Milking the cash cow

By ANNE GIBSON

The ocean cruiser, European car, corporate sports box, avid investment interest in horse racing, farm and opulent home - these are the trappings of the rich.

But when other people's money is used to buy the luxuries and the money runs out, toys like these can be hard to convert into cash. An Auckland academic reckons he can spot trouble with businesses like the collapsed Hartner empire long before it becomes apparent even to its managers.

Australian Dr Russell Kenley left Melbourne to become professor of construction at Unitec's faculty of architecture and design. His book Financing Construction - cash flows and cash farming is due out in Britain next month and here in October ( Taylor & Francis/Spon Press, distributed by Macmillan New Zealand, $101.95 on order at technical and university bookshops only).

The mistake many make is to delude themselves that the money they have been paid by a developer and which is owed to subcontractors is their money, Kenley writes.

"They think it's profit. It must be. It's in their bank!"

His use of the light-hearted term cash farming was coined by a New South Wales Royal Commission into productivity in the building industry in the early 1990s.

"The term cash farming is used to draw out the meaning implied - the deliberate manipulation to derive benefit of the fallow field of construction cash flow," Kenley writes.

"It is the milking of the cash cow. To stretch the analogy to breaking point, just as a real farmer can use and abuse the land, so can we see good and bad farm management practices at work in construction."

In chapter eight Cash farming: strategic management of organisational cash flow , Kenley compares what he calls the surprised firm - in a weak financial position and without full understanding of their cash flow position - with the aware firm which is in a strong, competitive position and knowledgeable about their cash flow position.

The difference between the two firms is simply the ability to recognise whose money is being used and when it has to be returned or paid out to other contractors. The builder is only the conduit for cash but what goes in must be paid out. The contractor is due only a percentage as the profit margin. Trouble starts when the builder tries to hold on to that cash.

Kenley criticises the low financial entry barriers allowing undercapitalised operators to enter and exit at will. This encourages a dangerous culture where working capital is generated from operations. Builders manipulate the payment system to achieve this, sometimes to good effect but sometimes not.

As a building firm grows and accumulates work, its funds available also grow. Less skilled and knowledgeable bosses can mistake the large amount of funds in their account for their own money, writes Kenley.

Building firms try to generate more profit by exploiting the cash flow stream for their own benefit. When trouble looms, the building firms blame developers.

"It is an axiom that when a firm fails, it was someone else's fault - usually the developer for late or non-payment. But this is unlikely to be the true cause as failure to pay part of one project should never send an experienced and profitable company to the wall," Kenley writes.

This starts a dangerous cycle and the building firms often try remedial action like reducing margins on jobs, making requests to a developer for early payments, under-bidding for building, delaying payments from 30 days up to 90, having a high staff turnover, becoming embroiled in costly disputes and taking legal action. Firms in this position often look great to an outsider, with apparent success through new work. Success like this is a prime indicator of imminent failure.

Delaying tactics help a little because they reverse the immediate cash flow crisis by bringing in further work and deferring outgoings. But regeneration is shortlived.

Any new surplus is only being generated through delaying payments, which eventually fall due. New projects beome harder to win. Suppliers put prices up because they had to wait for the previous payment. The quality of building work deteriorates, leading to further problems.

Eventually all these problems compound, usually quite quickly. Although the responsibility for the disaster does not rest with the client who was reluctant to pay disputed claims, the blame will be laid at the feet of all clients. They may be vilified because their reluctance to pay will be portrayed as responsible for destroying otherwise good businesses, Kenley writes.

All this explains how a firm owing only $8 million can cause $50 million worth of damage.

In uncovering the abuses of cash flow, Kenley points to academics' fears about biting the hand that feeds them.

"Contractors generally claim to be good cash managers and academics may not be eager to rock the boat as they are increasingly reliant on industry support or funding for their research," he writes.

Kenley is contactable at rkenley@unitec.ac.nz. He wants to apply for a Foundation for Research, Science and Technology grant to study cash farming here. The work could take three years and require a grant of $250,000 to $500,000.

Peter Degerholm, of the Building Subcontractors' Federation in Wellington, is writing a handbook for contractors managing cashflow under the new Construction Contracts Act, expected to become law this year. The handbook is due out later this year. It will be marketed through trade associations and the federation.

Unitec

Macmillan