This article is about cash flow, the movement of money into and out of a business. With few projects to go around, however, the real story, as with most stories today, is the economy.
The construction economy is so atrocious, the number of projects to work on so few, that most subcontractors compete on price. They bid low to land jobs in order to maintain a measure of liquidity. Get the work first, then tap the reserves and hope for a happy ending. Will this situation ever improve? Probably not anytime soon.
“I think it will get worse,” says Vincent “Vince” Nihipali Sr., president and general manager, V&C Drywall Contractors, Inc., Kapolei, Hawaii. “The generals [general contractors] are tight on funds, and many subcontractors are in trouble. So, the generals are playing the smart game of holding back the money.”
Why are GCs slow in making payments? How does low bidding contribute to a low cash count? What, if anything, can subcontractors do to improve their cash management? Let’s take a look.
Subcontractor as Banker
As we reported this summer in AWCI’s Construction Dimensions (“Win the Bid,” July 2012), general contractors and subcontractors came into the current downturn with decent balance sheets. To survive in a market lean on projects, however, many firms tapped their available liquidity and are now stretched thin.
“A lot of companies burned up their reserves by staying in business without the volumes of work,” says Mike Poellinger, president and general manager, Poellinger, Inc., La Crosse, Wis., speaking about general contractors. “So, rather than using more of their cash reserves or their lines of credit, they’re using the subcontractors.”
Take hospital projects. The few that come along these days are still large-volume contracts. For Poellinger, that means having 25 to 30 people on the job with monthly billings of $150,000 to $200,000.
The problem comes when the draws are delayed. In Poellinger’s market, the project managers now process the paperwork instead of the hospital owners—a recent switch in practice, he says—and the managers, he adds, have indeed delayed making payments. If Poellinger’s receivables end up 90 days out, he can easily have $500,000 of real labor costs come due well before he is paid. His bankers watch and worry over this money, despite the hospital owner being good for that money.
“We used to be able to ‘cash flow’ those kinds of projects,” Poellinger says.
The company had enough overall volume of work so that billables on one job were easily covered by the payments received from others. But as his firm’s volumes declined with the economy, and as project managers took the reins of making payments, cash flow gaps became a real threat. It’s become a world of No Wiggle Room. It seems there’s little a subcontractor can do about it, and the situation is made worse by today’s bidding wars.
Bids Too Low
“The problem with cash flow is that too many bids are just too low,” Nihipali says.
Here’s how it comes about: You’re tempted to bid an upcoming project for 20 to 30 percent below cost. A winning bid will provide cash for operations and some staying power. Eventually, though, you’ll need profitable work. You hope that your competitor runs out of cash before you do. But sooner or later, you’ll run dangerously low, too. Nobody can survive while operating at a loss.
“[Subcontractors] get caught up in what we call the Wal-Mart Syndrome,” says Barry Wallis, general manager at DAIco Supply Company in Fort Worth, Texas. “They think price is king, but they don’t understand the difference between price and cost. Low price doesn’t offer the same performance, and I think it costs them additional labor.”
Wallis tells the story of a job where the steel framing (sold by a competing supplier, not by DAIco) was rolled out to the thinnest allowable gauge. The architect shut the job down for a week. The screw retention wasn’t at the minimum standard. They had pull-out issues as they began hanging the exterior sheathing.
Arguably, the wall contractor hurt himself by buying the job based on price, rather than with an overall package of price, serviceability and quality controls. In this instance, the subcontractor’s make-good required $27,000 of additional labor and steel bracing. A thicker gauge steel might have only cost an extra $3,000 upfront, Wallis says.
The lesson is that low pricing leads to problems. Sadly, Wallis says this type of shoot-yourself-in-the-foot bidding is happening more often.
Tactics Worth Trying
The bidding wars are what they are, and some industry executives feel there’s not much that can be done about today’s low margins. And receivables seem destined to remain two months outstanding, more or less.
“If 30 to 45 days was really good before, now it’s 45 to 60 days that’s typical,” says Gregg Brady, president, Brady Company/Central California, Inc., Castroville, Calif.
That being so, maybe the solution to collecting payments more quickly is to pursue different kinds of projects:
Integrated project delivery. Brady Company/Central California, for example, is currently working on a project where construction milestones determine when profits are released. This Integrated Project Delivery of construction means Brady Company is part of a team at risk for its profits and bound by an Integrated Form of Agreement business contract. The profit component is released based on overall team performance, which is largely about hitting installation millstones on schedule.
“I am reimbursed for my actual costs plus an overhead percentage that’s agreed to,” Brady says. “I’m getting reimbursed for my costs in a typically better-than-average period. It’s that 30- to 45-day period.”
Brady notes that the cost reimbursement schedule still makes it hard to get ahead of his bills, since there is a month to a month and a half payment delay. In addition, he says his accounting firm spends more time on this small job than on bigger jobs because of the backup accounting validation required to justify costs. Even so, Brady says the integrated project delivery method of construction improves his company’s draw schedule and may even be better for cash flow in other ways long-term.
“I think it’s holistically a better process. It’s a collaboration, a team performance,” Brady says. You want the owner to say, ‘Why would we go through this learning curve again? Why not take the same team that we’ve come to trust and go on to the next project?’”
Working directly for owners. Poellinger says working directly for owners allows his company to develop its own schedule of work, which includes setting milestones for material and equipment expenditures.
Recently, for example, Poellinger had the stucco work for a large, private winery. The job required some upfront scaffold to be put in place. Poellinger forwarded a spreadsheet to the owner.
“He knew that as soon as I had that in place, I was expecting a check for $30,000,” Poellinger says.
It was a $450,000 project. In the first month of this three-month job, Poellinger had billings of $190,000.
“He was prepared for that, and the bank was prepared,” Poellinger says. “They knew that although there was not a lot of work in place, I had all the material and equipment on the job, and that it was a big part of the job.”
Clearly, the payment rules that general contractors use have become stricter during this tough economy. They want to ensure that each and every subcontractor has paid their material and labor suppliers before they themselves can get paid.
“They want it verified,” says Brady, who has accepted the current state of affairs of paying bills before pocketing checks.
Still, Brady concedes that in the area of cash flow subcontractors might have a tendency to be soft.
“Maybe there’s a partially higher tolerance for paying and severing than there was previously,” he says. “We’re just happy to have the work.”
Still, Nihipali says that the days of bidding 30 percent or 40 percent below cost need to end.
“I understand their point of view,” Nihipali says. “If they don’t go low, they will not be awarded projects and their cash flow will completely stop.”
But what a way to go about business. Knowing that they’re going to lose money, the incentive becomes, Nihipali says, “finding creative ways to cover their tracks.” He knows of one Hawaiian subcontractor with a $1 million contract and turning in only 1,000 hours of labor to the union.
“That’s a red flag right there,” Nihipali says. “How can you do a whole job for 1,000 hours? Go to the other contractors who bid the project, and get their hours from their estimators, and you’ll see that they averaged 10,000 hours on their bids. If 10,000 hours should have been reported, and the company is reporting only 1,000, then you need to look into how the company is doing that project.”
Nihipali suggests that the labor is off the books. It all comes to light not through a laborer, but through his wife or girlfriend. She takes the children to the doctor, provides a medical card for the local carpenters union and, because he has not logged enough hours in the quarter, she finds out she doesn’t have coverage.
“The husband was working but collecting cash,” Nihipali says. “That’s when everything gets interesting.”
Mark L. Johnson is an industry writer and marketing communications consultant. You can reach him on Twitter via @markjohnsoncomm.