This article was originally written by Dave Yoho and published by Qualified Remodeler.
The average home improvement or remodeling company is often owned by someone who worked for another similar type of company before starting their own business. Many were installers. Some were in sales and marketing roles.
What they have in common is the desire to be successful entrepreneurs. They want to make things happen and create a business utilizing creativity and intuitive judgment. They believe this will make them comfortable and happy. This is also an illusion that can lead to unintended consequences.
Most owners of home improvement and remodeling companies lack experience in structuring and managing the backend of the business. The majority also struggle with “working capital” issues, some of which are not easily apparent. This often starts when the business is established and continues as the business grows.
Many companies appear to operate at a profitable level yet have not increased their level of working capital to accommodate growth. Startup companies often do so with little capital and a lot of sweat equity. A lack of cash flow can create immense problems.
Suppose a business produces $1 million in revenue and earns a 7 percent pretax net profit in the first year. That means the business 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 then follow up by creating an operating budget to meet these ongoing costs.
Couple this with the fact that they are usually operating on a “cash basis.” If they are savvy, they require deposits or progressive payments with contracts—and this often results in a false perception of profitability, which can be disarming and often can also be costly.
Another example: An owner who came out of a sales role with some marketing experience starts a business with a few salespeople. They do $2.5 million in their first year and end with a 7 percent pretax net profit of $175,000. This means the company spends $2.33 million on labor, material and operating expenses. That’s over $190,000 a month or slightly under $49,000 per week.
Some startups have accomplished this with less than $10,000 as an original investment. Most who start with this level of funding, however, don’t survive, or they continually struggle with cash flow problems. They also suffer complications that eventually affect their tax liability.
Companies Seldom Grow on Cash Flow Accumulations
In each of the examples shown, estimated net profitability was 7 percent, which would be subject to federal and state taxes. 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, cash flow becomes more workable.
We find numerous cases where jobs are completed yet balances remain unpaid. Delayed collection and/or litigation is lengthy and costly. Settlements often wipe out the profit, and the virtually uncollectable balance often requires the owner of the business to pay taxes on a “receivable,” which may never get collected.
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 for the work not satisfactorily completed, then get repairs done promptly. Hopefully, this will help you keep customers satisfied while reducing “receivables.”
Golden Rules of Positive Cash Flow
- 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 discounts for prompt payment. 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.
- Convert all payrolls (W-2 or 1099) to bi-weekly, or every two weeks.
- 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 can earn up to 37 percent when compounded annually. You might be able to borrow money from your bank at a reasonable rate of interest, and that loan would earn you big dollars in return.
- Adjust commissions due for jobs sold at an underpriced rate.
- Create a weekly (or monthly) cash flow report.
Know Where Some of Your Capital Might Be Hiding
Companies with large marketing budgets and those companies who advance a portion of the commission upon “approval” will have cash depletion based on their investment in the backlog.
Backlog, which is business sold and approved for installation or waiting to be scheduled, usually contains advances for labor and material as well as marketing expenses and advances to salespeople, plus overwrites to sales management. All of these deplete cash.
Here’s an example using a good-size company who sells products such as roofing, siding, insulation or windows:
Backlog $1,000,000
Marketing expense 15%
Commission and overwrite advances 7%
22%
Total 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.
Additional Quick and Easy Ways 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 or cash flow report 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.
- Offseason purchases. Many vendors such as 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 reminder: The more times you can turn your money in a given year, the easier it is to accumulate cash.
- Reduce accounts receivables. Collect all balances on the day the work is “substantially completed” and collect for all change orders or extras at the time they are executed.
- When a deposit is received, remember that this money still belongs to the customer and is issued to the contractor as an “in-faith” deposit. It technically does not belong to the contractor until the job is substantially 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.
- Evaluate all products and 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. QR
Dave Yoho is the president of the oldest (since 1962), largest and the most successful small business consulting company specializing in the home improvement industry. His company employs a staff of consulting experts who specialize in advising companies on how to become more profitable in their business. They also sponsor a series of ongoing educational programs in the form of webinars and seminars at hipsummit.com. His recorded materials are sold throughout the U.S. and several foreign countries. To learn more, visit daveyoho.com.