Although most economists and remodeling industry experts agree that we won’t return to the heyday of 2006 anytime soon, many companies are anticipating an uptick in volume over the next year.
But growth eats cash — for breakfast, lunch, and dinner. Easy credit has dried up and many companies depleted cash reserves just staying afloat — so most companies can only finance growth with cash on hand plus whatever they can produce from operations. In that scenario, two cash-flow measurements become critical: Cash Turnover Rate (CTR) and the Sustainable Growth Rate (SGR).
The Cash Turnover Rate measures the average number of days it takes company operations to produce cash. Cash is invested in putting materials, subcontractors, and labor on the jobs, which becomes Accounts Receivable, which turn into cash when the customers pay. Obviously, to be profitable, more cash must be available at the end of the cycle than was invested at the beginning.
To determine the number of days in your company’s cash-flow cycle, use the two primary accounts on the balance sheet where cash resides: accounts receivable (A/R, bills clients have not yet paid) and under-billings (UB, job costs paid but not yet billed). First, calculate Annualized Sales Volume (divide total sales to date by the current month, then multiply by 12). Then use these formulas to figure out how many days cash is tied up by A/R and UB:
Average Age of A/R = (A/R ÷ Annualized Sales Volume) x 365
Average Age of UB = (UB ÷ Annualized Sales Volume) x 365
For example, if at the end of May your sales volume was $500,000, your annualized sales volume would be $1,200,000 (see table).
Then, if A/R at the end of May was $75,000, the average age of A/R would be 22.8 days ([$75,000 ÷ $1,200,000] x 365). And, based on a balance of $125,000 in under-billings at the end of May, the average age of under-billings would be 38 days ([$125,000 ÷ $1,200,000] x 365).
The total cash conversion period is the sum of the two; in our example, this means it takes an average of about 61 days for cash to move through the company. The Cash Turnover Rate — the number of times that cash moves from work to A/R then back into cash — is almost exactly 6 per year (365 ÷ 61).
Once we know the cash turnover rate, we can use the following formula to determine the Sustainable Growth Rate — the amount of work the company can handle on cash flow alone:
SGR = CTR x (Cash + A/R + UB)
Continuing with our end-of-May example, if our company had $50,000 in cash, $75,000 in A/R, $125,000 in under-billings, and a Cash Turnover Rate of 6, the maximum amount of work the company could do annually without resorting to outside borrowing is about $1.2 million ($250,000 x 6).
Before you jump into the recovery with both feet, test the waters to be sure your company can fund its own growth.
—Judith Miller is a Seattle–based remodeling business consultant and trainer specializing in accounting, finance, and computerization. Visit her at www.remodelingmag.com or at http://remodelservices.wordpress.com.