Paired with a solid foundation of good accounting practices, cash flow forecasting will help you track the movement of cash into and out of your business at both an individual job and company-wide level. This means less funding projects out of your own pocket, no more surprise cash flow gaps, and more control over your financial position.
Key Takeaways
- Good cash flow management is about knowing how much money is coming in and out of your business at any given time.
- Cash flow forecasting lets you see this movement at both the job and company level, so you can plan accordingly.
- Bigger jobs don’t always equal more profit. Long payment terms can create cash flow gaps that are hard to recover from. Make sure you’re ready before you take on bigger contracts.
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Building a Cash Flow Forecast at the Job Level
They don’t say “cash is king” for nothing. Knowing what to expect financially on each project you take on can mean the difference between bringing home a nice profit and just barely breaking even.
Cash flow forecasting at the job level starts with setting clear and measurable project timelines. Your timeline doesn’t have to be perfect. In fact, you should plan to adjust it as needed throughout the lifecycle of the project, especially on longer jobs. A good baseline project timeline should include:
- When you plan to start work
- When you plan to finish
- Built-in milestones (when you plan to have the foundation done, etc)
Once you’ve outlined specific milestones, calculate the cost it’ll take to achieve each one, and add that information to the timeline. Now you have a good idea of when you can expect to incur the costs to complete each milestone.
After you’ve covered costs, it’s time to tackle revenue. Outline when and how you’re going to bill. Are you going to bill a fixed amount each month, or are you doing cost-plus? Make a clear plan of what your billing structure is going to look like over the timeline you’ve already built.
Now you’ve got a job-level cash flow forecast that will tell you when expenses will go out, and when revenue will come in. The big goal here is to build your timeline in a way that allows revenue coming in to fund your expenses (instead of funding the project from your own pockets). This won’t always be possible, but it’s a goal contractors should always strive toward.
Cash Flow Forecasting at the Company Level
By creating a cash flow forecast for every active job in your business, you’ll give yourself a nice bird's-eye view of what your financial situation looks like at the company level. Keep in mind though that there’s more to cash flow than operations.
To get the most accurate picture, you’ll need to factor in overhead too. To account for this, I recommend putting together a 12-month cash flow forecast. To do this, start by looking at the last 12 months of company spending broken down by category. You’ll use this data as a baseline to project what the next 12 months of spending will look like. Add this to the work you’ve already done from a revenue and COGS perspective, and you’ll be as close as possible to a company-wide cash flow forecast.
This isn’t as simple as writing an Excel formula and calling it a day though. When you’re projecting spending, you’ll need to take your company’s future goals into account. For example, maybe you spent $5k a month on marketing last year but would like to ramp up your efforts this year. Going off historical data alone, a simple formula would tell you to budget $5k a month for marketing - but that doesn’t work if your goal is to spend $10k moving forward. This is the kind of granular, strategic thinking you’ll need to work through as you’re building your yearly cash flow forecast.
Taking Your Balance Sheet and P&L into Account
After you’ve got a company-wide cash flow forecast, the only thing left is to adjust the numbers based on your balance sheet. This is because there are several things on the balance sheet (like depreciation on fixed assets or payments on debt balances ) that impact cash flow but may not line up with the picture your P&L paints. To forecast accurately, we have to consider the movement of cash on both the balance sheet and P&L.
How to Read a Statement of Cash Flow
The statement of cash flow is one of the most misunderstood and underutilized tools in construction, simply because most contractors don’t know how to read it. I’ll explain how to read it shortly, but what you need to know first is this: The ultimate goal of this document is to reconcile cash on the balance sheet to profit on the P&L. Put simply, it explains why the amount you have in the bank doesn’t match the number at the bottom of your P&L.
There are a couple of different ways to create a statement of cash flow, but by far the easiest is to have your construction accounting software do it for you. Once you’ve got one, here’s how to read it:
At the top of the statement, you’ll see your Net Income for the period. At the bottom, you’ll see your Cash Balance. All the information in between explains why these two numbers aren’t the same. All the adjustments in between are broken down into three categories:
Cash Flow From Operating Activities
This section takes all adjustments from operations into account, including Accounts Payable, Accounts Receivable, and credit card payments. Because the timing of when these activities hit the P&L and hit your bank account is different, it creates a gap that must be explained on the statement of cash flow. For example, you swipe your credit card to pay for a tank of gas. That immediately hits your P&L as an expense, and won’t hit your cash balance until you pay off your credit card. What’s on your P&L doesn’t always equal cash movement.
Under Total Operating Adjustments, you’ll see Net Cash Provided by Operating Activities. This is strictly your Net Income - Operating Adjustments.
Example - If you have $1 million in Net Income, but $900k of that is still sitting in Accounts Receivable, you would see a -$900k adjustment in this section. To reconcile Net Income to Cash Balance, we have to back out $900k until that cash is collected.
Cash Flow From Investing Activities
This section captures all adjustments related to investments and capital expenditures.
Example - You spend $100k on a new service truck for your business. This hits your balance sheet as an asset, and you recognize depreciation expenses on your P&L over a period of time. In other words, you have a $100k decrease in cash right away, but virtually zero expense represented on the P&L. This section reconciles situations like these.
Cash Flow From Financing Activities
This section represents cash flow from financing activities.
Example - Let’s say you take out a loan for $500k. The balance you received on that loan will show up here as an increase in cash. It doesn’t hit the P&L but shows up on your balance sheet as debt. This section explains why there’s a $500k increase in cash that doesn’t show up on the P&L.
Tallied up together, your Net Income along with these three sections should equal exactly the amount you have in the bank at the end of the day.
What to Do if You’re About to Have a Cash Flow Gap
If you’re in a cash crunch or know you’re about to be in one, there are two courses of action I recommend:
- If you have a cash flow gap that’s going to put you in the red, that probably means someone’s not paying you. I’d immediately run an Accounts Receivable report and start making some phone calls. This is the most common situation I see contractors run into.
- If you’ve accepted a job with unfavorable payment terms and don’t have enough cash to ride out those gaps, you need to have a sufficient line of credit set up. A line of credit will cover your short-term expenses and can be paid off (with some added fees) once you’ve collected - just make sure you’re pricing the job with those fees built in. It should go without saying, but never take on jobs like these if you don’t already have a line of credit in place. Banks aren’t going to give them to you on the spot - you’ll need to secure one before you need it.
My word of warning: Don’t pursue these bigger jobs with longer payment terms until you’re absolutely ready for it. A lot of contractors see these jobs as breakthroughs, when in reality they can quickly become cash flow nightmares if you aren’t prepared. Unless you have a healthy cash balance in place, one or two late payments from these big clients can completely wreck your business.
Wrapping Up
Cash flow management doesn’t have to be rocket science. Building out detailed project timelines and learning how to read a statement of cash flow will give you the foundation you need to make sure you’re never left wondering where all your cash went.
My team at Cruzumi can help get things kicked off.