In the fast-paced and capital-intensive world of the construction industry, effective treasury management plays a vital role in maintaining financial stability and increasing profitability.

By strategically structuring operating accounts and cash reserves, construction companies can drive additional yield, protect capital, and align their cash flow management with long-term goals.

The development of an investment policy statement tailored to your unique needs can also help provide a roadmap for efficient financial decision-making, risk control, and tax planning.

This article explores:

• What is treasury management?
• Operational versus strategic cash
• Treasury management considerations
• How to create an investment policy statement in six steps

What Is Treasury Management?

A treasury management function includes strategic management of your cash, cash flow, and excess liquidity. Having this process in place enables your business to take a long-term view that aids in strategic considerations about how you’re managing liquidity.

This may include the management of your:

• Cash and cash flow in alignment with your organization’s goals and tax planning
• Liquidity through a defined decision-making process
• Controls and transparent reporting to keep the implementation of your strategy on track

It’s important for construction companies to think about decision-making and governance processes. Through those processes, the data you collect allows you to create an investment policy statement to utilize through marketplace disruption.

Many large companies prioritize treasury management. This is one business approach that doesn’t discriminate based on size. For small to middle-market companies, you can implement similar best practices from those world-class organizations to manage your cash, cash flow, and excess liquidity.

Treasury Management in Construction

Treasury management plays a crucial role in the construction industry, where cash flow management is essential for project success. Construction companies often hold cash to fund ongoing projects, manage working capital, and mitigate unforeseen expenses.

Effective treasury management in construction involves building a strategy that maximizes yield while aligning with the business's needs and objectives.

This can be achieved by improving cash flow forecasting, implementing efficient payment and collection processes, and exploring investment options that offer competitive returns without compromising liquidity. By striking a balance between maximizing yield and maintaining sufficient cash reserves, construction companies can maintain financial stability and support their growth and expansion plans.

Operational Versus Strategic Cash

Effective cash flow management is essential for success in the construction industry, encompassing both operational and strategic considerations.

Operational

Operational cash refers to the funds required to support day-to-day business operations. It encompasses the cash needed for purchasing materials, paying subcontractors and suppliers, covering labor costs, and meeting overhead expenses.

The variability of cash flow is one significant aspect of operational cash. Construction projects often experience fluctuations in cash inflows and outflows due to factors like weather conditions, project timelines, and client payment schedules.

These variations can impact the availability and timing of cash, requiring construction companies to carefully forecast and manage their cash flow. By analyzing historical data, considering project timelines, and factoring in potential delays or disruptions, construction companies can develop fairly accurate cash flow forecasts.

Forecasting enables companies to anticipate cash needs during lean periods, maintain sufficient liquidity to meet ongoing operational requirements, and helps construction companies maintain financial stability.

Strategic

Strategic, long-term cash flow management is crucial in the construction industry to support growth and achieve business objectives. By carefully evaluating the timing and potential benefits, construction companies can make informed decisions to improve their long-term cash flow and drive sustainable growth.

Strategic cash flow involves planning and allocating cash resources to increase returns and create value over an extended period. Construction companies may allocate cash to invest in new equipment or technology, acquire land or properties for future development, or expand into new markets.

In some cases, treating cash as ownership cash now can be advantageous, allowing construction companies to pull cash out of the business and onto the owner's balance sheet when it makes sense. This approach provides flexibility and opportunities for personal wealth accumulation while the business remains financially stable and capable of pursuing growth opportunities.

Treasury Management Considerations

Construction companies can enhance their financial performance and effectively manage cash flow for growth and opportunity.

Some areas of consideration are around bank-related controls, financial ratios, other cash flow strategies.

Bank Related Controls, Bonding, and Covenants

Construction companies need to be aware of bank covenants, which are financial agreements with their lenders. Understanding covenants can help you maintain compliance and avoid potential penalties or restrictions.

Construction companies also need to be aware of bonding requirements, as bonding capacity plays a vital role in securing and completing projects.

Consider these factors:

• Marketable securities. These can impact bank covenants as they’re considered assets that can affect a company's liquidity and financial ratios.
• Underwriting assessments. Underwriters assess the discount of specific securities to determine their value and risk. Understanding the evaluation process can help improve bonding capacity.

Assess Your Ratios

Construction companies should evaluate key ratios like liquidity and profitability to help gauge their financial health and make informed decisions. By comparing their ratios to industry benchmarks, such as those provided by the Construction Financial Management Association (CFMA) and through the Moss Adams Financial Analysis Report, construction companies can identify where they are doing well and areas in need of improvement and implement strategies to enhance their financial performance.

The table below highlights several key ratios in the construction industry based on composite financial data published by the CFMA. While metrics will vary depending on the nature of a construction companies’ operations as well as the region in which the companies reside, the data can provide a general guideline on industry norms and key performance indicators.

The current ratio and number of days cash are generally key indicators of a construction company’s liquidity while the working capital turnover and revenue to equity often indicates the adequacy of a construction company’s capitalization and leverage at a particular revenue level.  

Key Ratios from CFMA

Alternative Strategies

You may want to explore alternative strategies such as using margin as a replacement for limit-on-close (LOC) orders.

LOC orders are commonly used to manage risk and control cash flow by setting a predetermined limit on the price at which a security can be bought or sold. However, in the construction industry, where access to capital is crucial, companies can consider utilizing margin accounts to tap into dry powder as needed.

Margin accounts provide the flexibility to borrow against existing securities, allowing construction companies to access additional funds without selling their holdings. This approach enables companies to maintain their investment positions while still having the ability to deploy capital when opportunities arise.

How to Create an Investment Policy Statement in 6 Steps

Following are six steps to begin building your treasury management function with the eventual implementation of a strategic investment policy statement (IPS)—all with the goal to mitigate financial risk and identify return on investment (ROI) opportunities.

The six steps:

• Evaluate your current exposure
• Review your historical cash needs
• Project your future cash needs
• Assess risk and impact to your outside partners
• Structure your treasury management function, accordingly
• Implement a strategic investment policy statement

1. Evaluate Your Current Exposure

To effectively manage cash and cash equivalent assets, it’s crucial to assess the types and locations of these assets, including cash, money markets, CDs, and treasuries, as well as the financial institutions where they are held. Additionally, understanding the maturity timing of these assets is essential for comprehensive cash management.

2. Review Your Historical Cash Needs

It’s valuable to analyze the cash flow patterns over the business cycle to identify short-term, intermediate, and long-term cash reserves. This understanding can inform future capital structuring decisions and provide insights into cash management strategies.

3. Project Your Future Cash Needs

To effectively manage cash flow, it’s crucial to assess cash needs for the next 12 months by considering historical data, industry conditions, and potential capital requirements. Additionally, evaluating tax regulations and opportunities can provide insights into potential adjustments to cash needs.

4. Assess Risk and Impact to Your Outside Partners

It’s crucial to assess the risk profile desired by ownership or other relevant parties and consider any interests of external parties in the chosen structure. Establishing a process to gather input from ownership and external stakeholders is important to understand their expectations and preferences.

This includes determining the shareholders' risk tolerance, aligning cash flow management with ownership goals, and considering any specific capital structure requirements from outside parties such as insurers or strategic partners.

5. Structure Your Treasury Management Function Accordingly

Businesses often structure their treasury management function by dividing it into an operating account and strategic reserves to increase yield, ROI, and capital protection. The operating account should be established at a well-capitalized bank, considering working capital needs, major expenditures, credit and lending requirements, and covenant agreements.

Strategic reserves, typically held in a brokerage account linked to the operating account, consist of various instruments like money market funds, CDs, bonds, etc., and offer specific safeguards to protect customer assets from being used for the brokerage firm's own operations.

6. Implement a Strategic Investment Policy Statement

The investment policy statement serves as the strategic plan for managing liquid capital, providing a customized framework to track, monitor, benchmark, and adapt to organizational strategies and market conditions. It segments assets based on time horizon, controls risk, streamlines cash flow management, incorporates tax planning, documents decision-making processes, and benchmarks progress.

Private companies often seek the assistance of an independent advisory team to develop an investment policy statement that aligns with their corporate tax planning and strategic goals, as they may lack in-house investment resources compared to larger public companies.

We’re Here to Help

For guidance on developing a treasury management function at your construction company, contact your Moss Adams professional.

Additional Resources

• Construction Practice
• Private Clients Practice