Cash Flow Management, A Key Driver of Contractor Success
The first thing we need to do here is decide what we mean by “contractor success”. I could get all academic and ramble on with various definitions, but I’ll keep it simple for this blog:-
Contractor success means not going bankrupt!
Now how to avoid going bust varies from country to country with their different cultural attitudes to construction. One extreme I’ve experienced is the U.S.A. The V.P of their second-largest commercial property developer told us that he expects his main contractor to make 30% profit and sub-contractors 50%. His logic?: “If they do the job for me once, I want them to be there when I need them again!” The other extreme is here in the U.K..
How it comes about is a story for another time, but U.K. construction companies are forced to Tender allowing, if they hope to win a contract, a profit margin of around a mere 1%!!! With a profit margin like that they can’t afford to go running to the banks asking for a loan, not when they would have to pay upwards of 7% interest on any money borrowed!
So let’s have a look at what a U.K. main contractor has to do to ensure Cash Flow Management. If they accept a contract they have had to make sure they have the cash in the bank to pay for everything they’ll be incurring during the first month on site. This is when they’ll be submitting the first invoice to the Client. Now usually this won’t be contractually payable until about 3 weeks later. That means the main contractor has to also have the cash to hand so they can survive another three weeks! Not only that, but the sub-contractors will have been banging their bills in to the main contractor and they want paying, too. Now if everyone did their sums right before the start, no problems. If they didn’t; hiccups!
The worst offenders for not paying by due date, in my experience, are Public Sector clients. No idea why they think that way and it never seems to sink into their thinking that, if their main contractor goes bust, whoever picks the contract up will charge a lot more! Now I know that we muddy boot brigade are renowned for being a bunch of de-brains, but our Quantity Surveyors and Estimators have enough sense to know when a client is between a rock and a hard place and they try to make the best of it! Profit margin and price will go up!
The same screws will be tightened up on any main contractor who doesn’t pay his subbies by due date and puts them out of business. The prices demanded by a successor will eliminate any potential profit from the contract!
Another thing that can mess up Cash Flow Management is changes to the designs or specifications by the Client after the start on site. For reasons best known to themselves these changes usually increase build costs. The QS’s have to be on the ball here and make sure their payment requests are up-dated and also that there is the cash around to meet these additional costs.
So we now know that a U.K. Construction Contractor can’t borrow money because the interest charged for it is higher than the profit margin on the project. This means they must have the cash in their bank account. We know that Clients change the designs and specs, so we have to watch out for that and demand the extra costs be met – an ensure the extra cash is in the bank to carry over for that 7 weeks!
Now all this Cash Flow Management is the responsibility of our Quantity Surveyors. They have to do their monthly assessment of progress of the works and then bang their bill in – and pester to make sure it is paid by due date! The main contractor’s QS’s will be given no peace! They be getting hounded and harassed by the subbies QS’s!
Hence this CASH FLOW MANAGEMENT, is a key Driver of Contractor Success. It keeps them in business and out of bankruptcy!