I have had business owners, baffled, ask me “Why does my income statement show I’m making money, but I have none in my bank account?”
And that’s a very good question. Why does it look like you’re making money, yet your bank account is low, or even overdrawn? There are a number of things that could be causing this – and we’ll touch on a few of them here.
Holdbacks – these are a cash flow killer in the construction industry. If you are following my earlier advice and recognizing the revenue for the holdbacks, there will be an increased discrepancy between cash flow and profits. Make sure you review your uninvoiced holdbacks regularly, keeping in contact with the client to ensure you invoice this money as soon as possible.
Accounts Receivable turnover – Great! You’ve made the sale, but it is even more important to collect it! If it is taking too long to collect your money – if a large segment of your receivables are over 90 days – you are heading for trouble. Make sure you stay on top of your receivables – or better yet, implement good credit granting and management policies right off the bat. Bad customers can kill a viable business quickly, costing them the time and money to provide goods and services they never receive payment for.
High inventory – sure you need to keep inventory on hand, and there may even be value to buying larger than necessary quantities in terms of volume discounts – but keep a close eye on the turnover rate to ensure you are maintaining a balance between the inventory you need, the price you’re paying for it, and your cash flow. Having inventory in hand can help speed up production, but the inventory can’t pay the lights or salaries. Make sure you maintain sufficient cash flow levels.
Revenue recognition and underbilling – in the construction industry, it’s often a negotiation between the subcontractor and the general contractor as to how much of a project is complete for billing. If you are underbilling, your cash flow will suffer. A properly completed set of records in the construction industry includes WIP, which will properly allocate revenue to costs, but make sure you keep an eye on the WIP. If your WIP is consistently adding revenue to the bottom line, you are likely underbilling your jobs.
These are just a few of the reasons for discrepancies between cash flow and revenue. Some others may be heavy shareholder draws and personal spending, acquisition of large assets, and a heavy debt load – the principal portion reduces cash, but not your income.
If you are having cash flow issues, you should be sitting down with your accounting provider to determine exactly what the cause is and how to minimize it. Your business may depend on it.