Driving Financial Clarity in Real Estate and Construction: Cash Flow, Overhead and Smarter Growth

“I can actually have very profitable jobs and have an unprofitable business because I’m not factoring in my overhead.” — Daniel Roccanti, CPA

In this episode, Daniel Roccanti, CPA at James Moore, breaks down why profitable projects don’t always mean a healthy business. From cash flow timing to overhead allocation, tax planning and the warning signs of growing too fast, Roccanti shares the financial strategies every real estate and construction operator needs to know.

Resources

• James Moore Real Estate Industry Page
• Real Estate Industry Update Playlist
• Watch This Episode: Driving Financial Clarity in Real Estate and Construction

Full Transcript

[00:01] Faith: Hi everyone and welcome to the JMCO channel. I’m excited for today’s conversation. I’m here with Daniel Roccanti. I hopefully got that last name right. We went over it in the pre-show.

[00:14] Daniel Roccanti: You know, it’s a pretty Italian last name, but I’m mostly American, so however you pronounce it, I’m usually good with it.

[00:23] Faith: And he is a CPA at James Moore who specializes in working with leaders in real estate and the construction industries. And today’s topic, we’re talking about driving financial clarity in real estate and construction. And Daniel, it’s so great to have you here. I’m excited to have a conversation with you and I think we should just jump right into it because I think there’s a lot of good questions in here to cover.

[00:46] Daniel Roccanti: Let’s go. I’m ready.

[00:48] Faith: All right. Awesome. So the first question is, why do so many profitable projects still result in struggling businesses?

[00:55] Daniel Roccanti: Yeah. This is a big issue with a lot of our industry today and it’s because most people don’t realize that profits and cash don’t necessarily always translate into what a healthy business is. They’re not the same thing. Most owners are looking at the cash and not really looking at what profits are. Cash can get squeezed with timing of payroll, materials, collections. If you’re in construction and development, retainage, lender draws, there’s going to be a lot of things going on. And so really it’s making sure that you understand that cash and profits are different.

[01:35] Daniel Roccanti: And then you’re going to throw in overhead. All right? Overhead is one of the biggest issues because that’s really at the project level and then you have overhead at the more administrative level here. And so if you’re not counting what your overhead is, you don’t really actually know if your business is a healthy business or you just have profitable jobs that you’re then overhead basically eats up all the profits on.

[01:59] Faith: Wow, I like that. And then I’m actually interested to see how you answer this one. What’s the difference between job level profitability and overall business profitability?

[02:10] Daniel Roccanti: This kind of just goes right off what I said on my last question here. So when you’re looking at your business here, you’re going to have the job level. So if you’re a construction person, it’s your actual construction job. If you’re in development, your development job. And so you’re looking at, all right, what’s my actual profit on this specific job? Did we get this right? Did we price it right? Did we get our labor right? Did we get our material right? Everything that is very job specific.

[02:37] Daniel Roccanti: But then we have to think of all right, what are all these other expenses it takes to run a company. The staff to do the accounting and the supervising and all the stuff that we have just running a business. Your general and administrative expenses. This is where the biggest difference is with overall business profitability. I can actually have very profitable jobs and have an unprofitable business because I’m not factoring in my overhead. And so then you actually look like from a business perspective I have poor results. And so really you got to make sure that you understand what both of those are and it’s like, does this project work? And can now my overhead, when I add my overhead, does it still work once my overhead is added to it?

[03:13] Faith: Right. I like that. So where do you see owners confusing growth with financial strength?

[03:20] Daniel Roccanti: I think the biggest confusion here comes probably with treating revenue growth or bigger projects as proof that a business is stronger. Just because revenue goes up does not mean your business is better or because I’m getting into bigger projects doesn’t mean I’m getting better. You can actually have growth and be a weaker company because it’s more capital, more overhead, thinner margins. This is a big one I see. Like, hey, I doubled my revenue, but now my profits are split in half.

[04:02] Daniel Roccanti: So all you did was double your workload for the same amount of profits. And so when that happens, your cash is worse, stress goes up. Now you’re basically looking at maybe potentially debt. So you really want to make sure that real strength actually comes from growth when it comes with stable margins, clean billing, controlled overhead. So you really got to understand that strength isn’t necessarily just am I increasing my revenue line, am I increasing my projects. It’s really about controlled growth, stable growth, so that way when I grow, my profit margins stay the same and then I’m having true growth and that just looks good on my revenue line.

[04:49] Faith: Right. What’s the most common cash flow surprise you see in real estate or construction firms?

[04:55] Daniel Roccanti: This would probably be, I see this a lot where it’s like, hey, my P&L looks fine, but cash isn’t there. Or, why does it look like I’m making money? Why am I getting profits but I have no cash? And a lot of this is timing. When you’re dealing with real estate, cash is just a timing difference. You got retainage, you got underbilling, you got AR, in real estate you have capex, you got turnover, vacancies, your debt service is hitting. So you have a lot of these different things going on. And so you got to realize that my profits and my timing is a little different when I’m thinking of just cash here.

[05:36] Daniel Roccanti: So you really got to understand where my cash is at all times. And then don’t always forget about those non-job expenses like tax payments. This is a big one that surprises people. Like, hey, I made money, now I got to pay this huge tax bill and I didn’t have it. And it’s like, all right, that’s something you got to think about too. The company made money even though you’re like, I don’t feel like I have cash. And I see this sometimes with some of our clients. That’s why projections and planning is very important because you really want to make sure you understand. I don’t want to be surprised with a huge tax bill come around April. I’d rather have enough time to realize what that is and then maybe some good planning can actually take care of it.

[06:22] Faith: Have you ever had clients come to you that have been blindsided, that are kind of like, don’t know what to do?

[06:28] Daniel Roccanti: I would say the majority of clients, especially new clients, come to us and that’s how they are. This is a big issue with them. They’re surprised and a lot of this comes into there’s just no planning, there’s no projections. They’re just getting a tax return done, compliance, and they’re just looking at basically the cash of a company and they don’t truly understand what profitability looks like, how it works with taxable income, and then how that all relates back to actual cash in your account.

[07:05] Faith: When should tax strategy start influencing business decisions instead of just cleaning them up, which is kind of what we just talked about a little?

[07:12] Daniel Roccanti: This can be a lot of things. It depends on how new you are in your business. A lot of people when they’re first starting out their business, I’m like, look, the most important thing is get profitable. All the strategy in the world doesn’t matter if you can’t make a dollar.

[07:32] Daniel Roccanti: But once you do start becoming profitable, really these tax strategies should start influencing your decisions before you actually ever commit to it. It should all be proactive, not retroactive. There’s very limited things you can do. So before you’re going to take on this big project, before you’re going to buy this equipment, before you’re going to change entity structuring, before you’re going to take on another partner or investor, or in real estate before you sell the property, all these things, that’s when you need the tax strategy. And so the best tax strategy is not the end of the year, not after the year, it’s beginning of the year, mid-year as you’re doing that. And sometimes the best planning is even years before it even happens, especially for really big stuff like if I’m going to sell my company or something like that. I mean, I always tell all my owners, if you’re thinking about selling your company, especially like a construction company, I mean, we need to be three to five years out in front of that.

[08:30] Faith: Wow. What’s the biggest mistake owners make when scaling?

[08:36] Daniel Roccanti: This kind of goes back to the revenue and I would say it’s scaling the revenue before you start scaling your systems. Owners a lot of times, they really want to grow their business so they take on more work. They add people, they buy equipment, and they forget about all the extra things. They forget about the back office. They forget to do the job costing. They forget about AR follow-up and forecasting, financial reporting. All that stuff is on the back because I’m worried about revenue.

[09:09] Daniel Roccanti: Revenue is flashy. It’s what everyone wants to see. But really if you’re making a huge mistake if you’re not thinking about scaling and actually going to create a bigger problem for you. Because you increased your revenue but you don’t have the systems to actually service it. And then you’re going to go out and actually have lower profit margins, bad reviews. I can’t tell you how many times going out there and doing a bad job on something will lead to no work in the future. You really need to be building your systems so that your margins are repeatable, your cash flow, your controls are disciplined. If you can get your systems, then you can scale your revenue and you won’t have to deal with the problems that come with growing too fast.

[09:54] Faith: Right. And I feel like the next one is like a piece of wise information you’re giving away for free. But what is one financial metric every operator should consistently track?

[10:05] Daniel Roccanti: So I’ll probably, I don’t know, some operators might agree with me here, but there’s always the metrics everyone thinks about like what’s my rate of return and everything like that. In this situation when you’re dealing with operators, I would say the one that actually matters the most is your cash runway. And this is how many weeks or months you have to operate using the cash on hand basically until it runs out.

[10:38] Daniel Roccanti: And so what this does is it gives you a warning sign of what your company is. I have three months of cash on my hand where if collections slow down and I don’t get what I have, I can still pay my bills before it’s a red flag. And so you can have a large ROI and then run out of cash. That actually happens all the time because of timing.

[10:57] Daniel Roccanti: So you really want to understand this. And it’s even better if you pair this with a 13-week forecast. So that gives you kind of that three months. That three months is kind of key there. You always want to know, hey, do I have enough cash to pay the next three months? If you’re really just always going month to month on your cash flow, worst case, it’s going to be a lot of stress on you. You’re not going to sleep well and you don’t want to deal with that. But more importantly, you understand truly when something goes wrong because that’s just business. Business, something happens. And now I know three months in advance that I’m going to have a cash problem. I have three months to deal with that instead of I have a cash problem today and I have no time to pivot and make a better decision.

[11:47] Faith: I love that. What’s one proactive move a real estate or construction owner should make this year?

[11:55] Daniel Roccanti: I’m actually going to go right off that last question here. Implement the 13-week cash flow forecast. We just talked about this, the cash runway and everything. If you really care about your cash, implement it. And then actually review it. I can’t tell you how many people will implement it then never look at it. I know it sounds simple but it really does change a lot.

[12:14] Daniel Roccanti: You just see everything before it happens. Cash dips, purchases are coming up, when I’m doing my owner draws, surprise tax payments, what if I got to negotiate with the lender. All that, it gives you actual strength in your numbers and in your business and so there’s no panicking. We want less surprises. So 13-week cash forecast, those surprises disappear if you’re actually doing it and reviewing it.

[12:41] Faith: Absolutely. And I think that kind of goes back to what we said before. I feel like you’ve had clients come and you’ve been like, no, you should know this. This will save you. This will help you sleep at night.

[12:52] Daniel Roccanti: Absolutely.

[12:54] Faith: How should owners think about overhead allocation across multiple projects?

[12:59] Daniel Roccanti: So allocation, this is one where we talked about a little bit before, but overhead allocation should help you price your contracts and not hide a problem. This is truly you understanding what the true cost to deliver a job is. Including the burden of running the company. And so you got to think here. I need to have a consistent method. What is my common direct labor hours, direct labor cost, direct cost in general? And how’s that compared to my applied overhead versus my actual overhead?

[13:37] Daniel Roccanti: The biggest trap that a lot of companies use here is they say, all right, I’m using overhead allocation to actually make my numbers look better. Instead of using it to answer the real question. Don’t manipulate the numbers to get to what you want. You should use the numbers to manipulate your actions.

[13:56] Daniel Roccanti: If I’m just, this is confirmation bias at its truest form here. Hey, I need this project to have 20% margins. So now I manipulate my overhead allocation to get myself 20% margins. What you should have done is said, all right, based on the overhead allocation, the actual one, I have 10% margins. I need to have 20% margins. What can I have done better so that now my next job will have 20% margins? That’s what you really need to be doing when it comes to this and when you really think about your overhead allocation.

[14:30] Faith: I like that. And actually I’m interested in this answer for the next question. What early warning signs tell you a company is growing too fast?

[14:40] Daniel Roccanti: It always goes back to cash is king. But it’s cash and operations, and how they kind of mesh up together. So like if your AR is always stretching, like that 90-day AR is turning into 150-day AR, you’re too busy to follow up on AR. These are all signs you’re growing too fast. You’re not doing the most key part of owning a business and that’s bringing revenue in, right? You’re not going to collections.

[15:13] Daniel Roccanti: You’ll see this also with relying more on debt like lines of credit or things. Even though revenue could be up, right? My revenue is high but I’m still not collecting. Gross margins are down. We talked about this already. You should be making sure you understand what your true gross margins are. If every project, it could be a one-time thing, but if I start seeing all of my gross margins start drifting downward, that’s a sign I’m growing too fast.

[15:33] Daniel Roccanti: And then books, like delayed books, not clean numbers. I mean, when I see a business go from, oh man, I got my books always, information, three, two weeks after the end of the month, I got good numbers, to I never have the time, I never have books. That’s usually a sign to me that something’s wrong. Something’s growing too fast. Too much of the company is on your shoulders. You really need to look at it here and just understand that this goes back to scaling your systems. You’re scaling work, you’re not scaling your systems. So your company’s growing too fast. You actually might need to slow down. Slowing down might be the correct choice here and actually give you a more healthy company.

[16:21] Faith: Oh, I love that. How do financing structures impact long-term profitability?

[16:28] Daniel Roccanti: Well, I think a lot of times people think financing is just like, I got to get this deal done. Especially in real estate, right? Like, I got a deal. I need to get financing. I need to get this deal done. But the reality is, you’re buying real estate. This is a long-term asset. And so how you finance this deal can completely change how profitable this deal is or it can make it not even profitable at all.

[16:59] Daniel Roccanti: And so a lot of times when they’re buying real estate, especially now in today’s environment, debt is just harder to come by, the traditional debt. So you have to layer debt, you have to do a lot of things to make deals happen. So if you try to do a bridge loan, if you try to do all these things, I mean, you’re basically taking a short-term structure and creating pressure on this long-term asset.

[17:23] Daniel Roccanti: And so favorable rates, things like that, these are things that can turn a good deal into a bad deal if interest rates change. And so when you really are looking at financing, you really need to understand that it’s part of my long-term profitability. And then if you have to use something short-term, you need to really model what is a good case and a bad case. What if I do a bridge loan that’s five years, which is still a pretty good bridge loan, some less than that. And then in five years the market’s not better. It’s worse. It’s a higher interest rate. This happens. It’s happening right now because a lot of people did this pre-pandemic and now we have all these bridge loans coming up and people are having to refinance at a much higher rate or maybe not even getting as much debt to loan value.

[18:14] Daniel Roccanti: And so this can really make your deals go upside down. So you just got to realize that when you’re doing financing, you just got to really understand how that long-term impact will have on your profitability of your projects.

[18:30] Faith: Oh, I love that. And I’m sure people made a lot of rash decisions and mistakes, and now five years later, we really have to deal with it and look at things now.

[18:45] Daniel Roccanti: Yeah. And these are real life, with my clients and things like that. These are real problems they have. I have several clients who have a really good debt package that they got pre-pandemic or something. When those interest rates were really low, maybe they did interest only or it was something where you’re not paying that much principal down.

[19:10] Daniel Roccanti: Now they’re coming back and they’re having to refinance. They’re not getting anywhere close to those kind of deals. Higher interest rates. The banks are really being risk-averse right now. They might not even be able to get a full traditional one. They might have to bring some mezzanine debt in there. And now they’re basically having all this real estate and they didn’t plan for it because real estate has been excellent for the last 10-plus years. Ever since the ’08 crash, it kind of bottomed out in 2012. Real estate’s been up ever since then. We’ve never had to think about this for a long time. And now we do. And so now their ROIs are actually lower and this is a big problem. And it’s tough to tell an investor, hey, we were living good five years ago, but now we’re not getting the same kind of returns that we were.

[20:02] Faith: Absolutely. So we’re just going to do one or two more questions. But I think this has been such a great conversation, very informative. You’ve actually taught me a lot. So I love it. I love talking to you. Okay. So how should owners assess whether to take on a large new project?

[20:20] Daniel Roccanti: I would say it comes down to three parts. So we got margins, we got cash, and we got capacity. So margins, this is, what’s my profits? And what is my real profits? Going back to the previous questions here. Not just profit at the job level. What about my overhead? What’s my risk? What’s my contingencies? What is it going to be in five, ten years when I got to refinance my debt? So really understand when you’re taking on a new project, understand what your margins are and understand what your risk of what your margins could be when there’s a big event like a refinance.

[20:58] Daniel Roccanti: Next is cash. This really comes down to, can you actually fund this deal? Because a lot of deals, the revenue comes in later. So I have to fund all the project before I even get paid. And then if you’re in construction and development, you have to deal with billing terms, you have to deal with retainage, things like that. Really understand what your cash is so that you can take on this large project.

[21:31] Daniel Roccanti: Last is capacity. This goes back to systems. If I take on this big job, do I actually have the resources to do it? Or am I getting a little bit in over my head here and taking on a project that’s too big? I got to make sure I have the right systems, the right people in place because nothing’s worse than taking on a job and failing. That’s going to prevent you from getting other jobs in the future. You want to make sure you take on a job you overdeliver on, and that’ll just lead you to even larger projects in the future.

[22:00] Faith: Yeah. Oh, I love that answer. What separates financially disciplined operators from those constantly under pressure?

[22:10] Daniel Roccanti: This kind of just goes back to almost like a summary of everything I said. A good operator is disciplined. It just runs on rhythm, right? It’s these weekly cash flows. It’s these clean monthly closes. It’s actually job costing and looking at it. Not just something that your CPA needs at the end of the year to get your tax return done. It’s the change order discipline. It’s all this stuff. Understanding what my overhead is and how it deals when I insert it into my profits.

[22:52] Daniel Roccanti: You’re not just kind of on a whim like hoping everything goes well. Am I keeping good reserves? The 13-week cash flow, everything here. These are the best operators. When I see issues is when I see operators coming under pressure. And they all have the same story. I can see this even with my own clients. Hey, I need you to get your numbers. They’re running late. I’ll get it to you in a few weeks. They make decisions without actual good financial numbers in front of them. They’re just making a decision based on my knowledge, what I think, not what I know.

[23:27] Daniel Roccanti: And then when you’re talking about cash, they just never know. Do I have enough cash? Do I have enough cash? And it just really comes down to trying to make sure the best operators have the most information in front of them. They’re not surprised. They’re disciplined. They know how to run their systems and they don’t look like they’re just running around like chickens without their heads on.

[23:47] Faith: Yeah. Oh, absolutely. No, I mean this has been such a great conversation, Daniel. You’ve taught me a lot and I think this is such an exciting kickoff for your episode one of our lives and we are going to have Daniel back April 9th where we’re going to talk about turning projects into profitable businesses. So I’m excited to have another conversation with you and I know this is a really busy time of year for you.

[24:12] Daniel Roccanti: It is, but it’s also the time that everyone thinks about this the most. And so I always tell everyone else that’s a CPA, my staff, wherever, I’m like, look, this is like our Super Bowl. Everyone’s paying attention right now. I know you’re busy, but this is also when your clients care the most, too. So this is when you need to be on your game. Whether it’s preparing the tax returns, advising your clients, or jumping on these webinars with Faith and giving out a little bit of tidbits, all of this stuff right here will actually help your clients become more profitable, increase the business, which of course just makes my job a little bit easier.

[24:54] Faith: Yeah. Oh, yeah. I love that. Thanks so much. Okay. Well, we will chat with you again April 9th for your second episode. And it was great talking to you today, Daniel.

[25:02] Daniel Roccanti: Thanks, Faith. Take care.

For more insights on real estate and construction financial strategy, watch the full episode and catch Daniel Roccanti on the Real Estate Industry Update series.

 

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