How one contractor's cash flow wake-up call changed everything

Most contractors believe that working harder and landing bigger jobs will solve their cash flow issues. But is that mindset holding them back? In this episode of the Contractor Success Forum, Wade and Stephen discuss the financial struggles of a seemingly successful contractor who had to fundamentally change their business approach.

They delve into the reality check and lessons learned, emphasizing the importance of proper cash flow management, accurate job costing, and strategic debt management. Tune in to discover the epiphanies and strategies that can help contractors avoid similar pitfalls and move towards financial stability.

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Topics we cover in this episode include:

• 00:19 A Real Contractor's Wake-Up Call
• 00:35 Meet the Hosts: Wade and Stephen
• 01:12 The Case Study Begins
• 02:11 Financial Realities and Epiphanies
• 03:58 Implementing Profit First
• 05:40 The Cash Flow Projection
• 08:06 Aggressive Strategies and Tough Decisions
• 18:23 Lessons Learned and Final Thoughts

LINKS

Visit the episode page at https://carpentercpas.com/breakingpoint for more details and a transcript of the show.

Take the FREE Construction Company Health Evaluation: https://profitfirstconstruction.com/free-resource-evaluate-your-accounting-system/

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

Transcript

[00:00:00] Wade: Most contractors think that if they work harder, land a few bigger jobs, and just hit that next revenue milestone, then their cash flow problems will automatically disappear. But what if that thinking is actually what's holding them back? Too many contractors are stuck in a cycle, making good money on paper, but you're constantly scrambling to find some cash.

Today, we're diving into a story of a real contractor who hit a financial breaking point and had to completely rethink how he ran his business. We'll talk about the wake up call that changed everything for him, as well as some of the lessons you can use to avoid the same mistakes. Welcome to the Contractor Success Forum. I'm Wade Carpenter of the Carpenter Company CPAs. With me, Stephen Brown from McDaniel Whitley Bonding and Insurance. Stephen, you've worked with countless contractors over the years. You ever see a contractor that looked successful on the outside, but behind the scenes, they're barely staying afloat?

[00:00:53] Stephen: It's a perception that kind of turns into a reality and, I kind of know where this case study's going and it's so much better to tell a story of something that happens to someone else so our listeners might learn from it, than just to be negative.

[00:01:08] Wade: but,I'm excited for our listeners to hear about what you brought to the table. 

 This actually just happened yesterday, and I'll try to tell the story.Some of this goes hand in hand with writing the book about Profit First for Commercial Construction, and I have started teaching it very differently to contractors. It's a brand new client and I'm going to purposely leave out some details just so that I don't want anybody identifying the contractor.

[00:01:34] Wade: I don't think they could, but obviously don't want to divulge any, confidentiality thing like that.

[00:01:39] Stephen: Fair enough.

[00:01:40] Wade: It was a sort of an epiphany for me as well. It's like forcing profit. How are we forcing profit to change the game for yourself. And so I think I sort of need to set the stage on this one a little bit.

[00:01:52] Stephen: Okay.

[00:01:53] Wade: Took on this contractor. Been around for several years.About two months ago, they hired a new chief operating officer and brought him in, and they realized that they were not where they needed to be on their accounting side. 

So they hired me about a month ago. And so my team has been working with them. Long story short. quite frankly, these people are completely insolvent. And hate to be so blunt about it, but that's the truth of the matter. Very deep in debt. And started going down the road of having these pay by the week loans that cost so much money. And,took on a very expensive COO, and hired us. They came to me through Profit First. The COO was trained in EOS, the Entrepreneurial Operating System that Rob Williams used to talk about a little bit, which I know some about.

But essentially They had a hugeoutgo on just paying their notes payable, just coming up with the notes payable. And they'd been losing big dollars every year. And sort of on the brink of, we need to change the game. Compunded the whole thing by an owner is paid fairly well. She's very, very smart, but likes to travel and likes to eat very well. And I think you and I have had some conversations about owners that we just want to say sometimes if you will just make some changes in your life and just get your company to a certain point, maybe you can get there one day. 

[00:03:17] Stephen: Yeah, you're supporting a false front. You're living beyond your means and,it's something you prefer not to deal with. It generates debt and it, generates problems and, I know that's just the beginning of this story, isn't it?

[00:03:31] Wade: What's sad is that this is a very well known contractor that has a great reputation. And that's what I was saying in the intro.You can appear to have everything together, but you're this close to being completely out of business the next day. And this is the type of situation we're talking about here. And so,that's where I want to get to where I was talking about one of these light bulb moments. There's some epiphanies that I had as well as he had as I go through the story. 

I was working with him and we wanted to implement Profit First. So I had a meeting with him as well as the owner. And again with my book, I'm teaching it. in a way that Mike Michalowicz did not teach as well as there was a derivative book by Sean Van Dyken. They're both wonderful books of great teaching, but I have come to the realization that contractors need to know exactly where they are.

So I'm approaching like, hey, let's get this started. But in my book, as well as the way I approached it with these people is number one, you need to understand your job costs and cash flow. Which I, in my book, start talking about job expenses as opposed to just some materials and subs, but that is cash out on your jobs because you have a job.

The other thing is the overhead, and everybody always preaches about overhead. They don't know what it truly costs them. And so we walked through an exercise of, yeah, you can approach overhead from a profit and loss standpoint, but what is really cash out? And in this particular case, cash out is also going out to pay all these notes payable. And tens of thousands of dollars every month just covering notes payable.

So you can imagine what that strain is putting on their cash flow. But if you take a traditional overhead approach from the profit and loss standpoint, you're not taking into account what that operating expense account has to cover. And so I very vividly showed them that where you're at is it actually turned out to be like 113 percent of every dollar that came in needed to go out. And obviously that is not sustainable. 

They had this sink in a couple of weeks ago when we had this meeting. And then we started talking about cashflow. We started putting together a cashflow projection. And,part of what they were started doing. They, to their credit, they did start taking it like, where can we cut our overhead? And, where can we get some cashflow? And again, that's where the COO, he came from a very different industry, which I was surprised, but he's asking some really good questions.   

[00:05:59] Stephen: What I'm hearing you sayin this actual case study is that first order business was explaining the concepts of Profit First, and then, doing a analyzation of exactly what is the percentage of loss that you're incurring. And what you can do to turn that around.

[00:06:16] Wade: Right.

[00:06:16] Stephen: 113 percent does not sustain itself in any way, shape, or form.

My first reaction, too, is by running these cashflow projections,you're giving that COO, some ammo to help renegotiate some of this debt. If you can prove that the cashflow is coming in, that's what any lender would want to see. 

[00:06:33] Wade: To that point, quite frankly, this is such a bad situation, nobody wants to renegotiate. No traditional bank would take this. And,what came out of it, there was a few epiphanies from their standpoint, as well as, this is one I had many years ago. We can have all this profit on paper.

And that's why I really have taken to Profit First and teaching contractors this, is that, if you're so worried about paying taxes at the end of the year, and you go buy a truck on December 27th every year, just to write it off, and then you've still got five years of payments on it.

Yeah, you got the expense. You took that up front, but your cashflow is going to suffer for the next five years, right?The epiphany that I had many years ago from a cashflow standpoint, which sounds like the complete blinding flash of the obvious, is that the only way you pay off debt Is to have profit. And I know that's probably the simplest, stupidest thing I could say on here, but it is a realization that contractors do not have.

[00:07:31] Stephen: It's about the profit. It's not about the sales. If your sales are bleeding 100 cost.that's not the answer. Okay. 

[00:07:38] Wade: Again, if you look at the P& L, it was still negative, but it was like 103 percent or, you know,but if you look at the cashflow effect, it was 113 percent that were behind. When I said that to him, I think there was a light bulb moment. Not that they didn't get that, but it sort of hit him in the face.

I want to tell the story, I don't know if this is a good thing or a bad thing. I guess we'll find out. But I thought this was a very interesting approach to it.They were negotiating a job. They had an owner that actually offered to, if they cut their price, would pay them cash up front.their profit, and then they would pay their costs as they go. 

I don't know if you can follow where I'm going with this. They're like, okay, we got $275,000 up front. What can we do with that? My first inclination is that, okay, number one, you're not going to be covering anything else but your job costs, or job expenses, JobEx as I call it in my book. From a cashflow standpoint, that's all you're doing. 

[00:08:38] Stephen: Number one, you've literally cut out about 10 percent of your profit on a 2. 5 million job, so you just cut 250, 000 of profit. And whether I would have told them to do that, they had already done it, number one. So the idea is what is the smartest approach to taking this cash and moving forward? So are you following the story? Yeah, I, and I think I know where you're going. You have to set aside some profit at some point in time. How are you going to get ahead? Would it be even more compounded if that owner took that 270 and said, I'm rich now. I think I'm going to go out to eat and buy a new car, Gosh, that happens.

[00:09:16] Wade: Well, to be honest, the COO was concerned about that. He's like,I want to get rid of the cash.

[00:09:22] Stephen: Yeah. it needs to be in some sort of escrow. 

[00:09:25] Wade: But that was my thinking is, and again, I'm not sure whether this is the right or wrong approach, but I want to talk about the approach. Cause I was thinking, okay, you need to put every dollar of this back. Cause you're going to be running out of cash. You're using your capacity in the company to do this work, butyou're not going to be covering a lot of the overhead, plus there's no profit left. There's nothing else to give. 

They truly negotiated, likeif there's change orders, the cost of something goes up or down, we'll just eat the cost of that particular thing, but you don't get to recognize profit or overhead on that because it doesn't cost you any more to make this change, if that makes any sense. So that's where they're at. 

Now, again, we started digging in and going through this is exactly what every note costs you. And to be honest, they had some trucks, they started selling some trucks, that still had notes on them and didn't net some cash out. But now they're stuck with this 275, 000.

And they're like, okay, we would like to pay off debt for that. And I'm like, okay, that probably doesn't make sense because you're going to run out of cash. And again, to be seen whether this is the right approach or not. 

But here's the story. They went and, said, okay, we've got these particular notes. And two of them were, these pay by the week or pay by, some of them, they're incredibly high pay by the month. 

Stated interest rate on this thing was like 48%. if you do the annual percentage rate, I think it's actually much higher than that. But the long of the short of it is there, there was a clause in there that gave a 25 percent discount on the interest, which actually would have saved like seven to 10, 000 overall. 

[00:11:00] Wade: But,what we're looking at is cashflow. Andwhen I said to him, okay, we could take out this much cashflow, what we have to cover every month and every week, cause some of them were weekly payments. And I'm like, I completely get that, but you're going to run short on all these other things. 

And to be honest, they were also approaching it, I've said it, like we always need a bigger boat. You know, It was like, if we just get the revenue to the next level

now here's where we take a little twist in the story, if you're still with me.

[00:11:30] Stephen: Ah, I'm just, spellbound.

[00:11:31] Wade: Okay, so to his credit, he's like, okay, I don't want her to spend this money. And if it sits around, it's going to get spent. And I would rather take out the cash flow, the monthly, and we did do an analysis of how much cash would actually be coming in versus the monthly payments that we would be taking out. And It was very comparable. So I'm thinking, okay, you're going to only pick up this much cash but you're still going to be running short on your overhead. When we started looking at it and I was like, okay, that's a very aggressive approach. That's where I'm going with this. it's incredibly aggressive approach. 

And , after looking at it, I was like, this is what you're going to have to do to actuallyfind other jobs. And this is where you're going to have to put the level to cover these other overhead. Plus, we'd started talking about the fact that they weren't bidding high enough. And again, I ask them, this is a question I have a lot of times when I've talked to a contractor for the first time is, they're not profitable.

And I'm like, are you really bidding the right? And the ultimate answer that always comes back is that's all I can get, whatever. But sometimes that's just perception.

[00:12:37] Stephen: But then I ask, if I'm just talking, I did the exact same thing with these people. How many jobs do you actually lose because of price? And when they looked at it and thought about it, they very rarely lost a job because of price. They have a great reputation. Again, on the outside.

They're getting the work done.

[00:12:55] Wade: Yeah, they, super reputation. And I think I've changed their, they're obviously stuck with the jobs that they're working through.

[00:13:01] Stephen: That's huge. But did you teach them how to price things to meet their debt burden,and start putting money in a profit account?

[00:13:10] Wade: Well, honestly, that's the premise of the book. It's taking an approach of, not just a P& L approach, but what does it cost you in cash? The standard break even point is for any, we look at it mainly from a financial statement perspective.

So if you got cost of sales of 70%, that means you got a 30 percent margin. And let's just say you've got a half a million dollar overhead. You can take that overhead number of half a million dollars, and then you got a 30 percent margin, you divide that by 30%, that gives you your break even point, right? So if you can get a little higher margin on the top end, then you lower the amount you need to break even, or you can build profit in.

By the same token, obviously if you reduce overhead on the bottom side, then you have less to break even. But the spin that I talk about, which I touch on in the book, is the fact that, okay, instead of using the regular financial statement drivers of this, what is our book, cost of sales and, margin, we're looking at that from a, what I call JobEx, which is a margin based on cash flow. And then the other epiphany that they got when I started going through this is, your bottom line number for overhead is a lot higher than you've been bidding with. Again, that's one of the epiphanies that came out of that.

[00:14:29] Stephen: That allowed them to tackle that overhead on two fronts,lowering it and raising the cost of their bids.That's a tangible number that could help them immediately. I'm just, I'm blown away by the,the debt that they're a slave to. 48 percent interest rate.

How in the world do you get out of that? I'm sure that somebody's giving them adviceto file bankruptcy and I beg them,no, please. That's a last resort. To think that you can file bankruptcy and then start your company back in, because you've already got a name for yourself and you already do good work.

So there's other resources to to be able to get out of that mess. And I wish I knew what all they were, but they're out there, right?

[00:15:07] Wade: Continuing with the story--

[00:15:09] Stephen: Yes.

[00:15:09] Wade: I believe that's the answer. That's their, that's what they're going to do is they're going to take this money up front and and knock down your cashflow to be able to survive it. Now I made them fully aware of what they're going to have to do. They're going to have to, number one, just make sure that they find some more work and keep that pipeline going outside of this particular job, because they're not going to be pulling any revenue off of that. 

That's where, having this detailed cashflow that we did of like month over month projection. And is the stuff I just love doing after years of spitting tax returns back at contractors. I just love seeing helping a contractor work through this.

Is this an incredibly aggressive strategy?

Absolutely. Is it the right one? To be determined. When I thought about this, it's exactly the same thing that Profit First tries to do, is we're going to put some guardrails around the fact that we're going to have profit in cash at the end of the day.

It's just a different way to go about it. So that's what I was saying, forced profit. And he's forcing his hand because he has no other ability to get other financing, unless he goes down this path of these very expensive loans. 

[00:16:22] Stephen: That's such a good analogy, Wade, because the same things that caused their decline, when reversed, can cause that decline to turn around for the better, slowly, but surely, incrementally, you can't always fix something immediately overnight, but there's always the opposite of the worst possible news.

There's always something that you can do. And it's so reassuring because both of us have seen so many of our clients,just go under. They were too frustrated. They didn't have the skills. They got into problem. They didn't get good advice. I'll say this. hiring that COO and hiring you was a good step.

And you'd say, wow, you're already in debt. How can you afford these people? But literally, they couldn't afford to stay in business without the right kind of advice and help. 

And that's one thing. And then another thing that just stands out to this is one of the things that we underwrite, for surety bonding credit, and that is character. The character of the person you're bonding is one third of the equation. Cash, character, and capacity to do the work. Those are the three C's of getting surety bonding credit. Add collateral, that's the four C's involved in getting banking credit. Incrementally, they will be getting a better credit rating and Negotiate better rates for borrowing, for sure. And, incrementally, they will be making the adjustments to,bleeding. I think of, triage unit in an emergency room. someone's going in there, and they're literally, bleeding out, and if they don't know to stop the bleeding from this one particularly artery, they're dead.

And it's the experts in the emergency room, it's the doctors that know, okay, this has to be done first. This is triage. Most important first is the philosophy behind someone going into an emergency room. And here we are, we have a customer of yours coming into the emergency room. And what's so exciting is that you had some solutions for them.

The proof's in the pudding. I can't wait to hear how this story ends. I'm rooting for them. I think all our listeners are too, Wade.

I 

[00:18:20] Wade: spent a lot of time thinking about this particular thing. You know, part of it goes hand in hand with stuff I'm talking about in the book, but I actually came up with a few takeaways that I got from it, as well as hopefully our listeners are getting something out of it.You know, I've said it all the time that we're implementing Profit First and we're only putting 1 percent for profit and 1 percent for tax and starting small.

So you know, just again, going back to what are the core problems, the other realization that,we see it all the time they're underpricing their bids. And in the book, again, there's some realizations about COVID as well as, the great learning lesson for me, Great Recession of 2008.So many epiphanies that, what happens when like the grading guys, the heavy equipment guys, some of the residential work dried up. So all the commercial guys were competing against all these other people to just survive.

And so they start getting into this okay, we start chasing cashflow, and we bid lower, and it becomes a cycle. The point here is these low bid jobs just digs the hole deeper. There was some things about this job that was not happy about the fact that they gave up 200, 000 plus of margin, but what's done is done. The other thing that, I just, deep thought in here, paying off this debt, number one, may or may not be the solution. But paying off debt does not fix broken cash flow habits of the owner. 

And what I'm hoping is that the owner will take away from this is, you know-- and we're, we'reconstraining our cash because we got it broken down into seven different buckets in this particular case. So she's got an amount to cover payroll. She's got an amount to cover her job expenses, and she truly knows what she's got to cover from overhead. So I think there's going to be some changes there and that's what we're all going about.

[00:20:05] Stephen: Yeah.You know, I always see the glasses half full, Wade, and, youthat may be a problem with me and my personality, but I'm rooting for, she went out and she found some help.Again,cost her a lot of money, but something's got to give. Sometimes the best people just can't see the forest for the trees, and you heard that expression a million times until they have that epiphany like you had with your book. And also that,you're anticipating your,your clients to get. That epiphany, eureka, that one moment of light that shines on the idea that changes everything around. Anything that's bad that's happening to you that you can take and turn around.

Right.

I think this was a great podcast and, I can't wait to hear more about how it turns out. But it sounds to me like, you're doing something and I see so manyclients that just give up or bonding agents working with those clients to say, I just can't take it anymore. I can't take you doing this anymore.

You've not taken any of my advice,for getting you bonding credit. And the two go hand in hand. That's why I'm your co host. They go together. And so these kinds of stories are my favorite kind of stories to tell, where there's hope in a hopeless situation.

[00:21:17] Wade: working harder will not fix a broken cash flow system. Profit has to come first, not last.

[00:21:23] Stephen: First.

[00:21:24] Wade: You can't pay off debt without profit. If your bids are too low, you're digging a deeper hole and forced savings, whether it's profit first or doing this, eventually can lead to financial freedom. Will it happen here? We will find out.

[00:21:38] Stephen: Yeah, taking that to $70,000 to me and paying off debt is robbing Peter to pay Paul. You heard that expression. Where does it stop? How do you put an end to it? and, at 48 interest, when is that going to end? All I can pray is that it wasn't a big loan, and if it was a weekly loan, it probably wasn't that big.

Bigger than you think. Yeah. Hundreds of thousands of dollars here.

Okay, we're still going to end this on upbeat. Okay.

[00:22:01] Wade: Yep. So for our contractors out there listening to me right now, start small, like Profit First, just carve out 1 percent to start forcing that habit. Audit your overhead, evaluate your pricing, open a separate profit account so that you're not tempted to use it, and then stop relying on debt to run your operations.

And when you start realizing those kind of things in your business that are taking you down, hopefully that you can turn things around if you're not where you want to be. So that's myclosing thought, unless you have any others.

now that's a great closing thought. I always remember that when you have debt, you're a servant to that debt until it's paid off. You don't own debt. It owns you. Some debt is good. Some debt is bad. 

Yeah. Debt leveraged properly can help you grow. Improperly can-- and again, this is a situation where I didn't really tell all the story, because some of it was understandable. There's some things that happened, but for our listeners, I hope you may have taken some things from this episode that made you think about it. 

[00:23:01] Wade: If you did, we'd love some comments below. If other epiphanies came to you, we'd love to hear about it as well, or any other topics you'd like us to talk about in the future. But with that said, if you're still with us, we appreciate you. Please like, share, subscribe, do all that stuff. Again, if you have any thoughts. Let us know, but if nothing else, we will see you on the next show.