Three key financial business drivers work together to drive a company’s profitability and viability — revenue, cost, and cash. A successful company aligns all parts of its business around maximizing revenue and cash while simultaneously controlling cost.
This article discusses best practices for controlling cost and how the two major areas of a construction company — the office and the field — align to make it happen.
Key Factors for the Office
The office has five major factors tied to cost.
Pay on Time
It is important to view vendors as partners and pay them on time. If paid late, they could begin to remove discounts, increase costs, or even decide to stop selling to your company, which can drastically hinder profitability and success.
Reduce Risk
A contractor’s administrative team should also focus on reducing the risk of overpaying vendors by only paying what they are owed and when they are owed. Strong controls on cost and process can help achieve this objective.
Prevent Fraud
Having effective controls in place can provide checks and balances to ensure money is leaving the company correctly. Without proper controls, payment may be made to vendors for more than the value owed, or, in a worst-case scenario, for amounts not due at all. Controls help to better manage how cash leaves the company to maximize cash flow and increase the company’s value over time.
Add Profit & Value
Administrative departments seek ways to not only be a cost center, but also bring value and additional profit to the business. Proper planning and leveraging of cost controls will help add that value.
Manage Cash
Construction financial professionals know that cash is king. A company may be highly profitable, but if it doesn’t have enough cash, it can still face bankruptcy. Collecting billings is a major part of the cash flow cycle; however, controlling when cash goes out of the business in parallel with collecting accounts through a quality process is crucial.
Key Factors for the Field
As with the office, here are a few major cost control factors in the field.
Efficient Review & Approval Process
Where the office is focused on cash and controls, the field is focused on getting the work done. This focus drives a different goal for the cost control process; the field needs quality information in order to know how it is performing along with an efficient process that allows it to focus on completing the work rather than pushing paperwork. This is not to say the field does not care about controlling cost, but it does not want to be slowed down on a jobsite.
Spend Management
To some field personnel and project teams, “cost controls” sounds like policing — removing privileges like company credit cards, cutting budgets, and making jobs more difficult. However, this misconception is one reason companies should consider adopting spend management, which is proactive rather than reactive.
Field personnel and project teams should be empowered by the best tools available to get their work done, which includes the best tools for cost control and spend management. For instance, company purchasing cards can be tied to budgets and controlled in real time, along with efficient methods for project teams to complete approvals and make requests (addressed later).
Effective cost control also means properly categorizing and organizing cost items in the right buckets. This requires proper budgeting techniques (also addressed later).
Proper tools are essential for allowing field and project teams to manage spend, but a tool is only as effective as the process around it. Regarding processes, keep in mind that the best tools are only as good as how they are used.
Seven Keys to Drive Company Value
When aligned as a system, these seven elements work together to drive business value.
Budgeting
If something is not quantifiable and trackable, how can managers know whether the company is performing as expected? This concept applies directly to cost controls.
A well-run company has a budgeting process that establishes company goals and standards. Done well, this includes a corporate income statement, balance sheet, and cash flow statement that identify the responsible parties for each line of those statements. Direct visibility into who should be measuring and managing each part of the business allows cost approvals and controls to be tied directly to the person or team responsible for each particular part.
If there is no budget in place, then the best A/P approval and review process will only control spending with no target; this same concept carries to each construction project, as there is an original budget that the job is measured and managed against.
Once a budgeting process is in place for all levels of the business, from project to total company, it’s time to address how purchase orders help manage cost.
Purchase Orders
There are many different approaches to purchase orders; some companies don’t use them at all while others use them for every dollar spent. While each company should have a reason for its process, a balanced approach is key.
If a company does not use purchase orders at all, then spending can run rampant (i.e., you can only measure what you manage).
Having purchase order processes in place for large spends like jobsite materials or subcontracts align with managing cost and providing efficient approvals. However, if a purchase order is required for a $10 item, then the labor cost of creating that purchase order exceeds the cost of the item purchased.
Finding a balance between managing major costs with using a tool like a company spend card for smaller items can empower the field to focus on completing the work while also providing effective cost controls.
Once purchase orders are used for the right type of spend, next focus on the level of detail required for a purchase order. For example, if a purchase order for a large material order is detailed all the way to the smallest dollar items on the order, then that purchase order and related change orders may slow down the A/P payment process and cause vendors to be paid late.
Large dollar items should be detailed in the purchase order, but consumable types of expenses should have lump-sum line items to efficiently match and manage a purchase order for payment.
As such, the key to a healthy purchase order process is balance; too much or too little detail leads to lack of control or significant delays.
A/P Process
After the budgeting and purchase order processes are dialed in, the next steps are moving invoices through the company and paying vendors, which are great places to leverage technology. Many companies still rely on paper invoice approval processes or sending emails for approval. Either of these methods make it difficult to know what needs to be paid and what is awaiting approval.
Putting a paperless A/P approval system in place creates visibility and empowers the user to know where invoices are in the payment process. There are many available systems that can enable this process as either a stand-alone solution or one directly tied to the company’s accounting software.
For example, consider an invoice that is scanned and coded in the system. If it matches the purchase order, then it goes directly to payment when it is due. If the invoice does not match the purchase order, is not tied to a purchase order, or has another issue, then it is routed to the appropriate approver to validate, resolve, or mark for payment.
This type of system allows A/P to know where the invoices are in the approval process, empowers the field to approve invoices when time allows, and creates accountability for and insight into the invoice process. Such a system permits great control and expedites the approval process.
The final detail about the A/P process that is key to managing cash and spend is that invoices need to be put into the system quickly. The day after an invoice is received, it should be entered into the system to start the approval process. The focus feeds into the forecasting process as addressed in this article.
Once the A/P process is in place, it is time to think about the next steps.
Credit Service
For payments that should be made with a credit card service program, the right system and controls can add value to the company and empower the field to focus on building the projects.
This area of the cost control process is closely related to the steps previously discussed. By having a budget and layering in purchase orders for large spending, the company should have target budgets for items that do not require purchase orders. This is a great opportunity to use a credit card for spend at the corporate level or job level, as both have spend that can be measured via the budget to prevent overspend. This system allows employees with cards the flexibility to quickly obtain needed items rather than having to wait on a formal approval and order process.
Mike Tyson once said, “Everyone has a plan until they get punched in the face.” Similarly, construction projects are often filled with change and unexpected occurrences; a quick run to the hardware store is a great example of how field credit cards can help manage budget items on a job and prevent a slowdown.
With the right card program that provides insight on spend and approval when issues come up that can be tied to budgets, companies can be nimble to manage spend too small to require a more formal invoice and approval process.
Forecasting
Now let’s shift focus to how controlling spend and approval information can be used for forecasting. If you are only looking at historical financial information, then you are creating spend management that is reactive rather than proactive.
Just like with a budget, every company should have a job level monthly forecast of major jobs to predict expected billings and spend for each job. The purpose of this practice is to incorporate information into a rolling forecast in a balance sheet, income statement, or cash flow statement. Just as a company produces a financial packet every month that looks back, the packet should also include a forecast that looks forward.
Once job and financial forecasts are done on a monthly basis, the next step is to produce a rolling 13-week cash forecast. If A/P is being entered daily, then the company should know what will be paid each week for the next month. In addition, the company should know what has been billed and what the target collection for each bill is in the coming four weeks. Outside of the first four weeks, the rolling financial forecast provides a look at what is coming up to fill out the rest of the 13-week cash forecast.
With the cash forecast in place and a strong approval process for A/P payments, we move into focusing on cash.