It's important that owners read and understand the statement of cash flow, especially the section that reports cash flow provided by operating activities. That number indicates the true amount of cash profit the company is producing and the resources it has on hand to pay the company's obligations – job materials, rent, payroll, benefits, unions, debt service, and the like.
Do you know your break-even cash flow? Remarkably, some owners don't know the amount of cash they need to collect every week in order to pay their bills. The ratio "days-of-cash" is a good start to determining how much cash you need to have on hand at any given time during the year.
This number can also be compared to industry benchmarks. More than 20 days of cash is a good target. Anything below this number begins to put pressure on receivables collections and ultimately impacts the company's ability to fund its day-to-day operations.
Tip: Having a working capital line of credit is one way to weather short-term disruptions in cash flow. It's usually best to set up this arrangement with your lender before you actually need the money. This added safety net will really come in handy if the company hits a rough patch.
A Strong Balance Sheet Can Weather the Storm
As important as these two documents are, it is the balance sheet that serves as the cornerstone of your financial statements. This is the instrument that answers the question, among other things, how leveraged is my company? The ratio "debt to equity" is the key barometer that measures leverage.
A ratio of under 3-to-1 usually indicates that a company has enough resources to withstand a downturn in business. A higher ratio shows that the company is more highly leveraged and that it may be operating under growing financial stress.
Even if a company shows a net loss on its P&L, or if it reports a negative cash flow on its year-end cash flow statement, it can still continue to operate provided it has a strong balance sheet. A weak balance sheet makes it more difficult to continue because there will likely be fewer resources available to fund operations, pay bills and make the kind of investments necessary to return to profitability.
Generally, if your balance sheet is strong, your lender will be less likely to pull your line of credit or send you through the work-out process. In fact, it is one of the factors that has allowed healthier (i.e., less-leveraged) construction companies to absorb the downturn in business these past few years.
And as these same companies prepare themselves for improving market conditions, a strong balance sheet will be a key in securing the resources to fund their future growth.
Bill Rucci is a partner with the Boston area accounting and business advisory firm Rucci, Bardaro & Barrett where he heads the firm's Construction Business Services Group. For a complimentary copy of "The 17 Most Useful Financial Indicators for Construction Businesses," contact Mr. Rucci at (781) 321-6065 or email@example.com.