Working Capital Strategies That ACTUALLY Work

You ever feel like your projects are running smoothly, but your cash flow isn't? Join Wade and Stephen as they dive into the critical importance of working capital in the construction business. Discover how adequate working capital acts as the lifeblood of your company, helping you manage payroll, materials, and equipment costs. 

Learn key strategies to ensure you have the right amount of working capital, improve your financial stability, and avoid cash flow crises. With practical tips and real-life examples, this episode is a must-watch for any contractor aiming to build a healthy, sustainable business.

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Topics we cover in this episode include:

• 00:29 Importance of Working Capital
• 01:10 Bonding and Working Capital
• 02:26 Understanding Working Capital
• 03:27 Managing Cash Flow and Working Capital
• 05:43 Improving Working Capital
• 12:00 Employee Dishonesty and Working Capital
• 13:38 Debt and Working Capital

LINKS

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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com

Transcript

[00:00:00] Wade: You ever feel like your projects are running smoothly, but your cash flow isn't? Or maybe you're constantly waiting for payments while trying to cover payroll materials and equipment costs? It's a cliche, but working capital, really is the lifeblood of a construction business. It's what keeps everything running, especially when you're trying to pay your workers or keep suppliers happy, ensuring you're not scrambling for cash when you need it the most. 

But how much do you really need? And more importantly, how can we know if we have the right amount of working capital to help you make more money? That's what we're diving into today on the Contractor Success Forum.

I'm Wade Carpenter with Carpenter Company CPAs. With me, as always, my co host, Stephen Brown with McDaniel Whitley Bonding and Insurance. Stephen, working capital in your world is everything. It's a big factor in getting bonding. 

[00:00:53] Stephen: No, it is. And my first analogy is something you mentioned yesterday, but without adequate working capital, it's like an engine running without oil or enough oil. Eventually that engine's going to seize up and stop. I thought that was a great analogy. In my world of bonding, working capital is the number one key that underwriters look for in approving your bonding credit.

And the reason is, Wade, over and over again, we see contractors go out of business and have bond claims. that's one reason I've been so passionate about the Contractor Success Forum. we've seen contractors get into financial trouble and go under, and we want to try to beg, borrow, and plead with them to listen to what we have to say about cash flow and about maintaining adequate working capital.

So there's so many factors of why that's important. And so many reasons why not having working capital can cost you your business.

[00:01:55] Wade: Well, the whole analogy was, you know, assuming your construction company was a car, you could have as much projects as you want, fuel in your engine, but if you don't have that oil running through your business to grease the wheels, just like the cash flow running through your business, it's going to come to that grinding halt.

And I thought that was always a very appropriate analogy. Whether you're thinking about the bonding or a banker it's not just about that. It's the sign of a healthy company. So thought we would chat a little bit about, what is working capital? I don't, I don't know if you want to address that or. 

[00:02:32] Stephen: I mean, you just are on a roll with your analogies. I love it. Sales being a full tank of gas. you can run all day till the engine seizes up. Yeah, I get it. But working capital is your current assets minus your current liabilities. current asset is considered anything that's liquid, and that can be turned into cash easily.

And current liabilities or any debts you owe or expenses that you have in the next 12 months. You have car notes, equipment notes, rent, overhead expenses, subscriptions and fuel, well, that could be job costs, but nevertheless, you have overhead.

Then you also have costs that vary as the project goes on. And you manage that to the best of your ability, right? But then, you have a problem that comes up. A problem that is mismanaged by someone in your company, and it just gets worse. And that's when the cash starts bleeding, like triage, like the oil draining out of your engine.

It's just going and going, and you gotta do whatever you can to stop it. And that's what I'm so passionate about. Bonding companies have certain requirements. A healthy ratio of working capital. You mentioned 1. 3 times current assets to current liabilities.

[00:03:50] Wade: In my world, it's closer to one and a half or two times. I think that's a minimum is 1.

[00:03:56] Stephen: Okay. So there's a guideline of how much working capital to have. But from a bonding standpoint, a bonding company is going to look for anywhere from a 6 or 7 percent to a 10 percent working capital case. So, what that means is if your current assets minus your current liabilities are a hundred thousand dollars, then you divide that by ten and you can get a million dollars worth of bonding.

So, that's a ten percent case. Five percent case would be double that, for example. all underwriters do a five minute underwriting when they look at your financial statement. They try to quickly gauge the working capital and net worth, and then they flip to your job schedules to see if you have a backlog of profitable work, and then they look at your completed job schedules to see if you lost money on any particular jobs.

That's what we'd call the five minute underwriting rule. Why is that so important? Because if that cash is not there and a problem occurs, what are you going to do? You can't just borrow your way out of it if there's not enough backlog gross profit to pay that debt. And it creates a cycle, like a domino effect, you know?

You know, what I see, a lot of contractors probably say, well, you know, working capital, we talk about that all day long. I only have to worry about that when I'm doing financial statements. But essentially this is your cash flow. This is what's going in and out of your business.

[00:05:19] Wade: Whether you understand these ratios or not, you understand when there's nothing in your bank account. You feel great. When the bank account is high. But we all say it all the time, that, balance in your bank account can disappear in construction in a heartbeat.

And you wonder if you're going to be able to make payroll next week. So what I want to talk about today is how do we put this in perspective? What does it mean to have a healthy working capital ratio?

It means that you're gonna have a healthy business that can meet your obligations and be able to pay yourself a good wage, have some profit left over. When you run into downturns, how long can you survive a downturn?

[00:06:02] Stephen: That's a great point. How long can you survive? When you have a healthy amount of working capital Everything's better. You're evaluated as a viable business by people looking at your financial statement. Banks are more ready to line up and prepare to give you a loan, and you can get pre signed up for a loan or line of credit before you need the money.

Bonding credit is exponentially better the more working capital you have. Wade, when you've got a job you want to bid it's your chance to really shine. It may be larger than any project you've done before. It may be a little bit different and might have more moving parts, but you got to talk the bonding company into backing you on that one project.

The better your working capital and net worth are, the better chance you're going to get approval on that. Especially if you and your bonding agent can, convince the, underwriters that this is a good risk to take and it's not risky. Great working capital is great for getting things that you need. And it's great for putting out fires when disasters happen. They do happen in the construction industry. There's just so many moving parts. I've seen things from personnel that have been rock solid for years. Something personal happens, something is going on behind the scenes in their family.

 They're not managing a job and it just tanks. Your fault, my fault, nobody's fault. Next thing you know, they have gone from what profit they were going to make on that job to losing hundreds of thousands of dollars.

[00:07:42] Wade: Yeah.

[00:07:43] Stephen: If the working capital's there, that's a hit you take as a business. You understand that, you learn from it, you move on. If it's not there, you got to borrow money to meet payroll and all your other expenses until you can get some cash coming in.

[00:07:58] Wade: One of the things I have started doing the last few years is especially with me going in with Profit First, I mean, working capital is not just comprised of your receivables and retainage. cash is a big part of it. And the ability to survive a downturn.

A lot of times I've started expressing not like, okay, well, here's a work in capital, but do you have X amount of overhead, and what do you have in your bank? Do you have enough to cover one month of overhead or three months of overhead? Or essentially, are you working paycheck to paycheck? 

A lot of contractors are in that cycle. This cycle that just, it eventually can consume the entire company.

And as you were saying earlier about when you're trying to grow through it, you do need extra capital to grow through it. You're going to have additional receivables and that cash is not coming in. So you got to have the cash in the bank to cover it. So when I think about it, I try to express it like How how are we going to fund this? What's our cash flow to be able to survive this?

[00:09:13] Stephen: You have to think like that all the time when you're running a construction company. What if this happens? What am I going to do? And of course, your bonding agent will talk all day and night about that with you and help you work that out. Because as a bond agent, I can't get your bonds approved unless we've got that working capital and we've got contingency plans in place and we can convince the underwriter that we're an open book on our game plan in the case something happened.

So you can lose money on a job and have working capital and make a mistake and you can bounce back. You can lose money on two or three jobs and bounce back from it. I have a customer that literally bounced back from the most nightmarish job you can imagine. it was just a absolute textbook case to any underwriter that character is equally important to cash to get a project completed.

 I mentioned many times before that bond underwriters look at your cash, your character, and your capacity. The cash is the working capital. The character is you do what you say you're going to do, and the capacity means you know how to do the work. But here's the thing, they made it through a nightmare situation and kept their name absolutely perfect.

And then they had another project mismanagement problem that started eating away at cash flow. And next thing you know, they weren't paying their bills on time. And next thing you know, all the subs that they were counting on and the material suppliers and everyone else, was scared to do business with them.

And then they couldn't get bonds and their work was bonded work. So it created, like I mentioned before, this domino effect. I hope I explained that correctly to our listeners, but it's so important.

[00:11:02] Wade: Absolutely. I think about me and you both probably have some case studies or things that we've experienced. I remember one in particular, general contractor that hired a new billing clerk and lo and behold, she forgot to bill one month. They were pulling down 10 million a month. Nearly took this company out. I've seen another one that was about 30 million that was not properly billing the retainage to the tune of like 3.5 million dollars.

[00:11:33] Stephen: Wow.

[00:11:34] Wade: And they're struggling today because of that. It's like when they realize, could you really be doing this? So what can we do to improve our working capital?

You want to go down that road with us? Sure.

[00:11:47] Stephen: one thing that we haven't ever talked about before is get some employee dishonesty insurance. You may have a key employee that's stealing from you. Talking about a way to deplete working capital. I've had a number of bonding claim situations where a key employee was stealing all of their cash and assets.

Back to your question, working capital is the lifeblood that allows you to pay all your short term obligations, and also fund emergencies. Working capital is a pile of cash that you may dive into when you feel you have enough of it to meet your current liabilities and also to expand your business.

And I see so many contractors, Wade, see an opportunity to expand their business, deplete their working capital, and then they haven't realized that they don't have enough to keep the projects going. So I've seen claims that way too.

[00:12:42] Wade: And I guess we could probably do a whole episode too on the employee dishonesty stuff, some of the things I've seen with contractors over the years.

[00:12:49] Stephen: Yeah. I don't like to give our customers a bummer type of podcast. I would just soon keep them upbeat and fun. We talk about, exciting things, like new technology and equipment. That's so much more fun. But then we promised each other when we started this, how many years has it been Wade?

 We're coming up on four, I believe.

Four years. Wow, man, I was just a baby when we started. Anyway, um, we, we promised each other that we would give our listeners what they needed to hear. If you're in a situation where your working capital is not where it needs to be and you're stressed over it, then you can refinance debt. 

You can lend some personal cash to your company and subordinate that note with the bonding company that you won't pay it back for 12 months or 18 months and they'll give you bond credit for that. You may need to finance your way out of it, and you've got enough backlog gross profit and you're just walking a, tightrope till you get paid.

But there's always a way you can manage yourself out of a working capital crisis. If you see yourself in that situation now, what would you advise that person to do first? 

[00:14:07] Wade: Sometimes just having an outside look at it. I've talked many times about speeding up your payables so that you're getting your receivables in. We could talk about, you know, the whole receivables process and getting the bills out the door faster.

But sometimes we'll let a customer, you know, they go over 30 days, 45 days, whatever, and we don't want to pick up the phone. We don't have a process for that. And sometimes you'd be surprised at how just a simple phone call can take care of these things.

Right. You know, there's other things like, to survive, If things are getting tight, I mean, having great relationships with your suppliers, I think is a good key thing to, you know, it's like we're having a little trouble here. Can you help us out? Can we maybe finance this kind of thing? Some of those thoughts just run through my head.

[00:14:59] Stephen: You may not have built in the interest of financing that material. and a job that you're losing money on, but in the future going forward it'll help your cash flow. Bonding companies don't give you working capital credit for the equipment you own that you don't have any debt on, but banks will lend you money on that and on your receivables.

They'll lend you money on also understanding your backlog gross profit and your ability to pay that note off. The longer track record you can show that you've been making consistent profits on the job and you have a healthy backlog, the longer they'll spread out a note for you, they'll amortize, called amortizing a note.

And that increases your working capital exponentially.

Yeah, and I know you talked about the line of credit, and we probably should talk about using that wisely. I mean, obviously, as they're supposed to be for the short term, getting through the crunches, if you will. But, you know, it's not something you go financing a new excavator off of.Yeah, you're exactly right. You can use a line of credit to help finance a project for an owner and then pass that cost on to the owner. or you can finance a project out of your own working capital or cash. the purpose of having a bank line of credit is that it's already in place.

We talked about this yesterday, but just a good old boy letter from a bank is not the same as being able to write a check and money be instantly deposited into your account. That's what a line of credit does for you. And even the best contractors from time to time have some sort of cash flow slowdown, I wouldn't even call it a crisis, whereit's better to borrow on that line of credit and keep things smooth and everyone happy, than delay payment to someone. Also you start cutting costs to try to make up for your lack of cash that's bleeding. And then the quality of your work goes down and then you start to lose your reputation.

[00:17:06] Wade: I think some of our listeners may be in a situation where they're not able to get a lot of credit yet, one of the things I still rail about is during, COVID, we had all these EIDL loans out there, the disaster loan, SBA loans out there. 

And that were pretty sweet. It's like 3. 75 percent pay it back over 30 years. So it's a long term note and, you know, I saw so many contractors get that 150, they ran them up to 500, 000 and even more for some contractors. But they used it and they essentially bought equipment or did other things with.

And had they just taken that money-- I know it's, it's one thing when you got trying to save your business, but a lot of our contractors were just trying to work on through it and didn't make adjustments during the bad times. 

I don't want to tell any stories, but I mean, I had one case where, you know, took that money, put it into a cash, money market account wasn't actually earning as much interest as it was costing them, but you think about what that cash did, it gave you very liquid, you know, bank balance.

And with a 30 year loan, only a little bit wascurrently due. So that could have bumped a lot of my contractors into a situation where they could get a lot of credit or built their bonding capacity. But I saw so many just squander it it's really sad because that was really, I just hate to say, it's probably a once in a lifetime thing that you're going to see from the SBA.

[00:18:43] Stephen: You're exactly right.Isn't it fascinating to see what our clients do when they're having cash crisis. The ones I like most, they're, they're fessing up to me. They're saying this is going on and they're saying, you got any ideas? I'm like, yeah, let's get with your accountant and let's sit down this afternoon and start breaking it down. Let's see what the problem is and what we can do about it. There's always something you can do. Wade, I encourage all of our contractors to get with their accountant way before their fiscal year end. And their bonding agent. So their cashflow situation is discussed and maximized before that year and happens. Because Wade, in my business, that year end financial statement is the number one tool I need for the whole year's worth of bonding.

It sets the tone of everything. It's that important to me in order to get you bonding, and it's even more important to you as a contractor to make sure you have adequate working capital.

[00:19:47] Wade: , Debt used properly is a great way to grow a construction business. Unfortunately with some of those, SBA loans was the fact that contractors lived better than they were able to for a while. And when they ran out, the company ran out, they never learned to run a proper business when they had, as I said, a once in a lifetime gift. 

So, you know, working capital to me is not just some kind of term. It's, you know, it should be meaning for these contractors, how do we build this healthy company? How do we create something that's sustainable in the good times and bad?

[00:20:26] Stephen: How do you do it? You make a profit on your projects and retain as much of that profit as you can that you don't pay out to yourself. So I see a lot of working capital being destroyed because of owner distributions at the year end. they have a very profitable year and then the owner is taking all the money out of the company. So bear that in mind. We need to keep some money in from working capital. 

And also remember that if you've already made a distribution, the best way to fix it, and you can't do this every year, but lend some money personally to your company and agree to subordinate that with the bonding company.

It's just an agreement that says, I will not pay it back in the next, usually 12 to 18 months, sometimes longer, or my working capital reaches a certain limit. And in the old days, Wade, so many times you would depend on the CPA's fiscal year end audit or review financial statement. Very few companies were giving bonding credit based on a compilation, or just a statement, with nothing being verified.

the bonding companies would ask for a verification of cash. And I had a customer that was, in, in pretty dire straits of, of, of working capital and, ran me an in house financial statement. And there was an additional, 50, 000 in cash. And I said, what, where did you label that from?

and he said, well, it's money I won down at Tunica at the casino. And, I said, okay, well, we need to call that paid in capital, please.

[00:22:05] Wade: Yeah. 

Not casino profits, but-- Is that what he called it?

[00:22:10] Stephen: Yeah. So again, that's some great advice. Take what little working capital you have, or profits from a job and take it to the casino. And I bet it on the pass line at the craps table. Okay, you know I'm kidding.

That's a true story. Well, I mean, the happy news was that we did call it paid in capital, and we got him the bond, and two years later, he went under. He had a pretty bad gambling addiction.

Yeah, these things happen. But, I don't want this to happen to any of our customers. So, please heed our warning. And, we beg you to think about working capital. Think about all the positive things that working capital brings to your business.

From stability to peace of mind, to ability to keep employees, vendors, suppliers, happy. keep your, your quality of your product and your communication and everything you do so well,right up to your high standards. Don't let lack of cash take that away from you.

[00:23:09] Wade: Think that's well said, and essentially that's, that financial Health of your business is essentially maybe your retirement or, your livelihood. So with that said, unless you had some other thoughts, I think that's a good place to wrap this up.

[00:23:24] Stephen: Okay.

[00:23:25] Wade: But if our listeners have any thoughts or comments about what we're talking about today or ways you express it, we'd love to hear it.

Drop it in the comments below. Always glad to hear from you and love to have some e thoughts on things you'd like to see in the future. Please let us know. If you enjoyed this episode, please like, share, subscribe, do all that stuff. We appreciate it. Helps the channel. And we will look forward to seeing you on the next show.