Author Archives: Mike Marsella

Cash Flow Strategies For Contractors

As the construction market continues its slow recovery, now is a good time to review your cash flow strategies. Questions to consider:

  • How much bad debt can my company absorb before having a critical impact on my balance sheet and cash flows?
  • Who bears the risk of non-payment by the ultimate project owner? Do I have any “Pay If Paid” contracts?
  • How is this private project being financed? Has anyone seen a bank commitment letter?
  • What would happen if my receivables were stretched another 30-45 days on average?
  • What is my added exposure when I bond a job?
  • How do I know if my subcontractors are still financially viable?
  •  How long should I perform work without being paid? What does my contract allow for in terms of work stoppages for non-payment?

For companies that rely on bonding to secure work, a strong surety relationship can be a key competitive advantage. Do your homework before signing a contract.


Contact Mike at 317.805.7524 or email mike.marsella@mjinsurance.com. Visit www.mjinsurance.com.

Managing Downstream and Upstream Risks

Managing Downstream And Upstream Risks

Examine your company’s cash flow needs and managing downstream and upstream risks

Even the strongest, most sophisticated contractor has probably taken a lump or two over the past year as a result of one of the worst stretches the construction industry has seen in decades. Because of these challenges, there are many ways that you should be examining your own company, your cash flow needs, profit estimate and balance sheet projections.

Managing both your upstream risks and downstream risks will be critical to your success in the coming years. Ask the following questions:

  • How much bad debt can my company absorb before having a critical impact on my balance sheet and cash flows?
  • How long should I perform work without being paid? What does my contract allow for in terms of work stoppages for non-payment?
  • Who bears the risk of non-payment by the ultimate project owner? Do I have any “Pay If Paid” contracts?
  • How is this private project being financed? Has anyone seen a bank commitment letter?
  • What would happen if my receivables were stretched another 30-45 days on average?
  • How would this job be impacted if one of my subcontractors could no longer perform their work (due to bankruptcy or otherwise)? How much would it cost me to replace them?
  • What is my added exposure when I bond a job?
  • How do I address onerous contract terms with my owner/GC/client?
  • How do I know if my subcontractors are still financially viable?

There are landmines at every turn so be sure to not discount the value of doing your homework before signing a contract. What are some specific areas of risk to pay close attention to?

Upstream Risks

We all understand the inherent risks with subcontracting a portion of “your work” to another contractor for whom you will be responsible. How many of us though give a lot of thought to upstream risk? Are you a sub to a general contractor? Sub to another sub? Vendor, supplier? Or a general contractor doing work for a private company? All of these scenarios carry several risks.

The most obvious upstream risk is no pay/slow pay from your client. As a general contractor doing work for a private owner, you will typically have the ability prior to starting the work to inquire about project financing. Do not dismiss this right and take full advantage of this opportunity as you will likely have difficulty getting anything else from the owner once the project has begun. Useful tools here include a “set aside” letter from their bank, loan commitment letter for project specific funding or a bank reference letter stating that the owner has sufficient cash on hand to pay for the project.

Even if you are not prime to an owner, all of these risk factors affect you. Unfortunately, you will not likely have access to your upstream contractor’s financials and will be somewhat dependent on their due diligence with the owner. Even so, don’t be afraid to ask your prime contractor (or upstream contractor) if they have done their homework. Also, check with your peers or any subs/suppliers who are working for your general contractor to see how timely they are currently making payments.

Downstream Risk

If you are a general contractor, part of your normal operating procedure is to monitor subcontractor bids and hopefully that includes a formal prequalification process for the majority of your subs. The amount of data you request is up to you, but the following is a key list of things you should know about your potential subcontractors:

  • What is their reputation? Do they have reference letters? How many jobs of similar size and scope have they performed in the past?
  • What is their safety history? Do they have a dedicated safety director?
  • What is their financial status? Have they ever failed to complete a job? Will they share financials?
  • Do they have a bond company and/or a bond line? If so, what are their single and aggregate limits? Can you obtain a letter from their surety stating these limits and current capacity?
  • Do they have all the required insurance currently in place? How do you monitor and track expiring certificates throughout the year?
  • Do you know how many subs or suppliers they will engage to fulfill the contract? If you are providing a bond as a prime contractor, these parties will all be covered by your Payment Bond and add to your potential exposure for non-payment claims.

This economy has certainly taken its toll on a large number of contractors. Often the smaller, trade contractors are hit the hardest as they did not carry large backlogs of work or large balance sheets into this downturn. They could be dependent on their next job for their very survival so it is critical that all parties are aware of potential risk factors with key subs and suppliers and employ as many additional tools as possible to mitigate those risks and prevent another contractor’s problem from being your problem.

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Cash is King, but Wrong Choices Can Bring Down a Contractor

You’ve heard the phrase a million times – “Cash is king.” But what are we trying to accomplish with cash? Does cash equal success? Profit? Stability? Does a lack of cash signal a problem? It all depends on your perspective.

Contractors are in a unique business where everything is based off of estimates, so revenue is recognized under the assumption that your estimates are accurate, although subject to change. For this reason you cannot afford to just focus on the profit/loss information driven by your income statement or WIP schedule.

We all know your jobs are typically not going to generate the EXACT amount of profit you estimated at bid day, so the income statement is just your “best guess” as of that day as to how your year is going. The list of why profit on jobs can fade is endless – requested change orders are performed but never approved by the owner, subcontractor issues, site conditions, weather, labor quality, project management, poor estimating, ambiguous bid specs, difficult owner, unexpected delays, etc. The point is that in addition to monitoring the status of all your jobs which will drive your profit, you must also be keenly aware of your cash position and cash flow, both now and on a projected basis.

Why should cash flow be targeted as a key measure of business performance? Because the income statement and balance sheet, although useful, have all kinds of potential biases as a result of the assumptions and estimates that are built into them. However, when you look at a company’s cash flow statement you are getting an indirect look into their bank account. In the end, cash does not lie.

As a former commercial loan officer, I had to continually advise business owners that even profitable companies can fail if they run out cash. Unfortunately, a strong income statement is not necessarily indicative of a financially healthy company. Contractors can fail from a lack of cash for a number of reasons:

  • Growing too fast without the appropriate equity or bank financing to keep up
  • Too many large projects undertaken at once with slow paying owners
  • Letting receivables get beyond 60-90 days past due
  • Working for owners with cash flow problems of their own
  • Bad debt that takes a long time to be recognized/written off
  • Purchased too much inventory or equipment using cash
  • Cash taken out of the business and loaned to shareholders/employees/other business interests
  • Excessive reliance on bank debt and leverage
  • Excessive distributions to shareholders
  • Excessive underbillings
  • Problems collecting retainage

Remember, every bank will have a limit they are willing to lend in order to support your business and cash flow needs. It’s up to you as the owner or chief financial officer to know your banking limits and compare those to your needs and identify solutions to make up any shortfalls. What are some ways you can help improve your cash position?

  • Forecast project cash flows when bidding new work to determine if there are periodic drains on cash for items like equipment or material purchases, mobilization, or peak labor periods and the delay in the outflow versus projected inflow (do you know how long the owner/GC typically pays after receipt of a submittal?).
  • Compare the project forecasts against your general cash flow forecasts to determine your cash flow needs and whether you have the available cash on hand or working capital line of credit to support the project. Be conservative in your assumptions.
  • Be sure to establish on ongoing dialogue with your banker around the size of your line of credit and understand how large of a line your bank is comfortable extending and the requirements to obtain that limit. Be sure they understand the seasonal nature of your business and cash flow cycle and that you may request an increase to your line at a time when you are cash rich and seemingly do not need the increase. It’s always better to ask for the increase before you actually need it. Typically banks do not charge a non-use fee for contractor bank lines so the additional credit limit should not come with much of a cost.
  • Discuss with your banker the ability to have a separate capital expenditure line of credit available for equipment purchases so you are not using your cash on hand or working capital line of credit to buy fixed assets.
  • Are you having a problem with getting your submittals approved the first time? This can cause unnecessary delays and impact your cash flow. Create a best practice in getting these to your owner/GC’s in a timely manner each month in the format required.
  • Are punch list items to blame for slow paying owners? Holding up retention? Again, this can often be avoided with a system of procedures to address them in a timely manner and keep the cash flowing.
  • While you need to keep your key suppliers happy, are you paying them faster than you are paid? Is this necessary? Can you work with your suppliers during a cash crunch to allow for extensions of time without an interruption of service or terms for new orders?
  • What role do your project managers play in getting paid by your client? Can they be more proactive and involved in the collection process?
  • How do you determine distributions or bonuses at year end and throughout the year? Do you analyze your cash on hand versus your cash flow forecasts to consider the impact of these items? Can they be accrued but not paid in order to conserve cash? How about deferring a portion of these payments? While we all want to reap the rewards of the most recent year, we also need to focus on the long term health of the “golden goose” so it can keep laying eggs, year after year.
  • Are you in the middle or beginning of a shareholder buyout plan? Can this be structured to be paid over time rather than cash out all at once? Are there provisions in your agreement to curtail payments in a given year if the company’s performance was below a certain target?

If time is taken to understand the cash flow needs of your business, the return on that investment in time can be considerable. In difficult times like these, it could likely mean the difference between success and failure. You must keep track of your effectiveness and timeliness in turning profit into cash. This will also allow you to see early warning signs of trouble and take appropriate action. Being able to proactively manage your cash needs is critical to the short and long term success of your business. Don’t forget though that you may experience times when you have good cash flow even without profit. Look at your statement of cash flows to determine the sources of your cash. A large reduction in A/R or increase to overbillings may boost your cash positions temporarily, but the income statement or backlog schedule may be painting a different picture. Be prudent with your funds as you determine how best to deploy you cash and always keep one eye on future needs.

Mike Marsella is a Surety Producer for MJ Insurance. www.mjinsurance.com