As a remodeling business grows, the amount of money passing through the company can increase dramatically. Deposits received for design retainers and construction contracts can add up fast.
If the firm is front-loading payments received as projects progress, this too will increase the amount of money the company is holding. On the other side of the equation, a business must meet its obligation to pay for the costs and expenses of doing business in a timely way. Direct costs on projects accrue and, at the same time, the business must pay operational expenses related to overhead.
Thus, as a business grows, managing cash flow becomes extremely important—even critical—to continued operations. The owner or manager soon becomes a money manager. As this happens, there may be opportunities to earn more money by using cash in a strategic way. In this article, we will address a few simple strategies you could apply today. I suggest you always consult with your accountant and tax adviser before trying any new strategies.
Create Good Cash Flow
For good cash flow to be a reality, two important things must be put in place. First, the business must know how to properly estimate project costs, as well as what markup the business needs to use to cover overhead and a planned net profit. Guessing at these and undercharging as a result will not cause bad cash flow. It causes a shortage of money to pay bills and will most likely lead to business failure.
Good cash flow, therefore, is caused by collecting money from your customers ahead of when you need to pay job costs and overhead expenses. In other words, to maintain good cash flow, you should be charging for each phase of work before you start that phase of work. Bad cash flow, therefore, is caused by doing the work first and not asking for the money until after each phase of that work has already been completed.
Use Accrual Accounting
Many companies leave all money collected in one checking account. The funds are then used to pay the costs of producing projects and the operational expenses of the business, often then leaving any excess of money in the business’ operating account.
If the business’ financial system includes the ability to predict revenue and expenses on a monthly basis, the cash flow needs for that month are easily determined. Any excess of cash that would normally remain in the account could become an opportunity to earn additional profits. In order to quantify what is excess cash, over and above monthly costs and expenses, the accounting system should be run on an accrual basis, not a cash basis. By using the accrual method of accounting, expenses are recognized as they occur, even if the expense has not yet been paid for. Income is recognized when the customer is billed, even if payment has not yet been received.
Revenue and expenses are then tracked by the exact day they are to be collected or are due, respectively. By tracking the revenue, costs and expenses in this way, one can easily predict the money that will be owed at a certain given time, as well as how much money will be available to pay for those costs and expenses at the time they become due.
Handling Excess Cash Flow
Consider opening a second interest-bearing account where any excess monthly funds could be deposited. The amount of interest this second account earns depends on how long the money will stay there. The longer the commitment to leaving the money in the account, the higher the interest rate. Interest rates on these account types may seem low, but over the course of a year a significant amount of “found” money can be added to your bottom line.
I also suggest that both this second account as well as your primary business account be held with the same bank. This way, transferring of funds between accounts can be done instantaneously. There will be no need to wait for checks to clear. Also, with online banking services you won’t have to leave your office and can be sure the money is actually available in a just-in-time fashion.
Protect Your Profits
As a word of caution, some may seek to move excess funds out of a business account to an interest-bearing personal account. By doing this, you will obviously need to pay taxes on the funds as earned income.
The advantage to this strategy is that legally the money is no longer the business’ money, but rather the owner’s. Should a client pursue legal action against the company, this money has now been protected, at least to a higher degree than it would be if it were deposited in the business account.
Unfortunately, I have seen situations where contractors keep excess funds in their business accounts, and the money was “attached” by a suing client’s attorney. When this happens, the amount of money in the account that has been “attached” is no longer accessible by the contractor, and meeting your business’ financial obligations may become impossible.
If this were to happen to you, you can always move the personal funds back into your business to meet operating costs. To clarify, if the tax has already been paid on those funds, you will not incur additional tax liability when you eventually take the same amount of money back out of the business to repay yourself. QR
Shawn McCadden is a speaker, business trainer, columnist and award-winning remodeler with more than 35 years of experience. He can be reached at shawnmccadden.com.