?? 6 Finance Points To Help Your Business
Saint Construction Support
Construction support specialists taking care of back-office of your business! It becomes simpler when you're a Saint ??
We had a great response to last week's article on Marketing KPI’s and one of the requests for this week was for a few questions on understanding the finance side of the business. - Remember if you would like a subject to be submitted for a Saint Sunday please let us know and we will always try to help!?
This can be daunting but by having even a little bit of the below information to refer to and being able to show or ask about the rest in a conversation with your accountant over time will really help.
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We had a lot of questions sent in about managing cash flow in the Construction Industry and how business owners can keep on top of this,? The accounts team have tried to not speak in too much accountanese!
?? Managing Cash Flow
Operating Cash Flow is a crucial aspect of managing cash flow for a construction company in the UK.?
While revenue is important, what really keeps the business running smoothly is the cash that's available to cover day-to-day operations.
Late invoice payments can indeed be a major challenge, particularly when dealing with slow payers or larger clients who impose extended payment terms like 60 days. This delay in receiving payments can create a strain on working capital and hinder your ability to meet immediate financial obligations such as paying suppliers, covering payroll, or investing in new projects.
Using the Operating flow report will give you a basis to see how the operation side of your business is running. Negative operating cash flows, period after period, may signal that cash will become insufficient to cover expenses or other obligations.
?? The Quick Ratio
?The Quick Ratio is a KPIs to see the short-term financial strength of a company.
?? How to calculate: (Cash + Accounts Receivable) ÷ Total Current Liabilities
This is often referred to as the acid test, it measures what assets can be quickly converted into cash (liquid assets) to cover short-term liabilities (suppliers, wages, rent etc). Inventory, vehicles and so on are excluded from this calculation.
?This metric shows you the business’s ability to ride out short-term rough patches. A quick ratio of above one is considered “safe”.
?? Accounts Receivables VS Accounts Payables
What is owed vs. What we owe
Managing accounts receivable (AR) and accounts payable (AP) effectively is crucial for the financial health of any construction company. Here are some strategies to help:
Accounts Receivable (AR) Management:
Invoice Promptly: Send out invoices immediately after completing the work or delivering the services. This helps to ensure that your clients are aware of their obligations and reduces the likelihood of payment delays.
Clear Payment Terms: Clearly outline payment terms on your invoices, including due dates and any penalties for late payment. This sets clear expectations for your clients.
Follow-Up: Implement a system for following up on outstanding invoices promptly. Send reminders before and after the due date to encourage timely payment.
Offer Incentives: Consider offering incentives for early payment, such as discounts for invoices paid within a certain timeframe. This can encourage clients to settle their accounts sooner.
Use Technology: Invest in accounting software or invoicing platforms that can streamline the invoicing process and help you track outstanding payments more efficiently.
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?? How to calculate: Accounts Receivable x Period Length ÷ Revenue
?Accounts Receivables Days tell us the average amount of days it takes for your clients to pay your invoices.
Accounts Payable (AP) Management:
?Negotiate Payment Terms: Negotiate payment terms with your suppliers that align with your cash flow cycle. Aim for terms that give you enough time to pay without incurring penalties but also maintain good relationships.
Prioritise Payments: Prioritise payments to suppliers based on their importance to your business operations. Ensure that critical suppliers are paid on time to avoid disruptions.
Take Advantage of Discounts: Take advantage of early payment discounts offered by suppliers whenever possible. This can help you save money and improve cash flow.
Monitor Cash Flow: Keep a close eye on your cash flow to ensure that you have sufficient funds available to meet your payment obligations. Forecasting cash flow can help you anticipate any potential cash shortages and take proactive measures to address them.
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?? How to calculate: Accounts Payable x Period Length ÷ Total Cost of Sales
?Accounts Payables Days tell us the average amount of days we take to pay suppliers, subcontractors etc
?By implementing these strategies and maintaining a balanced approach to managing AR and AP, you can improve cash flow, strengthen business relationships, and ensure the long-term financial stability of your construction company.
????Invoice financing/Credit Insurance
These are two helpful solutions to alleviate some of the pressure caused by late payments/clients going insolvent.?
By using invoice financing, you can obtain a cash advance based on the value of your outstanding invoices. It can help improve cash flow and ensure that you have the funds necessary to keep your operations running smoothly, especially when you know that the client is typically a late payer.
Another option is Construction Credit Insurance which is a safeguard against a specific client or across your whole client base against insolvency. If a client did go insolvent, this trade credit insurance will pay out a percentage of the outstanding amount owed (typically around 90% of the value).
???Tracking Gross Profit and Operating Profit Margins
?Following on from last week's Media Saint Sunday, we recommend businesses to focus on making jobs as profitable as they can be as often business owners can be drawn into how large the turnover is compared to how profitable the business is, for example, a 2 million turnover business with a 5% Operating profit margin can make the same profit as 500,000 business with a 20% Operating profit margin (60% cost of sales, 20% overheads)
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?? How to calculate:(Gross Profit ÷ Revenue) x 100
?? How to calculate: (Operating Profit ÷ Sales) x 100
?? Cashflow Forecasting
This can often be seen as an impossible mission but if it can provide some light down the tunnel then it is worth the investment (money or time!)
Using software like Float Forecasting will make your forecasting easier in the future but will take a learning curve to get used to the software and knowing what information you need to be seeing but if you invest time you will get the peace of mind you’re looking for.?
You can create scenarios based on winning that large project, taking on a new hire, hire purchase of a new van or when is the best time to pay off a large expenditure bill. This can be done on a spreadsheet but it can often be a case of “I don’t know where to start” - Software helps bridge this gap.