Steps for Better Managing Cash Flow

At the core of every business is the ability to bring cash in at the same rate or faster than it must go out to employees, vendors and suppliers.

The kitchen and bath remodeling business has some unique aspects to this process, and this month, we'll examine these with respect to forecasting requirements, procedures designed to control them and managing cash flow.

The most important element of controlling cash flow is knowing the relationship between the material and labor flow on your typical project and the cash requirements that will follow. In other words, when you have lumber delivered to a job, you need to know how long it will be before you will have to pay for it.

Figuring job costs

Take the time lines for a couple of your typical projects say, for instance, a facelift job and a larger one that might include an addition. Using a calendar preferably a computer spreadsheet program lay out the time lines and attach an estimated cost to each step, using the first day of the month as the start date. Next, mark on the calendar when the payments will be due for each of these elements. You will probably have to break down each step into a labor and material component.

From this exercise, you will be able to see what the lag time is between job production and payment. This can now be converted to a forecasting tool by substituting your actual projects for the examples on your spreadsheet.

Using your job-costing data, or simply estimating from your experience, attach the cost to each step you have identified and note these costs on the calendar. As you perform this analysis, you will see that material payments will tend to cluster at a certain time

of the month, regardless of when they are incurred.

Now that you have the job-related expenditures on your cash-flow calendar, you should add the general and administrative recurring expenses that do not flow with a direct relationship to job progress. These include office payroll, rent and utilities, taxes, etc.

From this information, you should be able to accurately forecast your future cash-flow requirements. Adding in the projections for payments from your clients will allow you to predict when shortages are apt to occur.

Control Procedures

There are several steps that can be taken to improve your cash position and increase cash flow. The first thing to look at is the payment schedule you have incorporated into your contract. Here, it's important to consider the balance between fairness to your client and your need to control that relationship.

You should try to develop a payment schedule that allows you to receive payments that will cover the amount of work you have done at any point in time. At the same time, a good "rule of thumb" is to always leave a balance owing on the contract that would cover the cost to complete the job. Following this will allow your client to feel secure that he has not paid for more work than has actually been accomplished.

In setting up your client payment schedule, you should provide specific "milestones" on which payments are due. To remove subjectivity from these milestones, try to attach them to the start, rather than completion, of various tasks, i.e. start of drywall, delivery of cabinets, etc. Another thing to consider with the scheduled contract payments is that payments are generally more difficult to collect as you near the end of the project. It also becomes more difficult to assign non-subjective payment milestones.

For this reason, it is best to try to collect 95% to 98% of the contract balance prior to performing the punch list. The majority of your clients will probably make their final payment without delay. However, leaving a payment of several thousand dollars subject to final adjustment of a cabinet door or replacement of a minor part is just too tempting to that occasional client who is trying to stretch his or her own cash flow.

You should also have a functioning job-cost system for your business.

We will not go into the details of' how job-cost systems operate here, but it should allow you to monitor the cost of your jobs and whether your suppliers and sub-contractors are billing you in agreed-upon, budgeted amounts.

Since it's imperative that jobs produce the expected gross profit in order to cover general and administrative costs, out-of-control job costs will result in cash-flow problems that cash-flow timing and management cannot solve.

Managing Cash Flow

A business can encounter serious financial stress even if it is profitable. Such a situation can occur when cash from sales comes in more slowly than payments for costs and expenses go out. One element of this is scheduling the collection of revenues, which was discussed previously. The other element is controlling the schedule of payments.

Assuming that the jobs are producing enough profit to cover general and administrative expenses and that you have scheduled receipts as aggressively as practical while still being fair to your clients, it's time to look at the schedule of payments.

The first thing to look at is your payroll. There are a variety of ways to approach this, but most employees expect to be paid at least twice per month. Some companies pay hourly employees on a weekly basis. It's important to think your policy through on this. Paying bi-weekly, one week after the end of each pay period, will permanently delay two weeks worth of payroll. If your payroll is $40,000 per month, this is essentially a $20,000 interest-free loan.

Another area to look at is supplier terms and billing cut-off dates. If a supplier has a cut-off date of the 25th of each month, with payment due on the 10th of the following month, scheduling non-essential deliveries for the 26th or later will allow an additional 30 days before payment is due.

Finally, it's prudent to arrange for a line of credit from your bank to take care of those times when a customer doesn't pay or more bills come due than current cash flow will handle.

The key to avoiding problems with cash flow is to spend the time planning. Plan your job budgets to assure a profit on each job that will be adequate to cover expenses, forecast your scheduled revenue and payments to allow you to prepare for those times when you will come up short, and take steps to manage payments and receipts to maximize your cash position.