The average home improvement/remodeling company is often owned by someone who worked for another home improvement company prior to starting their own business. Many were installers. Some were in the sales and marketing role.
What they have in common is that they are entrepreneurs. They make things happen and create business utilizing creativity and intuitive judgment. This often makes them comfortable, if not necessarily successful.
Most owners of home improvement/remodeling companies lack experience in structuring and managing the “back end” of the business. The majority struggle with “working capital” issues. This often started when the business was established and continued as the business grew.
Many companies operate at a profitable level, yet have not increased their working capital to accommodate growth.
Start-up companies often do so with little capital and a lot of “sweat equity.” “Cash flow” can create an immediate problem. Suppose the business produces $1 million in revenue and earned 7 percent pretax net profit in the first year. That means they spent $930,000 in labor, material and operating expenses. That’s $77,500 per month (or slightly less than $20,000 a week). Seldom does the average entrepreneur research this “need” and create a plan to make it workable.
Success can be disarming and often a costly experience. Example: an owner who came out of a sales role with some marketing experience. He starts a business with a few salespeople. They do $2.5 million in their first year and end with 7 percent pretax net profit (that’s $175,000), which means the company will spend (labor, material and operating expenses) $2,300,000. That’s over $190,000 a month, or slightly under $49,000 per week. Some companies have accomplished this with less than $10,000 as an original investment; however, the majority of companies who attempt this don’t make it or continually struggle.
Companies seldom grow on their cash flow accumulations.
In each example, estimated net profitability was 7 percent, which would be subject to federal and state taxes where applicable. All the while, these companies are attempting to grow without sufficient cash to make it workable. With effective (within the law) use of deposits, progressive payments, change orders, (paid for when negotiated), and prompt collection of “balance due” when the job is substantially completed, it becomes more workable. Instead, we find numerous cases where a job is completed and a balance remains unpaid. Litigation is lengthy and costly — settlements often wipe out the profit, and the virtually uncollectable balance leads owners to pay taxes on a “receivable” if “accrual” accounting is utilized.
NOTE: The use of the phrase “substantially completed” is a variation from the use of “completed.” If you have an unfinished portion of the job to complete or there is a punch list, either complete it properly or offer the customer a “hold back amount” of approximately 150 percent of what your costs are.
A Few Ideas to Consider
Get cash deposits (within state laws) or progressive payments on all contracts and be sure they exceed “work in progress.” If you are incorporated and utilize accrual accounting, cash deposits or progressive payments are not treated as income until the job is completed. This is the equivalent of having a capital loan with no interest.
Offer prompt payment discounts. On cash contracts create a phrase such as — “The balance of $_______ is due on the day the specified work is substantially completed. If paid on the date of invoice, which shall be considered the date of completion, the customer shall be entitled to a discount of ____ percent. Balances paid after that date are subject to interest at the rate of ______ percent.”
Add-ons and change orders. Large add-ons can usually be acquired by offering financing. Smaller add-ons or change orders should be negotiated, including contract amendment, and be paid for the day they are negotiated.
Here are some simple ways to improve efficiency and increase working capital.
A Checklist to Increase Cash Flow
Spend less money than you take in. If you have a budget based on anticipated business and anticipated net profit, spending considerably less than what you earn helps you accumulate cash.
Do not employ checkbook management. Many companies decide to purchase equipment or vehicles based on the amount of money they have in their checking account. Instead, use a current balance sheet to determine cash available less liabilities.
“Cutoff date” purchasing. If you purchase from a supplier who accepts credit cards, find the date each month that your credit card issuer totals the account for the prior month. Make purchases on your credit card the day after that cycle is completed. This will give you another 30 days’ use of that money.
Off-season purchases. Many vendors — including printers, stationary suppliers and similar — may be open to extended terms or special prices on large purchases made during their “slow” season.
Decrease your “turn time.” This is the amount of time it takes you to complete and collect a contract once it has been approved. A simple way to remember this rate is: The more times you can turn your money in a given year, the easier it is to accumulate cash.
Pay your bills on time (and ask your suppliers for a discount for prompt payments). A 2 percent discount for prompt payment on the 10th of each month will earn you 37 percent when compounded annually. You could actually borrow money from your bank at 8 percent, and that loan would earn you big dollars in return.
Reduce your accounts receivable. Collect all balances on the day the work is substantially completed, and collect for all change orders or extras when they are executed.
When a deposit is received, remember this money still belongs to the customer and is issued to the contractor as an “in faith” deposit and (technically) does not belong to the contractor until the job is completed.
Evaluate all new projects, staff additions and other actions. Programs should
be thoroughly evaluated both in advance and as they proceed. Don’t spend the money unless you are sure to meet objectives.
Products/services. Do away with operations that aren’t profitable or only marginally productive. It could be a product or an outmoded procedure. Every company has a few “sleepers” and “sacred cows.” Get rid of them.
Know Where Some of Your Capital May Be Hiding
Companies with large marketing budgets and those who advance a portion of the commission upon “approval” will have cash depletion based on their investment in the backlog. Backlog (business that
is sold and approved for installation or waiting to be scheduled) usually contains some advances for labor and material, as well as marketing expenses, advances to salespeople and overwrites to sales management. All of these deplete cash. Here’s an example: a fairly good-sized company that sells products such as roofing, siding, insulation, windows.
Marketing expense 15%
Commission and overwrite advances 7%
Estimated investment in backlog: $220,000
You will find that “positive cash flow” is a great stress reducer. With these suggestions, it won’t come overnight, but it will come.