The importance of cash flow management for MEP firms

The importance of cash flow management for MEP firms
Published: 5 February 2020 - 5:30 a.m.

MEP is a heavily cash-driven business; without a regular influx of cash, it can be hard to take care of your operations.

As a contractor, it is important to focus on project management, but a thorough understanding of cash flow can make a big difference.

Here are the possible reasons behind cash flow issues and how to address them:

Schedule planning
A good contractor never goes into a job blind; you have to start your cash flow planning from the bidding stage.

A cash flow statement from the tendering stage will give you a complete picture about the working capital, bank overdraft requirement, and will help you to price the project.

It will guide you to properly load your BOQ; preferably it should be loaded on first fix items.

A cash flow statement will also let you know about the Mobilisation Advance requirement and accordingly you can ask for the adequate advance payment.

I strongly recommend to ask for higher Advance payment even if you need to give some discount. Always try to put a condition under payment terms for retention release on submission of retention guarantee.

Efficient operations
Assuming there’s enough cash and knowing there’s enough cash are often two different things.

After the award plan your business around your cash flow. It is critical on the front end of the job to make sure billing deadlines are met and in the proper hands to start the payment cycle.

Depending on the type of project and funding source, payment could take anywhere from 90 days or more.

Knowing this at the beginning of the job will help you anticipate cash flow needs and help you determine the payment terms to be agreed with your suppliers and subcontractors.

The more you know, the better you can prepare, ensuring every obligation is covered with ease.

Projecting earnings
Forecasting earnings is a key aspect of operating a successful business.

Without comprehensive knowledge of what’s going in and what’s going out, it can be extremely hard to anticipate your overall income for any given period of time, including throughout the duration of a project.

If you’re not sure when cash is coming in, you’ll struggle to budget for the future with any certainty. Failing to keep tabs on payments can cost you more than you realise.

Billing and collections
It’s very common in construction to have issues in collecting unpaid invoices.

As an industry, these payment challenges seem almost ingrained in construction’s DNA. Nonetheless, it’s an issue that puts many businesses in a very precarious situation.

Continuous follow-up is required to collect the due outstanding. In case these outstandings are getting overdue and you sense some problems, always be open and flexible to offer some discount to collect the cash – cash in hand is always better than a debtor in the books.

Net profit and cash flow are different things
Focus on cash and not on net profit. Many companies make this mistake, since profitability is always on top of their mind, which results in accounting of higher top line (revenue/sales) with mounting WIP balances in the books.

Going forward it generates a huge work in progress which turns into uncollectable bad debt. Remember: you might know that your profit is based on revenue minus cost of goods and operational expenses, but the fact is that it will not impact your cash flow unless you’ve collected the cash.

Some will advise that one of the first things you should look at when cash is getting harder to manage is if you’re not charging enough.

Please note: net profit is what’s accounted in the books while cash flow is hard cash you have on hand.

Contractors can find themselves being profitable but still tight with negative cash flow – it doesn’t matter if there’s just one project underway or multiple. Please ensure billing to your clients on a timely manner.

If you’re under billing on a project or are burning too much cash before collecting on bills, you can be in the red.

The report that can help you most in getting an overview of how your cash flow is doing as a result of billing and collections is the accounts receivable aging report (A/R aging report).

Accounts receivable & accounts payable timing
As you know, A/R refers to your collectibles while A/P refers to your payables.

A cash flow crunch can be the effect of bad A/R and A/P timing. How? Simple, if you pay your vendors before you get paid, you will burn cash, and that can result in negative cash flow.

It can be tricky to figure out a cadence that’s both not overkill in terms of stretching the terms with your vendors and also getting you to a good cash position, but looking at your payment terms from your customers can help you to decide the payment terms with vendors.

See if you can set up the terms with your vendors longer than the terms you’ve agreed on with your client.

Always try and agree back-to-back payment terms with your major suppliers and subcontractors. You must be diligent when it comes to making sure that you get paid first and putting that in your contracts.

The closeout
Another potential source of cash flow woes is the ballooning of costs during the final days of a job.

The time when money is definitely true in construction is especially when you consider retention. Delayed closeouts mean you won’t have access to that retainage that you’ll only get when you finish the job 100%.

It’s common practice in construction to have 10% of the contract price to remain withheld by the client and can only be released when the job is done.

The reality is that the retention is often what contractors and subcontractors are counting on to reinforce positive cash flow or recover from negative cash flow throughout a job.

Generally, the net profit margin for subcontractor’s hovers only around 6%.

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