Dispatch #76 - Too Much Cash?
If your construction firm is sitting on a surplus of cash right now, it’s not alone. So, what should you do with it?
First order of business: how much is “too much” cash?
A rule of thumb for specialty trade contractors: 10% of annual revenue. For example, a $10M contractor would want $1M of cash on hand, so anything above that might be considered surplus.
Maybe set aside an extra 10-25% given the uncertainty of the current COVID-19 pandemic economic environment.
Other factors to consider:
For a specialty trade contractor, your line of credit capacity should also be about 10% of annual revenue. If your company doesn’t have access to that much revolving credit, keep more cash on hand.
Exclude PPP loan funds from your surplus cash calculation until they are forgiven.
This assumes the company’s basic balance ratios are healthy (working capital, current ratio, debt to equity, and return on equity). And that they’ll remain healthy after redeploying the cash.
Now that you know how much surplus cash your company has on hand, what should you do with it?
In this low-interest rate environment, paying down debt is a solid guaranteed return on investment, so that’s one option. Or pay cash for your next truck or piece of construction equipment.
You can invest in growth, which will reduce profits in the short-term, but should increase them in the long-term. But don’t use surplus cash to fund losses i.e. don’t hire a sales rep, hire a project manager, and upgrade your accounting software all at once if together they’ll push your company into the red.
Or you can take it out of the business and invest it elsewhere: into your retirement savings, your lifestyle, charity, buying real estate, or buying another business.
Excess cash is too exposed to the risks of this volatile industry, so above all, don’t let it sit idle in your company. Do something with it.
Need help with this or other financial matters faced by construction contractors? Let’s talk!
David Stern CFO makes every effort to provide useful and accurate information. This content, however, is not intended as a substitute for specific business-related financial advice. We disclaim all warranties and liabilities from its use.