Cash flow and emotions are funny things. There is no better feeling than being cash rich on Saturday night. The feelings of money and success engulf us at a very young age. 

Cash flow and emotions are funny things. There is no better feeling than being cash rich on Saturday night. The feelings of money and success engulf us at a very young age. Whether it is an allowance we received as youth, payment for a paper route or just Dad being gracious and giving us a few bucks, money was-and still is-a good thing. A little money in our pocket offered options for the movies, a candy bar, dates, and all the other fun stuff. Money may not bring happiness, but poverty isn’t a substitute for finding happiness.

So it is hard for some business owners to understand that how much money you have in the bank is not necessarily a good measurement of your current financial success. You can have cash in the bank and be going broke or you can have no money in the bank but profits are growing and the cash will follow.

Yearly cash flow cycles are a good explanation of this. In the spring, you may find cash the tightest as you gear up and have to spend more money on hiring, material purchases and other related mobilization costs. As you wind down in fall, cash flow can improve as you collect money from summer jobs and move into the slower fall season. In the spring, profit is up but cash is down and vice versa in the fall.

Moving from residential to commercial work can also cause contractors cash flow issues. Many residential contractors take a deposit before they begin the job and collect the remaining balance upon completion. If billed and managed correctly, you may actually have a positive cash flow, as you are working on the customer’s money. Moving into commercial work where it takes from 30 to 90 days to get paid means you now need 30 to 90 days of cash equal to your sales. A contractor doing $100,000 a month in sales who suddenly shifted to 50 percent commercial work would need $100,000 in cash to fund 60 days of receivables

Purchasing Equipment

Contractors also can misunderstand the tax impact of taking the 100 percent depreciation on equipment. Many contractors will sit down with their accountant at year end and find that they owe taxes. The accountant will ask them if they need to buy any equipment because doing so will reduce their taxes. It is important for the contractor to understand that this merely changes the cash flow timing of the taxes and may not necessarily avoid them.

Suppose a contractor buys $60,000 worth of vehicles to avoid taxes and borrows the money to make payments on the equipment. Suppose equipment payments are $1,500 a month. The problem is that this $1,500 is after taxes. By taking all the depreciation when the equipment was purchased, there is nothing left to write off, but the contractor still has to make payments. A $1,500 payment now requires $2,000 a month or more in profits as the money is after-tax dollars. Of course, the contractor can buy more equipment but now the pyramid builds and several years of this can have a contractor making thousands of dollars in equipment payments. Suddenly, the market slows and the contractor has huge after-tax monthly payments with no need for the vehicles. Buying vehicles merely to avoid taxes is a dangerous practice.

Dividend Draws

Another area where contractors can unknowingly impact cash flow is through dividend draws. Many contractors have chosen to use either an LLC trading as a Sub Chapter S or a Sub Chapter S as corporate structure. Under this structure, they can draw part of their salary as a dividend and not a paycheck, thereby avoiding FICA, unemployment, workers’ comp and other related payroll taxes. Sub Chapter S draws are not posted on the monthly profit and loss statements, as they are only a balance sheet transaction. Draws are taken out of the company equity and paid directly to the owner. Since owner draws are not listed on the profit and loss statement, contractors can mistakenly draw too much out of the company. To make matters worse, their accountants frequently post personal expenses or tax payments as a dividend draw. Many contractors are not that familiar with balance sheets and quickly get into a cash flow bind when taking draws. Consult your accountant and make sure you clearly understand how draws impact cash flow and whether the company can afford them.

Don’t be surprised if your bank tries to downsize or pull your line of credit. Credit is much tighter and bank guidelines are much more stringent. Pulling your line may not have anything to do with your own credit or ability to pay the loan. Your bank may simply have too much of that type of credit, has shifted ownership or their internal systems have changed. Lines of credit are not designed for use as working capital. Most banks are looking for lines of credit to be paid off for at least 30 days during the year. If not, they see the lines of credit as capital loans and not lines of credit. Another trend is for banks to charge a fee for your line of credit even if you are not using it.

Some contractors tend to look at a profit and loss statement as a checkbook. Unlike checkbooks, profit and loss statements do not measure how much money you have in the bank. You have to refer to you balance sheet to understand cash flow. Just because your profit and loss statement shows you made money does not mean that money is actually in your bank account.