A Financial Rx

By Lou Stoug as featured in Construction Today

In today’s slow economy, financial health is more important than ever. Is your firm due for a check-up?

There’s no denying that times are tough in the construction industry. Yet there are many actions contractors can take to improve the financial health of their companies. A vitally important aspect of one’s overall strategy is to have a working understanding of business finance options. That’s especially true for those who want to sell, buy and start a construction company or find a way to thrive in the current economic downturn. In these cases, access to adequate financing is often a key ingredient.

Contractors obviously aren’t the only business owners who were caught by surprise by the current economic slowdown and credit restrictions, but they are among the most threatened and vulnerable. The days of easy credit are gone. Financial institutions today are demanding much more from entrepreneurs who are fortunate enough to qualify as borrowers. As such, it’s critically important for owners to begin to plan their individual strategies for remaining profitable in this new environment.

As the economy slows down many contractors may, at some point, need to consider one or more of the following options: Sell the business, delay retirement and operate longer than planned, or close the company’s doors.

The degree of success owners experience in such matters depends on how effectively they’ve managed the business in the past, how well they plan for the future and the strategic value of the actions they take today.

Widespread Liquidity Problems

Cash is truly king in today’s unpredictable economy. Obviously, the more liquidity a company possesses – be it cash or hard assets – the greater its ability to ride out hard economic times. Far too many construction businesses, however, are dramatically under- collateralized. Historically, contractors have tended not to diversify their assets and holdings. Quite often, their only hard asset is equipment, much of that leased or financed with the equipment itself acting as security. For the average contractor, an unhealthy percentage of the company’s assets are tied up in real estate – an investment prone to regional fluctuations in value.

Other owners, in an attempt to lower their tax burdens, have spent years preparing documents and tax returns that paint the bleakest possible financial picture of their companies. When done legally, this practice produces the short-term benefit of lower tax bills, but the price tag – a significantly devalued business – is staggeringly high, especially today. Many contractors are discovering just how ill-advised and risky these shortsighted business practices are.

Healthy Dose

The sad truth is that a high percentage of contractors who continue to ignore fundamental, ethical and timetested business practices simply won’t be in business much longer. However, for those who are willing to make immediate and dramatic changes in the way they operate, there is reason to be optimistic. The same is true even for business-savvy contractors who run tight, professional and profitable operations yet remain worried – justifiably so – about the future.

Every business owner can reap immediate benefits if they put into action the principles contained in the five C’s of financial health: character, cash flow, collateral, capitalization and conditions. Here’s how these elements are important to businesses:

Character – Yes, your parents were right – character counts. The human element is still alive and well in the business world. Financial institutions want to support and do business with local employers who possess and demonstrate strong personal and professional character. Contractors who are involved in community affairs, treat their employees honorably and pay their taxes, debts and vendors on time – in other words, conscientious people who play by the rules – immeasurably improve their chances for a good working relationship with lending institutions, even in today’s tight credit market.

Cash flow – Healthy cash flow begins with a detailed and accurate analysis of one’s personal and company needs and expenditures, including loan payments. There must be sufficient cash flow to handle all of it. Debt pressure on the personal side always exerts profit-eroding pressure on the business side. Many contractors who have high personal debt and lifestyle expenses will want to reduce them quickly and by as much as possible. Owners can start by formulating a budget and sticking to it.

Collateral – The best collateral today is cash; the worst is real estate, especially an undiversified portfolio of land. Land-rich contractors with relatively few other assets have essentially tied their fortunes to an anchor that will pull their entire ship down unless immediate action is taken. It may be necessary to cut one’s losses entirely or sell a portion of one’s holdings at fire-sale prices. Granted, these are painful measures to consider, but one’s survival may depend on it. Before taking any drastic action, however, it’s important to seek advice from competent and trusted financial and legal professionals who specialize in business and real estate matters.

Capitalization – Adequate operating capital is the lifeblood of a company, and it comes form three sources: investment capital (funds provided by the owner and/ or other investors), retained earnings (profit made by the company that’s reinvested in the business) and borrowed funds (money borrowed at an interest rate from banks, lending institutions and private equity groups).

The first step is for owners to determine their capital requirements over an annual operating timeline and then decide how that capital should be allocated. Rule No. 1: never borrow money for operating expenses. Most contractors need the assistance of a financial professional in the analysis, planning and implementation stage of this crucial step. Once a plan is in place, it’s a relatively simple matter of following it and fine-tuning it at regular intervals.

Conditions – Market conditions are constantly changing, and like a good sea captain, construction company owners who keep one eye on the weather will fare better than those who do not. What are the trends in the local construction market? Is it time to diversify or change from a commercial to a residential focus? Or perhaps move one’s operations?

Here’s an interesting fact: The current economic slowdown is not evenly distributed. Some U.S. and global construction markets are doing much better than others. The same phenomenon holds true for the types of construction work available. Government-related construction projects, for example, can be a particularly stable and lucrative source of work. Nimble business owners who combine creativity with a willingness to try something new – even moderately risky ventures – will find plentiful opportunities for work.

Adapting to Changes

Doing business as usual clearly isn’t sufficient to thrive in the harsh financial realities of today’s construction industry. Selling one’s business, for example, is dramatically more complicated and difficult now that potential buyers are finding it hard – if not impossible – to secure sufficient credit. Contractors wishing to retire or move on to other opportunities need to be prepared to partially finance the sale of their own businesses, a condition that’s unlikely to change in the near future. Seller financing, in which the owner of a business underwrites a percentage of the transaction – and therefore retaining a vested interest in the continued health of the company – is an increasingly popular method of keeping the wheels of the economy moving when more traditional means are not viable.