Creating Cash Flow Projections

What is cash flow and how does it differ from net income?

Recently the Sunday Edition of the Washington Post had the following headline, "Region's Builders Rein in Visions- With Real Estate Downturn Projects Scaled Back, Scrapped." Lenders are tightening credit standards. Time to hunker down and manage costs and to think cash flow not net income!

What is cash flow and how does it differ from net income? Simply put cash flow is the result of netting all sources of cash flowing into the business against all sources of cash flowing out of the business.

While both cash flow and net income are useful financial metrics, each reports the "timing" of transactions differently. Cash-basis accounting records construction revenue when cash is collected. Expenses are recorded when paid. If cash collected exceeds cash paid out positive cash flow is the result.

Under accrual-basis accounting revenues are recorded when earned and expenses when they are incurred. If revenues exceed expenses net income is the result.

An example will help show the difference between cash-basis and accrual-basis accounting. Assume that B Contractors signs a contract for $90,000. After the first month B Contractors has completed 1/3 of the contract and bills the customer $30,000 and records $30,000 of revenue earned. Also during this first month B Contractors incurred and recorded various expenses amounting to $25,000. Under accrual-basis accounting, the firm has earned net income of $5,000. But under the cash-basis method zero revenue is recorded and, in fact, no revenue will be recorded until a check is received from the customer. Lets further presume that $20,000 of the above $25,000 of expenses has been paid by check. Under the cash-basis method of accounting B Contractors would be showing a loss for the first month of $20,000.

One can see how a company could be "profitable" but not have enough cash.

So where can I find cash flow information?
Two major sources of cash flow information are the company bank statements and the financial statement known as the Statement of Cash Flows. The Statement of Cash Flows delineates a company's cash flow by three activities: operating activities, investing activities and financing activities. While both sources are useful to identify past trends they both represent yesterday's news.

The time elapsed from the estimating stage of a project to "punch list" can be months or years. In between are peaks and valleys of cash activity. Like a good equipment maintenance program it is advisable to identify cash needs before they arise. Finding out there is insufficient cash to pay material suppliers or make loan payments destroys credit ratings and erodes trust. Bad news is bad news but bad news late is a disaster leaving little time for more than panic and poor decisions.

What is needed is forward looking information. A cash flow projection highlights potential cash issues allowing for proactive decisions.

So what is a cash flow projection and how is it done?
Most financial software packages provide some form of cash flow modeling and excel spreadsheets will also work. The format is not as important as the process. As President Dwight D. Eisenhower once said. "In preparing for battle I have always found that plans are useless, but planning is indispensable." So don't let the lack of a formal financial program or worksheets delay the process.

Step 1 First collect detailed information about the construction jobs. The original job cost estimate is a good starting point. Normally the estimate will indicate such things as: the number and timing of work crews, work to be performed by subcontractors, the amount and type of material, rental or depreciation rates for equipment as well as the projected contract revenue for the job. Because every job has its own pattern of cash flow a projection should be done for each significant contract (use the 80/20 rule). In accordance with "Murphy's Law" projections should be updated monthly because information has a brief shelf life (bad weather, increased labor required, increased material costs, equipment breakdowns- you can finish the list).

Step 2 The worksheet format will generally start with job specific information taken from the accounting records. If this information is based on accrual-basis accounting it will be necessary to convert the job contract revenues and costs to a cash-basis job report. Subtract accounts receivable from job revenues and add accounts payable to job costs. The end result shows, on a monthly basis for each job, a cash surplus or cash deficit.

Step 3 A construction company requires more than those directly associated with the construction fieldwork. There are estimators, accountants, secretaries, office rent, office supplies, software, taxes, utilities, phone bills and other "overhead." Non-job related costs can be substantial and also must be included in the cash projection. This can be time consuming but once done future updates take less time.

Step 4 The finished projection will show, month-by-month, job-by-job, and in total for the company the peaks and valleys of cash. This will allow the business owner to drill down to those months that are net "users" of cash. Armed with this information the owner can then begin to make decisions. Perhaps collections need to be accelerated. Are change orders processed and paid timely? Do seasonal cash shortfalls require external financing? Are accounts payable being paid too early? These are but a few considerations.

Step 5 Develop an action plan. Be specific. Assign names and dates. Hold people accountable for results. What gets measured gets managed.

The completed cash flow projection provides the business owner with a continually updated 12- month map of cash sources and uses. Sometimes cash shortfalls are larger than expected or occur for a period of time (like the start-up of the construction season). When this happens some form of financing is required whether from the owner or lender. Identifying cash needs early allows for sensible solutions. The proper timing of financing can save interest costs and transaction fees. A cash projection also helps insure that the business owner has the necessary financial resources to take on new work and replace aging equipment. The projection is a useful tool to demonstrate to prospective lenders the amount and timing of cash requirements as well as the prospects for future cash flows to make loan payments.

Current economic conditions are difficult. But for those proactive business owners that keep close tabs on cash flow there will be fewer sleepless nights.

Donald E. Bowman is a partner of B2B CFO, a national firm that provides CFO services to small and mid-size businesses. Bowman has more than 30 years of executive experience as a CFO, Controller, and CEO at public and private companies, both domestic and international. Bowman graduated from The University of Baltimore, cum laude, with a B.S. in Accounting. He has a Masters in Professional Accountancy from Loyola College, Baltimore, Maryland, also cum laude. Bowman is a CPA, a member of The Maryland Association of CPA's, and The American Institute of CPA's and Financial Executives International. He lives in Southern Maryland, where he also serves as Adjunct Professor at the University of Maryland University College and The College of Southern Maryland. He can be reached via email at