The Deadliest Sin in Business
When I opened my construction company in 2003, I was awestruck by the lifestyles of other contractors. Every year, Ford came out with a new pick-up and my competition couldn’t lease one fast enough. The buying binge didn’t end there. In tow was usually a double trailer complete with Jet Ski’s. At home, they had closets full of new suits and few pairs of goat skin Lucchese boots in black, tan and cordovan. These were guys who had only been in business for 18 months and by the measure of cool toys, these boys were killing it! Life-experience should tell every entrepreneur that business, like life, just isn’t that easy. Of these guys, 90% were out of business within two years and the other ten percent were gone within five.
A mentor once told me; “there’s only one sin that your business can’t be guilty of and that’s the sin of running out of money.” 100% of these guys were running their business on a “Cash Basis.” They took a down-payment for a job that was often twenty or twenty five percent of the project. As a result they initially had plenty of cash on hand. Being financially literate, as David Thomas Roberts details in his book “Unemployable!", is knowing what your true cash position is every day. You may not be able to predict what the economy will do two years from now, but as it relates to your business, you should know your cash position at every turn.
At year two of my business, I moved from a cash basis to an accrual basis. Under a cash basis, you recognize revenue when cash comes in but you don’t record debits until they’re paid. On a cash basis, you end up with a false sense of reality. Under an accrual basis you recognize revenue when you invoice the client. At the same time, you also book offsetting invoices from sub-contractors and suppliers. Think of it like paying with a credit card instead of cash. You may have $2,000 in your pocket. If you make a $1,500 purchase with a credit card, you still have $2,000 in your pocket, but do you really? That $1,500 purchase means you’re going to have a bill that will come due in 30 days leaving you with only $500.
Going into 2009 I had contracts on twelve projects to be worked over the next year. My goal was to find another eight for a total of twenty that year. The crash in October, 2008 set the stage for a stagnant economy in 2009. Of the twelve projects that I had under contract, four of them went away, and I only landed three more. Because we were on an accrual basis, we were able to navigate through a very tough year. While 2009 was a disaster for our industry and forced thousands of contractors into bankruptcy, we still had the capital to diversify into a service business so we were less reliant on new construction. We wouldn't have survived, let alone expanded, in that kind of business environment if we had still been on a cash basis.
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