Recently, I traveled to Idaho to meet with several customers over a two-day period. As a surety bond underwriter, I predominantly deal with small-to-medium sized public works and commercial contractors. My objectives, for each meeting, were to gain a better understanding of local market conditions, to see if a viable business plan was in place for each contractor, and to determine which clients would survive this vicious economic downturn. What became crystal clear, as a result of these meetings, was that financial decisions made during the economic boom will determine who survives this economic bust. Let me give you a hint: Paul Krugman, that channeler of John Maynard Keynes’ muddleheaded ideas, is dead wrong about savings.
Astute balance sheet management, in light of our current economic depression, has been the key to a construction company’s survival. Strong working capital, a strong equity base, and low debt are the hallmarks of a well-managed company — as revealed by its balance sheet. The most important component within working capital, in my opinion, is cash. Unlike what I was taught in grad school, cash is not trash; and my savvy clients know this. Cash is king and ever more so when construction revenues are dropping precipitously. Plain and simple, debts, expenses, and payables are settled in cash. Contractors who run out of cash, and have dismal prospects for picking up profitable construction contracts in today’s difficult economic environment, will fail.
So, do contractors view a buildup of strong cash balances as savings? Absolutely. My clients, who manage household finances in a conservative manner, typically do the same with their respective construction companies. When I see a contractor’s personal financial statement revealing low debt and enough cash (savings) to cover several years worth of living expenses, it is extremely likely his construction company has strong liquidity and little-to-no debt as well. Such companies, characteristically, have been profitable enough to accumulate significant cash holdings to the point where a large percentage of cash is not used for funding day-to-day operations. This "excess" cash is viewed as a rainy-day fund as seasoned contractors realize construction is risky and cyclical; and a strong cash position will help a contractor survive unforeseen problems including a down-cycle in construction.
To this end, during my recent Idaho trip, I posed this question to one of my most successful clients: "With a growing number of contractors struggling or outright failing today, what did you do differently than such competitors?" To me, his answer wasn’t rocket science; it was common sense and music to my ears:
From 2002 through 2007, nearly every contractor in the Treasure Valley was making good money in such a strong economy. Many of my competitors basically went crazy and bought extravagant homes, purchased motor homes, expensive cars, and even built ritzy office buildings for their companies. While they were borrowing and spending as if the boom would never end, my wife and I realized that our company was generating unusually high profits so we decided to save as much money as possible in our personal and corporate bank accounts. We knew this wouldn’t last forever and a day of reckoning would eventually arrive. Today, we are glad we saved as much as we did because our doors are still open and we have been able to keep our core group of employees. We’re in business for the long haul.
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And what is happening to the contractors who went "crazy" during the boom years? Well, they are dropping like flies. I am bearing personal witness to this. Heavy real estate and equipment debt are now proving to be financially crippling to numerous contractors. (Be assured that there was a construction equipment bubble which closely tracked the housing and commercial real estate bubbles.) With commercial and residential construction in the tank, competition for public works projects is tremendously intense. Profit margins, accordingly, are razor thin. Poorly capitalized contractors are belatedly recognizing cash has been king all along. Now it is too late for so many contractors to recover from prior financial mismanagement. When cash holdings eventually evaporate, thanks to a lack of savings, employees are terminated and frequently the businesses are shuttered shortly thereafter. It is a gut-wrenching process to watch. It is going to get worse as I foresee countless contractors failing during this coming winter.
There is a lesson here for Paul Krugman. His Keynesian-induced distaste for savings is completely misguided. The contractors who borrowed and spent, spent, spent (corporately and personally) are going out of business at an accelerating pace. Not a single contractor spent his way into prosperity. Those contractors who worked hard, spent wisely, and built up personal and corporate cash war chests are going to survive this depression. They will continue to provide good jobs for themselves and for those fortunate enough to work for such financially conservative business owners. Saving, not spending, is the key to financial survival let alone success.
If Paul Krugman was a businessman and adhered to his own academic beliefs, be assured his business would go broke.