How Smart Contractors Keep Money in the Bank

Many home remodelers bankroll customers’ projects, using their own capital to pay for materials and labor before getting paid when the work is done. It’s a high risk way to do business, but surprisingly common among smaller contractors with little formal financial training.

In the boom days before the recession, it wasn’t an issue. “There was always a flood of money coming in, so they would take it from one job to pay for another,” says Mitch Stanley, president of Stanley Renovation and Design, a Milwaukie, Oregon, design and remodeling company.

But when the economy tanked and work dried up, such careless business practices put many contractors out of business. Those who survived spent the last two years scraping by, often by not paying themselves and taking any project that came along just to keep the lights on.

Today contractors who made it through are breathing a small sigh of relief. According to the National Association of Home Builders' Remodeling Market Index, the remodeling market is heading into recovery. The index, which assesses industry confidence, increased 12 percent to 46.5 in the first quarter of 2011 from the fourth quarter of 2010, reaching its highest level in more than four years, according to the home builders’ group.

For remodelers and other contractors to rebuild their operations and avert another cash- flow crisis, they need to effectively forecast project costs and manage cash, says Matt Stevens, author of Managing a Construction Firm on Just 24 Hours A Day, and president of Stevens Construction Institute, a Gainesville, Florida, construction industry training company.

Yet the industry remains full of skilled tradesman who started companies but can’t forecast cash flow or set up client payment schedules, says Mike Davis, owner of TMT Home Remodelers, a $1million remodeler based in Central Oregon. As a result, they’re in a constant state of cash flow crisis. “It gives the whole industry a bad name,” he says. “When a few clients don’t pay, they go broke, and they leave vendors and subcontractors holding the bag.”

Controlling Cash Flow
It doesn’t have to be that way. Here’s what the experts recommend remodelers and contractors do to stay fiscally sound, even when a client doesn’t pay:

1. Forecast costs and cash flow needs before bidding on a project. To know your bid price, understand the true cost of your operation. That figure includes materials and labor, overhead such as insurance, gas, administrative work and your profit. “If you don’t forecast your costs, you are just guessing,” which is a quick way to go out of business, Stevens says.

2. Stop acting like a bank. It is not a contractor’s job to finance a customer’s project, so don’t cover up-front costs for material and labor. On Stanley’s projects, which typically run $75,000 to $100,000, he outlines payment expectations in the initial negotiation. “If they want the project done right they need to pay for it,” he says.

3. Get cash up front. It’s completely reasonable to request a 10 percent to 30 percent deposit. TMT Home Remodelers’ projects range from $20,000 bathroom remodels to $150,000 room additions, and for each one, Davis requires 10 percent down to get started. “It lets you know the client is serious about the work, and it seeds any pre-ordering or purchasing you need to get started,” he says. Small contractors often feel uncomfortable asking for money before providing services, but they need to get over that, Stanley says. “It’s part of operating a business.”

4. Include a payment timeline in the contract. To eliminate confusion later on, set expectations up front about when you will be paid and what you will deliver for each payment. Use your initial conversation with a prospective client as a negotiating point. For example, offer a discount if they’ll pay in full up front. “This keeps your cash flow positive and lowers your risk, while adding value for the customer,” Stevens says.

5. Time payments to contract milestones. Davis ties progress payments to the beginning of each phase of construction. Those payments cover the actual cost of the work, not just a percentage of the total project. “If drywall costs $5,450, then that’s what they pay,” he says. By timing payments to project phases he always has capital to fund that portion of the job, and eliminates payment delays when the work is done. “There is never any doubt when a phase begins,” he says, “but there can be all kinds of ways to argue when it’s complete.”

6. Collect payments in person. Send email reminders a few days before an installment is due, and pick up a check from the customer before starting the next phase of construction. You could perform thousands of dollars of work before a check comes in the mail, Stanley says, and if the client doesn’t pay, you’re out the cash for that effort.

7. Ask subcontractors to submit invoices. Requesting invoices from subcontractors creates a paper trail, and gives you time to turn around your own payments, Stanley says. He generally pays subcontractors within a week of getting their invoices. “It’s part of an efficient bookkeeping process,” he says.

8. Use direct deposits, controlled disbursements or other payment options. Financial institutions offer dozens of tools, including corporate purchasing cards, online payments and automated cash management options that business owners can use to smooth the gaps between payments and receivables. “These tools can help you control when checks hit, and avoid a cash flow crunch,” Stevens says.

9. Make the final payment your profit on the job. By limiting the last payment to your profit, you ensure you have enough cash to pay contractors and vendors, even if the project drags on as you finish small details. “If the customer delays that final payment, you’re still covered,” Davis says.

10. Don’t lowball your way to success. Being the lowest bidder may win you a job, but if the total isn’t enough to cover your expenses you’re paying for the privilege of doing the work. Says Davis: “If you don’t include the cost of overhead in your bids, it’s just a matter of time before you go broke.”