For our project, we're going to have a client. They want the project done. They're the person asking for a project to be completed. Managing the project is going to be a general contractor. And that contractor in turn, we'll hire several trades. Now we're going to consider here ourselves to be one of these trades. Say we're this guy here. That trade contractor is also going to have employees, vendors and subs. Subcontractors who they hired to do work for them. How does cash flow. Well, we have revenues, right? And the revenues really are coming down. The client's paying for this. And the expenses though, the expenses come from everyone. Subcontractors send bills to trade contractors, who send them to general contractors, who send them to the client for payment. So this is relatively simple, right? But all of a sudden we have a lot more players involved in this equation. Now we're going to kind of step through how this equation works out on a real project. All right, so we know our equation here right, this is relatively simple. Revenue minus expenses equals capital. We know that on a project, our client is providing the revenue. Everybody has expenses, eventually hopefully we have positive cash flow. But how does it really work? Where is our revenue? Well, if we're this trade contractor right, we're this guy right here. Our revenues are payments from the general contractor. kind of goes like this. Now the question is how are we going to track these revenues? We'll get into that a little bit more in depth but let's talk about why we would want to track them a certain way. So we're going to track them using a principle called Conservatism. This is a generally accepted accounting principle, it's followed most of the world around. Now the idea of Conservatism is this. You recognize and expense as soon as it's possible that it exists. But you only recognize a revenue once you've received it. This might seem a little cynical. And seems kind of counter to what we talked about in those two accounting methods, right. But we're going to see why this is very important to cash flow. So why conservatism? I mean, shouldn't you be able to assume that you're always going to get paid? After all, if you're doing the work, you're going to get paid. But the reality is, that doesn't always happen. Why might we not get paid? Say we're working on a project and the client stops the contract. I saw this happen a lot in 2008. In 2008, there was the great recession. All the sudden financing dried up. Lending institutions lost a lot of money and clients all the sudden couldn't afford to pay for a project they thought they could. So they stopped that project and put it on hold for a while. The contractors who were working on that project might have forecasted they were going to be making money but it ended up they weren't pulling in any revenue. General contractors might default. Gilbane is a company that has assumed large projects before. Where one contractor started the project and midway through they weren't performing and they were removed from that project. Gobain took over but at that point the contractors who had been, the trade contractors, these guys who had been working on the project. They had to fight for all their money that they were previously owed. They had to justify that they had really done all the work that they were billing for. So you might not receive all your payments, if you're the trade contractor then. Or also in 2008, we saw clients and general contractors go out of business. How's this happen? Well, for general contractors it was simple. The economy was bad. I said, projects got stopped. So there was a lot more competition. So where we normally take our estimated total cost and we put a mark up on top of it for the overhead and profit. Now in 2009 and 2010, companies were taking their total estimated cost. And instead of putting a mark up. They were cutting numbers out, they were reducing that number before they submitted a bid. So now instead of starting a project with some profit, they were starting a project fully expecting to lose money. Now in 2010, 2011, 2012, companies start going out of business and if you were want to trade contractors, one of these guys working for those companies. If they went bankrupt, you might be able to recover a portion of what you're owed but if you're really unlucky, you aren't going to receive anything. So, we don't want to count a revenues, our positive cash flow, until we know that it's real. So on a cash basis, right? We're being conservative. We're recognizing our revenues only when we have them. But what about our expenses? Was we saw right? Our expenses, we kind of like using accrual method to track expenses. Because of the accrual method, we know daily that we're going to have a future cost. Our daily expenses are creeping up, growing. But with the accrual basis we know hey, we know that. We can track that. But our revenues, we want to track with cash. We want to track as cash because we aren't going to be spending money we don't have or don't know we definitely will receive.
