can happen because we made that investment. And we just got to look back the last hundred years and know that not everything is guaranteed.

Bjorklund: Now, on the jobs you haven't collected on, I would like to touch on this before we wrap things up. Is there a certain dollar amount of uncollected fees that should be a red flag to a business owner?

Stevens: Well, in our business in construction, we're very sensitive to the bad debts and to mistakes. Let me see if I can explain it this way. Because our business is one that is known as bearable cost, it's just a fancy way to say we have a lot of cost that we don't make any profit on that are committed to the job. We basically come down to a 3% net profit. Now, a 3% net profit business. If you have a bad debt of $10,000, OK that means $10,000 not collected as revenue. You have to go out and bill $300,000 of work to make that $10,000 back. That is a very ominous problem in construction. That is when you have a problem in cash or profit, you're at a loss. And you're just think of your 1 percent business. That's a hundred times that loss and if it's a $10,000 problem, it's a million dollars worth of billing, you're going to get out find a million dollar job just to break even to get the profit back into the company to break even. That's what I would have foresee the lag of receivables in construction are really not scientifically, you know, pure because we have a lot of private businesses that don't disclose a lot of information. They shouldn't. You know, it's a private business. Heck they're not going to.

Bjorklund: That's right. That's right.

Stevens: But what I would say is that if you're past 90 days on 5%, you're asking for trouble...

Bjorklund: (Affirmation)

Stevens: You're billing should be paid 95, 98, 100% within 90 days. And that/that's not a bad rule of thumb. That really puts the owners on you to go collect and if there's a problem, you solve the problem very quickly and then you get collection.

Bjorklund: So as we wrap up this discussion on cash flow, you just mentioned one rule of thumb. Is there any other point you'd like to reinforce?

Stevens: Well to look back over to people I work with, Kia and other people which I won't name, it is clear that the contractors that work in this businesses deserves to get paid. And you know, what is ashamed is that some people don't pay them or they don't pay them quickly. And puts them in a financial disadvantage.

Bjorklund: And this is true for all small businesses really. Services performed you deserve to be paid.

Stevens: Right. And in this business especially, craftsmen are not easy to find. And when you have you know, 12/15/25 or whatever craftsmen you do great work. There is no, you should not be ashamed out walking at somebody's office and standing there for 1 to 5 to 10 hours and saying I'm not leaving until you pay me. Because again your great crafts skill. I would/I would say in some review. Just don't be shy about collecting the money. You certainly worked hard enough in a risky business. You deserve to get paid and there is no compelling reason why people should hold your money.

Bjorklund: Kia, I'm sure you're going to agree with that?

Ricchi: Yes.

Bjorklund: I've really enjoyed having you both on the show. Kia, special thanks to you for sharing your experiences as a small business owner...

Ricchi: Thanks

Bjorklund: ...And Stevens, thanks for sharing your knowledge and expertise. I'm sure you have motivated many many small business owners and contractors in particular to do something about their cash flow problems.

Stevens: Oh, thank you.

Bjorklund: Our cash flow expert on today's show is been Stevens, president of Stevens construction Institute in Florida. If you have feed back for us or would like to recommend guests, send your email to podcasts@AllBusinees.com. I'm Bjorklund. Thanks for listening.