The U.S. economy has been growing strongly for several years, but many companies may be starting to wonder about the prospects of a downturn, especially in highly cyclical industries like construction.
One of the most important ways to get ready for the next economic slowdown or recession is to take proactive steps now to improve your cash management and strengthen your balance sheet. Having a healthier cash flow and a stronger balance sheet will help give your business a better chance of riding out any downturn in your industry — and you can start today, while your business is still going strong.
There are a few key strategies that construction businesses can implement today to help strengthen cash flow and cash management for whatever economic times are ahead.
Be Disciplined With Your Credit Management
As the old business saying goes, "Cash is king." Adequate cash flow is the lifeblood of your business. Especially for businesses like general contractors, who often rely on access to business lines of credit to purchase supplies or make payroll, it's important to manage cash flow and credit in a smart, disciplined, strategic way.
"We advise our clients to — at least once a year — have a 30-day cleanup in their line of credit," says Jay Dale, Southeast Market President for First Tennessee Bank, who is based in Chattanooga. "Doing a line of credit cleanup means that the business is able to pay down their line of credit to a balance of $0 for 30 consecutive calendar days."
Doing a cleanup on a line of credit is a sign of healthy cash management for a business, because it means that the business has enough positive cash flow to be able to pay off their operating credit balance quickly. A cleanup is also a good habit for your business's cash management, because it helps you stay disciplined in using the line of credit for its intended purpose.
“Any purchases that you're putting on your line of credit need to be truly working capital expenditures, not permanent purchases.”
- Jay Dale
Southeast Market President for First Tennessee Bank
If a business is relying too heavily upon its line of credit, and cannot easily do a 30-day cleanup to get down to a zero balance, that is a sign of possible trouble ahead.
If your business needs to make capital investments or equipment purchases, consider getting the right sort of financing for these longer-term investments in your business. "Do not use your business line of credit for long-term assets," says Dale. "If you're buying equipment, talk to your lender about applying for a longer-term loan that will be more appropriate financing for the life of the equipment."
The same advice applies to financing for new ventures, such as a new product line or new line of business in a new market or geographic area. Don't overload your business line of credit or your existing balance sheet by investing in new ventures, and get separate financing for the new ventures. "Come up with an independent capital source for any new ventures you start, so the core operating company maintains its balance sheet strength," says Dale.
Get Smarter With Your Strategic Operations
Cash flow and cash management are naturally going to be interconnected with your overall strategic business operations. Business strategy decisions also will affect your cash flow. For example, one of the most important business strategy decisions is to decide how to diversify your customer base. Having a diverse mix of customers and a diversified blend of industry sectors can help you diversify your revenue streams, which in turn can help even out your cash flow.
"For a general contractor in the construction business, it's important to diversify your base of revenue among a few different industries and types of projects," says Dale. "You don't want to have 100 percent or 75 percent of your business coming from one particular industry sector, like retail or multifamily housing or medical. You don't want to be too concentrated in any one industry or type of customer, because if that industry or customer segment suffers a downturn, it will hurt your business, too."
Another business operations decision that affects cash flow is paying attention to the quality of your accounts receivable. Getting paid on time by your existing customers — and knowing which accounts might cause problems with delayed payments before the problems occur — is often just as important as finding new customers.
"General contractors often have jobs in the pipeline that keep getting delayed, and you need to make sure that you can set up your operations to manage around those occasions where you're not getting cash from certain customers," says Dale. "Monitor the quality of your accounts receivable and keep them current."
Negotiating better payment terms with your customers also can help improve your cash flow by giving you more cash on hand up front, and better certainty about whether you will meet your sales projections for the year.
"Most construction firms have a budget target for each year, and it's a good goal to have a certain percentage of that annual budget under contract by end of 1Q," says Dale. "For example, you might want to set a goal of having 75 percent of your annual budget in hand by end of the first quarter of your fiscal year."
Build Stronger Relationships
Staying in business is not just a matter of having enough money, it's about having strong relationships: with customers, suppliers, vendors, subcontractors, and partners. If your business or industry is about to enter a downturn, having strong relationships in place is more important than ever; especially if you're in a tight labor market where it can be hard to find people with the right skills to help your business grow.
"Treat your subcontractors and suppliers really well," says Dale. "It's hard to find good subcontractors, so pay them on time."
Another important partnership is your relationship with your bank. Banks often will be more likely to work with your company through a potential downturn if you can keep them apprised of your business's situation and build trust with the bank before any trouble arises.
“In building a relationship with your bank, it's important to be transparent.”
- Jay Dale
Southeast Market President for First Tennessee Bank
"Notify them early of any negative event such as charge-offs or losses. Everything gets better in your banking relationship when you can build and maintain trust up front, instead of having unpleasant surprises," says Dale.
Many construction business owners may feel reluctant to go to their bank with bad news, especially if they're still making their loan payments and managing their credit without interruption in payments. However, Dale says that your banker will likely be more willing to work with you through a downturn if you communicate with them early and often.
"Don't surprise your bank," says Dale. "Your bank knows that if your industry is cyclical, there's probably going to be a valley at some point. So, if you talk to your bank proactively ahead of time, before some negative events happen, and they know you tried to communicate with them that you were anticipating a slowdown and that you've been through it before, they'll often be more able and willing to weather the storm with you."
Another underrated partnership that many construction companies need to maintain — in good times and bad — is their relationship with their bonding company or insurance company. "General contractors often cannot get projects if they're not bonded, and banks will often ask about that, too," says Dale.
"Bonding companies typically want to see construction companies having retention of earnings of about 15 to 20 percent, or have a net worth that's a certain ratio of revenue," says Dale. "If you do hit a downturn, your bank will want to know that your bonding company is sticking with you."
Strengthen Your Balance Sheet
Finally, if you want to recession-proof your company, you need to pay attention to your balance sheet and set aside some capital to survive lean times.
"Every company, especially in construction, should have a liquidity target or a goal of retaining a certain percentage of your income in capital and net worth," says Dale. "Too often, owners pull all of their earnings out of the business every year and have no capital set up in case of a downturn. Make sure you have some capital built up to strengthen the balance sheet. Partner with your bonding company or any other outside company to make sure you're on the same page about that."
As of this writing in April 2019, the economy is still growing and creating jobs. But even if your business is going strong, it's never too soon to reevaluate your cash management and strengthen your balance sheet for the future. "Clients we speak to are expecting a good year for the rest of 2019, maybe not as good as 2018, but at least a modest growth year. I don't see a lot of changes in behavior; maybe they are taking a look at capital expansion as they try to get a pulse of what the economy is doing, but I'm not seeing a dramatic change in the outlook," says Dale.
"But, no matter what's happening with the broader economy, it helps to be mindful of which sectors might be slowing down or growing in the industry that you serve. Be diversified. If you need to right-size your operations, don't wait too long to do it. And communicate proactively with your banking and bonding partners along the way."
Are you ready to expand your business or shore up your balance sheet with stronger cash management practices?
First Tennessee's treasury management solutions can help maximize your business's cash flow.