Cash flow is often confused with profit. If you are making money, there will be cash when you need it, right? It is not that simple. Cash flow lags profitability by as much as a year or two. Failing businesses, especially if they are growing, may generate cash as they leak profits, until they finally crash. Conversely, liquidity is necessary to support growth, bridge over lean times, and make judicious investments and purchasing decisions.

Sources of cash are internal or external. Profit is the internal source of liquidity. External sources include supplier credit, bank financing, sale and lease of assets, life insurance loans, government loans, and the sale of corporate bonds or stock.

Without increased cash flow, you cannot support growth and may have to turn down profitable work. To increase cash flow, make sure that you review your collection procedures to verify that accounts receivable levels are being controlled, especially with regard to outstanding retainage.

When profits improve, make sure accounts receivable do not grow disproportionately. Also, watch inventory levels. Although electrical contractors don’t generally maintain significant stores of parts, you may need to check office supply inventory or small-tool usage. Slippage in these areas can cause cash leakage that becomes noticeable at critical times.

Review your depreciation schedule with your accountant; you may decide to accelerate it. Also, any sale of assets, whether fixed or current, generates cash. When it is time to replace fixed assets, leasing may be the better option to improve cash flow.

Borrowing money creates an immediate cash inflow, and extending trade credit by increasing accounts payable levels reduces outflows, in effect generating ready cash. Of course, the eventual repayment of loans decreases monthly cash flow, and supplier relationships may be damaged by extreme extension of payable terms. It may be more productive to take advantage of supplier discounts by paying earlier, rather than later.

Cash flow is negatively affected by reversing the processes that generate cash. Elevated receivable and inventory levels, repayment of debt, asset purchases, and stock repurchases will all reduce cash. An unanticipated crisis may require cash outlays, before insurance reimbursements are received, or to cover deductibles or uninsured losses.

Lump-sum payments such as bonuses or estimated taxes may occur at inconvenient times. Rework, loss of production in the field, or equipment breakdowns are other unplanned sources of reduced cash flow.

The most severe impact on cash flow is usually created by growth in sales revenue. As volume increases, direct costs and overhead tend to grow disproportionately. Profit percentages decrease and receivables may remain uncollected for extended periods of time. Productivity often slips as companies are forced to hire unfamiliar workers to fill both field and office positions.

Poor budgeting, inaccurate accounting, failure to implement new technology and lack of coordination also undermine desired cash flow levels. Less tangible impacts result from the failure to invest in ongoing training, obtain employee feedback regarding operations and processes, or maintain a positive environment.

Exposure to litigation, severe accidents or other crises affecting the reputation of the company are also a result of failing to plan, monitor and make appropriate financial decisions or investments. Eventually, all will affect cash flow, although many of these factors are not perceived as measurable, or immediately associated with liquidity.

What can you do to minimize unanticipated reductions in cash flow and maintain the liquidity that provides long-term stability? First, make sure you are dealing with credit-worthy customers and negotiate appropriate contract terms. Second, establish and enforce tight collection procedures. Third, be vigilant in monitoring asset productivity and inventory levels throughout your company. Track job costs faithfully and create relationships with suppliers who will enhance your ability to be competitive and profitable.

Think of cash flow and liquidity as long-term issues. Consider the effects of management decisions or failing to plan and implement improvements on maintaining adequate cash levels. Finally, manage your cash effectively, so that the timing of inflows and outflows is coordinated, and you always have enough liquidity to meet unexpected contingencies. More about this next month.    EC

NORBERG-JOHNSON is a former subcontractor and past president of two national construction associations. She may be reached via e-mail at [email protected].