Contractor cash flow case studies

If you’ve listened to the Contractor Success Forum before, you know how crucial cash flow is to the health and longevity of your construction company. This week, we’re sharing some real life examples of cash flow nightmares, how they happened, and what you can do to avoid similar mistakes.

Topics we cover in this episode include:

• Cash flow and billing for retainage
• How good (and bad) relationships can affect your cash flow
• How to approach private projects when funding hasn’t been secured to protect your cash flow
• Billing issues can take even large companies down
• Liquidated damages and unreasonable time to complete a job
• Identify and address flawed processes and ongoing systemic issues
• Errors with bank feed accounting can cause cash flow problems

LINKS

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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com

TRANSCRIPT

[00:00:00] Wade Carpenter: Welcome to the Contractor Success Forum. Today we are talking about a common sore subject for many contractors, and that’s cashflow. And we talk about that a lot on the show. We’re gonna kick around some case studies and see if there may be some lessons in those. 

Here on the Contractor Success Forum, our mission is to provide game, game-changing financial education for contractors to help you be more profitable, grow and succeed in your business.

And who’s here to help us do that? As usual, my partner in crime, Stephen Brown with McDaniel Whitley bonding and insurance company. And I’m Wade Carpenter with Carpenter company CPAs and– 

[00:00:43] Stephen Brown: Partner, partner in crime?

[00:00:45] Wade Carpenter: Well.

[00:00:46] Stephen Brown: Well, I actually had a cashflow case study where one of my contractors’ bookkeeper was stealing from them and showing that they weren’t getting paid on jobs. That’s because she was taking all the checks and had a fake company set up. But anyway, I think this is a great topic, Wade.

You were telling me, but you didn’t tell me the details of, of something that happened to one of your contractors. But sometimes, when we talk about cashflow, when we talk about that pipeline of cash, it keeps your company going. It’s this kind of like blood.

[00:01:18] Wade Carpenter: Right.

[00:01:19] Stephen Brown: Sometimes you need infusions, sometimes, you know, that blood stops flowing.

I dunno, this could be too gory because, I think these case studies are, are more like cashflow horror stories. So what happened to your contractor?

[00:01:32] Wade Carpenter: Okay. And maybe we can come back to some of yours because I, I know I’ve had plenty of issues where people were stealing over the years too. But I guess this one was kinda one of the ones that I was thinking about. It just happened in the last couple of weeks. 

Cash flow and billing for retainage

[00:01:45] Wade Carpenter: An actual situation with a contractor. It’s in a southeast state. General contractor does commercial stuff, about 25 to 30 million a year. And we just started working with them in the last six months. They had grown up from being a developer to spinning off this general contractor.

And we started getting in there and, and working on their books. And we often talk about like retainage, bill retainage, you know, to your owner from the general contractor. But obviously this general contractor was also holding retainage on his subcontractors. Right?

So before I get into that part, let me ask you a question. All right. So Stephen, you’re a general contractor. You’ve got to bill your customer, and you’ve got a subcontractor on the job, and he’s done $20,000 worth of work on the job.

[00:02:43] Stephen Brown: Okay.

[00:02:44] Wade Carpenter: So you get a bill for $20,000. Are you able to bill your customer for that $20,000?

[00:02:50] Stephen Brown: Yes. Well, they, they’ve done the work. What does the contract say about payment, but–

[00:02:57] Wade Carpenter: Right.

[00:02:58] Stephen Brown: Of, of course, your, your subcontractor’s done that work as if it’s as if you had done the work.

[00:03:04] Wade Carpenter: Right. So, and you’re obviously entitled to your overhead and profit on that part.

[00:03:10] Stephen Brown: Sure. Right.

[00:03:11] Wade Carpenter: You haven’t paid that subcontractor yet. Do you have the right to bill it?

[00:03:15] Stephen Brown: Well, of course. The work’s been done.

[00:03:18] Wade Carpenter: Right.

[00:03:18] Stephen Brown: Does the contract say you’re gonna pay that subcontractor as you get paid?

[00:03:23] Wade Carpenter: Yes. So, so let me change the situation a little bit. So say you’re holding 10% retainage on that $20,000.

[00:03:32] Stephen Brown: Okay.

[00:03:33] Wade Carpenter: What, in that case, do you have the right to bill?

[00:03:36] Stephen Brown: Everything including the retainage, that’s between you and the subcontractor, not the owner.

[00:03:42] Wade Carpenter: Right, exactly. So that’s what I was hoping you would say.

[00:03:46] Stephen Brown: Okay.

[00:03:47] Wade Carpenter: Because this general contractor that was doing 25 to 30 million dollars was only putting in these current portion of the subcontractor pay. Right? In their accounts payable. And the accounting department was billing the stuff. Not project managers. And the project managers were clueless on some of this stuff.

So, $20,000, that’s $2,000 of retainage, you’re only billing 18, plus, let’s say we’ve got 20% overhead and profit in there. So, if we had 20,000 and we marked it up 20%, that’d be 24,000 of billing. If we only billed marking up 18,000, it’s like 21,000 and change, which is just barely covering your subcontractor, the total bill.

Right. So they had been doing it this way for many, many years.

[00:04:46] Stephen Brown: Whoa.

[00:04:47] Wade Carpenter: So they have a whole lot of work in progress and they do have long term contracts. And they were disagreeing that they had the ability to actually bill this because it wasn’t payable to subcontractor. 

They were like, this is the way it’s always done. We’ll never get paid on this. And I started looking at it and I did an approximation to the tune of 2.7 million dollars of cashflow that they had could had the right to bill, but it was sitting there because they didn’t treat their–

[00:05:21] Stephen Brown: That’s terrifying. That’s, that’s 10% of their overall sales right there.

[00:05:26] Wade Carpenter: Yeah, well, 10% plus overhead and profit. So,

[00:05:31] Stephen Brown: Plus overhead profit.

[00:05:33] Wade Carpenter: Yeah. So you know.

[00:05:35] Stephen Brown: So what happens when we haven’t billed properly and that affects the cashflow that much? You’re having to borrow. That’s an expense. You’re, you’re not using that cashflow efficiently, right? What else is happening?

[00:05:48] Wade Carpenter: Well, in that case, they, they were constantly having problems paying their subs on time. And they’re a very profitable contractor, but they didn’t collect all that retainage and all the extra until the end of the job. And so there were constantly cash flow poor. 

And this is an extreme example of that, but I see all the time where contractors are not booking retainage payable or retainage receivable.

But again, the contractor could not understand how they were able to bill it. And I’m like, the fact that you haven’t billed it doesn’t matter.

[00:06:22] Stephen Brown: Why do you think they didn’t understand that?

[00:06:25] Wade Carpenter: Well, it’s like, this is the way we’ve always done it and they’re never gonna pay us because we don’t have a current bill for it. So anyway, I–

[00:06:32] Stephen Brown: To me, there’s the issue of overbilling when you can, and what that means to your cashflow and your overall profit. We’ve talked about that in lots of podcasts in the past. 

How good (and bad) relationships can affect your cash flow

[00:06:44] Stephen Brown: But one thing that I, you know, when we were talking about case studies for cashflow, a private project or a municipal or government project, when there is an owner, an architect engineer, a contracting officer, those are the people that you get sideways with, they’re gonna make you miserable. 

And how do you get sideways with it? Well, for one thing, it’s signing the contract and not talking about the terms and conditions you understand and have agreed to. And also just sitting down and explaining to the owner and the owner’s reps, this is what it’s gonna take for us to do our best job for you. This is what we need from you. And making sure the contract backs that up.

But the whole issue that I see so many times in bonded jobs that a claim occurs, that the owner is claiming default. It gets that bad. It’s all about communication. Communication early. And respect. And in your situation, your contractor not paying your subs on time could be a real nightmare for their ability to continue, especially on some of the best subs. It’s like having an employee and saying your paycheck is due on the 15th and just on the 15th, telling your employees, I, I can’t pay you right now. I’m–

[00:08:09] Wade Carpenter: You can’t do that.

[00:08:10] Stephen Brown: Gonna be next week sometime, I think. How long would it take for that employee to walk out the door?

[00:08:16] Wade Carpenter: Probably that same day.

[00:08:17] Stephen Brown: You’ve probably heard that before. We’ve always done it that way.

[00:08:21] Wade Carpenter: Yeah.

[00:08:22] Stephen Brown: So what do you tell your customers about what they can bill and what they can’t bill?

[00:08:27] Wade Carpenter: In this case, I never had this extreme of a situation, but as far as that I was aware of, I couldn’t believe that they could not get it in their head the fact that no, you haven’t paid the regular payable. You know, that’s your relationship with your subcontractor. 

And the other part of what you were saying is yes, they were way under billed on– if they did a GAAP statement, not only would they be under billed, they would be significantly under billed because they haven’t picked up the overhead and profit on the, the retainage, much less the billing on that part.

[00:09:02] Stephen Brown: Yeah, that’s something I can tell you that bond underwriters never can understand. It’s a lot of underbilling.

[00:09:08] Wade Carpenter: Yeah.

[00:09:08] Stephen Brown: You’ve incurred all these costs and you haven’t billed yet, the first thing that pops in their mind is, are you gonna have problem being paid?

[00:09:16] Wade Carpenter: Right.

[00:09:17] Stephen Brown: Because, and also, I don’t understand Wade, why a lot of contractors will bill so slowly. Why will they finance a job? Why, why? 

It’s what you’ve agreed to do when you sign the contract, right? But it’s also what you don’t do, it doesn’t matter what the contract says. You may wanna get in with a certain owner and you may want to, I, I don’t know why some contractors are afraid to bill properly. And it may be just not having the system set up. A lot of times when you’re turning in a bill there’s a lot of moving parts to that to get paid.

[00:09:52] Wade Carpenter: Right. 

[00:09:53] Stephen Brown: Never as a general contractor is a sub gonna tell you you can’t get paid for your profit, or your at retainage on your subs.

[00:10:01] Wade Carpenter: Right. I agree. But I–

[00:10:04] Stephen Brown: And I tell contractors all the time, according to your contract document, none of them ever do it. But when you turn in your signed contract and your performance and payment bonds, then have an invoice for mobilization and utilization costs and your bond premium. 

[00:10:21] Wade Carpenter: Yep.

[00:10:21] Stephen Brown: And of course you mark up your bond premium with profit, like you do any other element of your job cost, right? Some of them don’t do that. 

A lot of times the general say we, we wanna pay the bond directly. That way you, you can’t mark it up as a project expense. Which is kind of a ridiculous way to micromanage a subcontractor. But nevertheless, you, you can turn in mobilization and utilization costs and your bond premium right off the bat.

So why wouldn’t you? Why wouldn’t you start–

[00:10:54] Wade Carpenter: I couldn’t understand it.

[00:10:55] Stephen Brown: Why wouldn’t you start off on that kind of basis? Even if they say, oh, no, no, no, no, no. You, you submit that in your first draw after 30 days or something. Say they say that. And you say, well, that’s not what the contract says. But even if you agree, okay, I’ll wait 30 days, but I am due mobilization utilization costs. Here’s the bond guaranteeing that the project’s gonna be done. 

I don’t know why we have to wait 30 days for me to get my mobilization utilization costs, and bond premium. I’ve got to pay that. I’ve got to pay it now. Well, anyway, what you’re telling that owner or owner’s rep is that I will be billing you promptly according to contract terms. So if you’re gonna get sideways over it, why not do it right there in the beginning while you’re communicating?

[00:11:46] Wade Carpenter: Right. I agree. 

I know you had some other stories you wanted to kick around too. Was there some that you–

[00:11:52] Stephen Brown: Yeah, that’s what I was gonna lead into.

How to approach private projects when funding hasn’t been secured to protect your cash flow

[00:11:55] Stephen Brown: A private project where you as the contractor are dealing directly with the owner and the funding for that project has not been secured. So we’re talking about different industries you do work for and bill them directly. We’re talking about situations where you may or may not need an architect or an engineer involved.

You may be dealing with one, it doesn’t matter, but it’s privately funded and you don’t know whether they have the money to pay you. As a bonding agent, I always request a a letter on those projects from the bank that the financing’s secured for the job.

[00:12:32] Wade Carpenter: Right.

[00:12:32] Stephen Brown: That has saved us a couple of times. I’ve also had horror stories where all the work was done and the contractor was browbeat into not billing on time, with all kind of excuses. And they had done 90 days worth of work and there was no money to pay him. So all they could do was file a lien on the project and lost their shirt. What a nightmare. 

I know you wanna get new customers and you wanna impress these owners and you want to be their go-to person for any construction work. But at the same time, you do that with the quality work and the speed of your work and the professionalism. 

[00:13:15] Wade Carpenter: Right.

[00:13:15] Stephen Brown: You, you don’t, you don’t do it by getting beat up before the job starts. I just see it over and over again, Wade.

[00:13:22] Wade Carpenter: Yeah. Well, another one I wanted to throw out there, again, a lot of times these things, these people are doing it to themselves, exactly what you’re saying. And sometimes like you were mentioning before about not billing and billing on time or whatever. 

Billing issues can take even large companies down

[00:13:39] Wade Carpenter: I had a case where– this was, was not my client, but it was a good friend of mine that was a CFO of a fairly large, they did 90 to a hundred million at that point. They’re even larger now. But she hired a billing clerk and she had been doing, you know, a lot of years in the business. 

But it was actually December, which probably was one of their lower points in their seasonality. But it was right around Christmas and the billing clerk just conveniently forgot to bill. When you’re talking about 90 to a hundred million, in a year that, that it was, she told me it was like $12 million.

[00:14:18] Stephen Brown: And so this billing clerk was experienced and your CFO was trying to let them do their job because of their past track record or?

[00:14:26] Wade Carpenter: I guess, but she just completely forgot to do the bills. And they had to wait six 60 days to get the 12 million plus another month. And in the lowest part of — and it’s a commonly known name here in, I mean, large general contractor. And it nearly took them down. They had to scramble because you’re talking about a huge chunk of money to continue to fund that.

So some of these extreme cases are kind of like, hopefully they’re a wake up call that–

[00:14:58] Stephen Brown: Sure. And especially if the job you’re operating on a thin profit margin, you know that going into it. Why would you let any financing issue get in the way before you start the job? And here, here was just a common mistake you were talking about. Huge mistake. 

But what can you do? You got a bag to breathe into? You’re trying not to hyperventilate, you gotta get a cash infusion into the company immediately. You got your 30, 60, 90 days payables. You would go to the bank, of course.

[00:15:31] Wade Carpenter: Right.

[00:15:31] Stephen Brown: Say, we’ve got a huge issue. Okay, well it’ll take us 30 to 90 days to get to get this paperwork filled out. And so of course you’re screwed if you don’t have a bank relationship there. Right?

[00:15:44] Wade Carpenter: Well, again, they had to like really stretch the bank relationship and owner had to pull a bunch of stuff out of her own pocket and beg borrow and steal.

[00:15:55] Stephen Brown: Liquidate stuff, you name it. Sell equipment on a fire sale.

[00:15:59] Wade Carpenter: They came through it, but that was a tough, that’s one of the biggest I’ve ever heard.

[00:16:04] Stephen Brown: So what could that CFO have done to make sure that was billed properly? What kind of indicator could be in place to help them make sure this stuff is being billed right?

[00:16:15] Wade Carpenter: Well, I think, probably just wanna have a double check on some of that kind of stuff. But a lot of times it’s not just that they’ve forgot the bill, but sometimes it’s the, the project managers don’t turn in their, the subcontractors pay apps and stuff like that. So all the costs don’t get in the system. Or they’re late billing them and that general contractor has, you gotta have it in by the 25th or you gotta wait a month.

And a lot of times these project managers, it’s not their problem that they gotta make payroll and pay all their subs and suppliers so–

[00:16:48] Stephen Brown: Taking all the risk of running a construction company.

[00:16:50] Wade Carpenter: Right.

[00:16:51] Stephen Brown: They’re taking all the risk of running that project.

[00:16:54] Wade Carpenter: Right.

[00:16:55] Stephen Brown: Well, that’s a great point. So this, this billing clerk back to this billing part, how could she forget such a large billing?

[00:17:02] Wade Carpenter: I have no idea. It was right around Christmas and apparently they let her keep her job, but I’m not sure I would’ve.

[00:17:10] Stephen Brown: Whoa.

Wow. What a nightmare. What a nightmare. We talked about cashflow horror stories as being a title to this podcast and we try not to be negative on the Contractor Success Forum. We try to have positive titles and topics, but when it happens, it is a nightmare and we’ve seen it over and over again.

I’m glad these case studies might help our listeners have some idea of how they can manage things ahead of time by learning from the mistakes of others. That’s the whole purpose of our podcast. I’ve had contractors get into huge liquidated damages due to situations beyond their control all the time.

[00:17:51] Wade Carpenter: Right.

Liquidated damages and unreasonable time to complete a job

[00:17:52] Stephen Brown: Projects have huge liquidated damages. Some of them have a hundred dollars a day and they bid an extra number of days into their bid to allow for liquidated damages. 

Then again, when you’re not doing a project, when an owner wants you to do a project, you can’t really play that liquidated damages game because you’re not performing the way the owner wants you to perform. So you’re losing face in the eye of a good potential future owner for a new business. I see that all the time, Wade. 

And then right in the beginning, unreasonable time to complete a job. You look at it and you say in the pre-bid meeting and you have to ask this question in front of all the other contractors. We think the amount of time is unreasonable. It can’t be done in that time, so we’re not bidding. Then others say, well, yeah, it can be done in that time, but we’re gonna be working 20 hour days.

[00:18:47] Wade Carpenter: Yeah.

[00:18:48] Stephen Brown: And we don’t agree to these kind of liquidated damages. All these sort of things come up before the job starts.

[00:18:54] Wade Carpenter: Yeah. Well, I guess a lot of these case studies, I got a couple of other ones too, but you know, some of these are extreme, but even if they’re not as big, all these factors contribute to the poor cash flow that contractors face every day. And it may just be a few thousand here, a few thousand there, but that’s what you’re needing to run your company off of. And that’s why a lot of contractors run themselves out of business, especially when they’re in growth mode.

[00:19:23] Stephen Brown: Yeah, it’s scary. But these, these are some great topics, Wade.

Identify and address flawed processes and ongoing systemic issues

[00:19:29] Wade Carpenter: So I had another one that was sort of an accounting issue as well, which we did an episode on joint checks. Where, again, that’s not pot smoking people writing a check. That’s not two people signing on a check. That’s where a general contractor is going to pay the sub and his, the sub supplier to make sure that they don’t get a lien on the job. 

And again, this, this was a situation with a concrete contractor that did 15 million or so at the time. And it was just one project, but apparently it was a systemic thing that had been happening. 

It was a $90,000 bill for, I think it was rebar and or rebar sub or something like that. But the owner did a joint check and as we talked about in that episode, the contractor recorded the receivable when they did the invoice. But they did not record the cost of this rebar company. And the owner didn’t have his eye on it. He had a project manager that was inexperienced and they did not pick up that $90,000 invoice until the very end. They didn’t discover it. 

And I don’t know why that particular one stuck in my mind, but we saw a pattern of this has been happening for years. And those kind of things, just little things like that, can take down these contractors. 

And simply having somebody come in with a hey, what are you actually doing? What are your processes? How can we eliminate, some of these things from happening. It is just a, it is. It is amazing to me.

[00:21:08] Stephen Brown: Yeah, well it is to me too and, you, you and Rob first introduced me a into Profit First. The whole, whole idea of managing your whole contract and then for your profit. And a lot of that has to do with billing and your cash flow. Financing a construction project means you are financing it, and that’s fine if that’s built into the cost and you know you’ll get paid.

But other than that, everything you do to spend your own cash that you hadn’t planned for because the project’s not cash flowing itself, hurts your bottom line. It’s an added expense you hadn’t planned for. It cuts into your profit.

[00:21:53] Wade Carpenter: It cuts into your ability to take money home and pay your mortgage, and pay your groceries and feed your family.

[00:22:00] Stephen Brown: That’s right. In a most fundamental way.

[00:22:02] Wade Carpenter: Right.

[00:22:03] Stephen Brown: And make payroll and pay your subcontractors, pay your materials, keep that pipeline going. The pipeline analogy for cash flowing, material flowing, everything, is all about communication and having systems in place to get things going on the right foot.

And again, that all ties into communication and being focused, right?

[00:22:25] Wade Carpenter: Right. Absolutely.

Errors with bank feed accounting can caush cash flow problems

[00:22:27] Wade Carpenter: I had one other one, a similar situation. We had another episode where we talked about the bank feed accounting and the owner was writing a bunch of manual checks. And so he was relying on that bank feed to pull that in and they didn’t actually do the work.

And so when they went to bill a job that the cost wasn’t in there for three months. Okay. And it was a, a chunk of money for, it was a multifamily type thing. But I see stuff like that all the time. 

So I guess my point of all this is again, take a look at what you’re doing. Take a look at, make sure that your cost records are actually correct, what you’re giving to your project to bill from.

Take a look at the procedures to make sure that you are covering Issues where things get billed on time. And I say it all the time, whether they should or should not be, project managers get blamed for these things because they’re not turning the paper work in or whatever, but, these things can severely hurt a contractor.

And so that’s, that was my only point for, for some of that.

[00:23:33] Stephen Brown: Well, that’s a great point, Wade, and I’ve enjoyed this topic. I think it’s, as always, you can’t talk enough about it. And you’re going through these problems and when they hit you, then all of a sudden you’ve got a knee-jerk reaction of what do I do now? And that’s the time where it’s vital to have your financial board of directors in place.

Best construction oriented CPA you can find, like you Wade. Banker, lawyer, bonding agent. These are all your key people to go to, to tell them that this is what’s going on, and help get a solution to that. That’s why we are here as professionals to help you get that done and then also help you put systems in place where that doesn’t happen again.

[00:24:18] Wade Carpenter: Right.

[00:24:19] Stephen Brown: Okay.

[00:24:19] Wade Carpenter: Okay. Well, I think we probably need to wrap up at this point. We’re getting a little long here. But thank you all for listening to the Contractor Success Forum, wherever you might be tuning in from. You can find us on all major podcast platforms, on ContractorSuccessForum.com or on the Carpenter CPAs YouTube channel for more information and be sure to check our show notes for more free resources. 

And if you hadn’t already, please consider subscribing to our channel and ring that notification bell to follow us each week as we post it. We sincerely appreciate your support and comments in this journey. We will look forward to seeing you on our next show.