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Contractors Take Caution: Succeeding During Economic Recovery Requires Vigilance on Cash Flow


1/9/15

As the economy steadily rebounds, the outlook for construction activity also remains on a positive trajectory. The Consensus Construction Forecast of the American Institute of Architects (AIA) predicts that commercial construction spending will experience 4.9% growth in 2014 and 8% growth for 2015.1 Equally positive are declining unemployment rates in construction and rising levels of construction put in place.2

However, contractors be forewarned. Continuing to struggle financially from the market downturn, many contractors are likely to face obstacles in successfully financing this growth. Ultimately, growth eats cash, and as contractors aim to restore their volume of work to pre-recession levels, the ability to adequately finance the work becomes riskier. Moreover, a shortage of skilled labor, rising construction costs and tighter bank lending standards all present challenges to the existing strong demand for construction financing. As reported in Engineering-News Record, research confirms that the failure rate of construction enterprises is three times worse during economic recovery than during a downturn.3

“Overall, contractors go out of business because they run out of money, not because they run out of work,” says Stephen Harrison, Co-Office Managing Partner of CohnReznick’s White Plains office, and Construction Industry Practice Northeast Region Leader.

What tactical steps can contractors take to ensure they are in the best position possible to reap the benefits of an improving construction market?

Positive Times Call for Proactive Measures

Surviving the recovery may be as vital as surviving the recession. It is during this recovery period that contractors need to maintain the equity in their company – and most critically – protect cash flow. Why? A primary reason is that sureties base their bonding capacity largely on the availability of working capital. As such, contractors should safeguard company equity by understanding the cash flow impact of any new project and creating a formal cash flow plan. “Recognize that traditional ways of doing business can negatively impact working capital and threaten cash flow,” says Harrison.

For example, while historically it has been advised to own equipment and to make debt service payments as low as possible, contractors with current operating losses may find it difficult to refinance and access equity and be forced to sell equipment. “Re-emphasize the ‘cash is king’ mantra and consider financing,” says Harrison. Maintaining a positive relationship with your banker and establishing a line of credit facility are crucial to securing future sufficient working capital.

CohnReznick also recommends focusing on the following areas to strategically plan for the demands of a growing market:

  • Devise the Right Management Team. Contractors should ensure three key departments are in place: 1) Sales/Estimating; 2) Production/Operations and 3) Administration/Finance. All three should consist of the right talent and include a leader responsible for each department. Establishing each department as complementary to the other will provide structure and the ability to successfully seize opportunities as they arise.
  • Manage Policies and Procedures. Closely manage the flow of all paperwork, with the proper checks and balances, to guarantee that internal controls are properly in place.
  • Establish insurance risk management. Insurance can pose a significant cost to contractors across a number of markets. Coordinate with insurance brokers to structure an insurance program that is adequate and appropriate for the business and establish an insurance risk team internally to manage the risks the business faces. Invest in a company-wide safety program and set the tone at the top on the importance of complying with such programs.
  • Maintain strict ethical compliance. Diligently monitor compliance with federal, state, and local laws and regulations to avoid breaches that can not only have a potentially costly impact on the business, but can also leave a negative impact on the broader construction industry. Identify an Ethics Compliance Officer who is responsible for internal training to ensure company compliance with contractual requirements in this area.
  • Carve a niche. “It is key for contractors to create a niche and stay within that niche,” says Harrison. This means building a business that is specific to a certain line of work – for example, water main work, concrete work, or a particular construction trade. It is difficult to succeed and prosper without having an expertise that sets you apart from your competition and enables you to be more competitive and also more profitable.
  • Choose your customers wisely. It is prudent to be selective with respect to engaging customers. Harrison maintains that contractors typically achieve greater success when selectively choosing customers with whom they already have a track record of successfully completed projects. For instance, general contractors should focus on pursuing work on projects with certain public agencies or private owners where, through prior experience, they understand the paperwork flow requirements, working capital needs and the ability to work through unforeseen conditions. A specialty trade subcontractor should focus on servicing general contractors with whom they already have an established relationship.  Do not try to be everything to everyone.
  • Planning how to approach each new project. Contractors should establish an internal team of experienced personnel to evaluate how to approach each new project that has been awarded to the company. The team would help to value engineer the project, approve the schedule of values, and determine the best strategy to attack the project. The best practices as evaluated and communicated by the most experienced and talented team members will help ensure that the project is planned appropriately.
  • Know your contracts. Monitoring agreements and post-project audits are becoming more prevalent, with prevailing wage, equipment utilization, and payments to suppliers and vendors as some key concerns. An integrity monitor – an independent third party retained by a company to minimize opportunities for fraud, waste, and abuse, and to assure compliance with legal and regulatory requirements – can assist in monitoring agreements. It is imperative to know all contract provisions, such as minority participation goals and overall documentation requirements. Keeping detailed daily logs on project activity should be standard practice. With respect to operating costs, understand what is allowable to be billed and do not duplicate invoicing. If there are unique conditions, bring them to the integrity monitor’s attention and again document the conditions and the associated costs.
     

The most judicious approach for managing the current economic cycle is to develop a strategy that exercises cautious optimism – keeping aware of what history has taught regarding the potential pitfalls inherent in a recovering market and striving to adequately finance recovery and growth. Carefully monitoring specific fundamental areas will ensure the outlook of the business aligns with the outlook of the construction industry as a whole – steadily rebounding and progressively regaining a solid footing.

What Does CohnReznick Think?
All market forecasts indicate an increase in construction spending activity for 2015 in both the public and private sectors. With the anticipated increase in contract revenues, construction contractors need to focus on fortifying their working capital positions and increasing project profitability.

Now is the time to strengthen surety and bank relationships and to review internal policies and procedures to take advantage of the increase in bidding opportunities in a controlled and profitable manner. Re-emphasize the ‘cash is king’ mantra throughout the operational flow of the entire organization.

Contact

For more information, please contact Stephen J. Harrison, Co-Office Managing Partner – White Plains and Construction Industry Practice Northeast Region Leader, at stephen.harrison@cohnreznick.com or 914-922-2107. For more information on CohnReznick’s Construction Industry Practice, visit our webpage.


1 http://www.aia.org/practicing/AIAB104284
2 http://www.fminet.com/media/pdf/forecasts/Outlook_2014Q2_FMI.pdf
3 http://enr.construction.com/opinions/viewpoint/2013/0114-beware-the-recovery-what-history-teaches-contractors.asp


This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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