Managing Cash Flow in Construction
Managing cash flow is a difficult and time-consuming issue for every business. However, construction company cash flow issues are especially complex and problematic. Slow, late, or only partial payments are the biggest reasons why companies experience cash flow issues. There are many reasons why the construction industry has difficulty managing cash flow, however, one of the most prominent issues is that it takes an average of 83 days for a construction company to receive payment.
Further, on a construction project, money touches many hands. In most cases, a bank will lend money to a property owner who then has to wait to receive a total invoice from the general contractor before distributing funds to every lower-level entity on a project. As a subcontractor or material supplier gets further away from where the money funding the project originated, payments get later and later. Because of the inherent cash flow issues present within the construction industry, it is vital that construction companies address the practices that hurt their cash flow and implement good cash flow management practices to prevent future problems.
What is Cash Flow Management
Cash flow management refers to when a company receives payment and when the companies using their cash to pay existing debts and expenses. While the total compensation you receive may be larger than the money you have to pay out, the timing of these transactions can greatly affect your financial standing.
One of the most common tools to track your cash flow health is to utilize a cash flow report. A cash flow report will help you understand how much money you will have on hand at a certain point. Further, the invoices you send customers and bills you receive will show up on your financial statements as income and expenses. However, until you actually receive payments or pay off debt, these activities do not reflect your actual cash flow.
Though a cash flow statement is most useful and accurate during the month you are currently in, this report can also help you project your future cash flow. These predictions, combined with your past cash flow reports, are very useful to project a company’s financial health.
The above description describes a common cash flow management strategy for construction companies. For example, if you know that you have a large payment coming in at some point over the next few weeks, you can make decisions on what debts to pay now and what bills to hold off on.
Construction Mistakes that Drain Cash Flow
Below is a list of the most common mistakes construction companies make that drain cash flow.
Labor intensive fields are some of the costliest businesses to run—and most construction companies fall into this category. As construction companies have to pay their employees weekly or bi-weekly, a customer that pays late can cause serious cash flow issues. While construction companies with numerous employees will experience financial issues if a customer pays late, companies that mostly utilize subcontractors have a little more wiggle room with late payments. The reason for this is that subcontractors typically receive payments monthly and, in most cases, will only receive compensation when the property owner pays the general contractor. These business relationships put the burden of late payment on the subcontractor and protect the general contractor’s cash flow.
While paying your bills early is in theory a good practice, this can leave you strapped for cash if a customer does not pay you on time. Waiting to pay your bills until they are actually due or at least until you receive the payments you were counting on to cover these expenses will help you maintain a healthy cash flow.
Failing to Budget
A common practice in the construction industry is called retainage. Retainage refers to the 5 – 10 percent of the total contractors worth that the property owner holds onto until a contractor or subcontractor completely finish their portion of the job. If you do not budget accordingly when working on a project that utilizes retainage, you will run into cash flow problems. Thus, as most construction companies only operate on a 5 – 10 percent profit margin, retainage can mean that you have no room to cover extra expenses that may come up on the job.
Paying Cash for Assets
Creating a positive cash flow largely comes down to a company’s ability to manage their working capital. The cash that you have in the bank will work to pay regular expenses and wages. However, if you are making a large purchase such as buying machinery or other construction equipment, you should not be using cash. Instead, finance these purchases so that if you run into any issues, you will have enough cash on hand to deal with the problem.
Slow Paying Customers
As mentioned at the beginning of the article, cash trickles down from the top to the bottom of the construction project. Further, when dealing with slow-paying customers, you will not only experience cash flow problems, but you may also end up paying more money for late fees and finance charges.
Slow invoicing is the one aspect of cash flow problems that contractors have complete control over. Customers will not pay you until you give them an invoice. So simply keeping track of your hours and materials each day can greatly improve your company’s cash flow.
Using Cash for Other Investments
It can be a good idea to invest the extra money you have into short or long-term investments so that you can make even more money off of each job. However, you should never invest all of your extra cash. The reason for this is that you need an emergency fund in the event that issues on the job occurs.
Solutions to Manage Cash Flow Better
There are many things that can throw off a company’s cash flow. However, below is a list of six ways construction companies can improve their cash flow.
Finance Fixed Asset Purchases
When looking to invest in new equipment, it makes more sense to finance these purchases instead of utilizing your cash. By making smaller payments over a number of months, you keep your cash flow positive while also giving yourself a cushion if you experience any issues on the job.
Another benefit that comes with financing asset purchases is that it can raise your credit score. This becomes especially important when you need to utilize a loan for other financing projects.
Negotiate Better Payment Terms
One of the best ways to lower your costs is to talk to your material suppliers. This conversation could take two different paths. First, you may talk about ways to lower costs by buying in bulk. Second, you could say that you are considering changing suppliers unless the company gives you a better price. Finally, ensure that the terms you negotiate with your suppliers last as long as the project you are working on.
Ask the General Contractor or Property Owner to Purchase the Materials Themselves
Another issue that can mess with a contractor’s cash flow is personally purchasing materials for a project. Instead, you should try and negotiate with the general contractor or property owner to purchase the materials themselves. As the general contractor or property owner will be paying for the materials anyway. Thus, getting them to purchase them can help you keep cash in your pocket and increase your cash flow.
Invoice Promptly and Regularly
A way to increase your cash flow is to send out invoices to your customers promptly and regularly. By consistently giving these invoices out and following the billing schedule closely, you will have enough time to remind your customers about the bill and still receive payment on time. However, good invoicing requires close coordination between the project manager and the office or credit manager.
Avoid Billing and Estimate Mistakes
If you overbill or underbill on a project, there are a few different issues you can experience. First, if you overbill, you may have more cash upfront but not have anything to cover the expenses later on. Similarly, if you underbill, you will have a low cash flow for the majority of the project. Additionally, underbilling or overbilling could lead to the general contractor or property owner to reject your initial invoice.
Another common issue that can disrupt cash flow is when you do not give the customer an accurate estimate. By giving an inaccurate estimate, you will have a difficult time asking the customer for more money.
Process Change Orders as Quickly as possible
When dealing with change orders, it is important that you document these orders and update your billing as quickly as possible. If you wait until the end of the project to bill for these changes, you may not have the cash flow necessary to cover any extra charges.
Contact our DC Law Office for More Information
Finally, for more information on managing cash flow in construction, contact us at 202-803-5676. You can also directly schedule a consultation with one of our skilled attorneys. Additionally, for general information regarding construction law, check out our blog.