Working Capital Requirements for Construction Companies
Whether you are just starting out in your new business or are a seasoned company the key to any successful business begins with working capital. The kind of capital that is used to run the business and make it work.
When you are going through the process of getting your contractor’s license, in the state of California, in the documents that are filled out you are asked to give a summary of your current assets and your current liabilities. This is the basic equation of what is known as working capital. The state asks this as it requires that there be a measurable amount of a cash cushion for your new business venture.
Current Assets — Current Liabilities = Working Capital.
I was given a bit of good advice once that it is a good practice to manage risk and not put any more than half of all project costs for the company into one job. This can become a precarious position otherwise. This small working capital risk assessment to your business will help make sure that your construction company should be able to deliver on your contracts without having the pressures and financial stresses and risks that might come from too much work and not enough money to do the work.
As you enter into the building business it’s a good idea to go to your material suppliers and request for lines of credit. This allows you, the builder, a bit of a financial cushion above and beyond your cash reserves. In addition, this process helps build the credit rating of the business for the long term. This will also allow you to increase your working capital leverage options. There are some creditors who might reduce working capital in some instances as they will consider certain assets to be non-liquid. As much as a home is an asset building investment it was not considered a liquid asset since you’re living in it. Sometimes there are contractor’s who use the equity in their homes as a line of credit for their new business. Or perhaps as a means of emergency if a project went sideways and losses its profit.
Other assets such as inventory, past due receipts that are also deemed non-liquid based assets are issues that creditors and bond companies call “adjusted working capital”. These can have adverse affects to your possible credit limits and bonding capacity creating higher rates for some builders in some cases.
One of your businesses most important financial indicators is working capital. It is the best business practice to continue to monitor your business and find ways to increase your working capital as a part of your financial strategy. Keep a keen eye and learn to understand how there are certain projects, or transactions, that will and will not affect your working capital. This helps you to better understand the company’s financial goals and business strategies. For every project you complete profitably you are increasing your company’s working capital.
There are various types of ways of looking at working capital and your businesses liquidity ratios.
- The current ratio, sometimes called the working capital ratio, is the result of dividing all current assets by all current liabilities.
- The quick ratio, sometimes referred to as the acid-test ratio. While the current ratio takes into account all current assets, the quick ratio looks only at cash, cash equivalents, short-term investments and accounts receivables — all divided by current liabilities. It measures the ability to pay for current liabilities without having to convert assets to cash.
- The debt-to-equity ratio is a leverage ratio that measures how much growth a company has financed through debt. To find this ratio, divide your total liabilities by the equity on your balance sheet:
- The working capital turnover ratio is found by dividing construction sales by your working capital. Because working capital is current assets minus current liabilities, this ratio reflects how much company value that is available and freed up for project operations.
- Lastly is the equity turnover ratio. Like the working capital turnover ratio, the equity turnover ratio looks at how efficiently a business is using its value, in this case, equity, to drive construction revenue. It’s calculated by dividing sales by total equity.
From small sole proprietors on through large contractors in the construction industry all are constantly looking to expand their businesses, maintain and launch new projects. All of which requires adequate working capital. These funds that are used for day to day, or purchasing new tools, equipment and hiring people for temporary jobs. Financing the business for construction companies can be difficult when compared to other businesses as there are not that many funding options available in the marketplace. Many times banks can be hesitant to offer loans for the new projects whether it is small or big. So, this leaves many construction companies to turn to alternative financing options.
ALTERNATIVE FINANCING
Acquiring traditional bank loans a company or business entity needs a high credit score and not have ever filed bankruptcy. The bank usually will require the business to be established in the industry for at least three to five years and be able to show a healthy profit and loss statement to approve the loan. The fastest and most efficient way to access working capital for construction companies is alternative financing.
It’s safe to say that not all businesses will qualify for traditional bank loans. There are a many lenders on the market that are into small business funding which will speed up the process of availing working capital for construction companies. These non-bank lenders advance loans at a competitive fee and interest rate, and the terms can negotiate to suit the company’s financial requirements. The application for these loans can be made online and needs very less documentation which generally includes at least six months bank statements and four months of card sales statement to initiate the process.
Collateral loans are an asset-based lending avenue which is another way to acquire working capital. The business can borrow funds on the equipment owned or lease new equipment. Funds can be received quickly when you have collateral to pledge with the lender. The funds from a collateral loan can be transacted rather quickly and is an ideal option in financial crunches and emergency situations.
One of the best ways to access working capital is known a factoring. This process of is one of the most popular and oldest types of alternative financing that is available. A small business can find funds by calculating the company’s bills receivables which are factored into the lender’s options at a discounted price. This can be a key means of using your businesses capital flow to your best advantage.
Douglas J Boggs - author of the acclaimed “Quantum of Justice - The Fraud of Foreclosure and the Illegal Securitization of Notes by Wall Street”
Real Estate Investor/Developer/Construction Consultant
