Updated: Sep 5, 2019
If you’re running a construction company, you may have seen or experienced how a cash flow crunch can endanger your business. Even if you expect to make a profit on a job, you can run into trouble with negative construction cash flow — when more money leaves your account than comes in during a specific period.
Without enough cash on hand, you could fall behind on bills, incur late-payment fees, or lose employees and subcontractors. Lack of available cash can also force you to pass on large projects or forgo purchasing equipment or hiring employees that you need to grow your business.
Managing cash flow can be difficult in the construction industry, as you may have to pay for supplies, contractors, and employees weeks or months before your clients pay their invoices. However, there are strategies that can help.
Cash flow in project management is all about matching the money coming into your business with the money leaving, and you should negotiate your cash inflows and outflows.
With vendors and suppliers, you can try to negotiate terms payments. For example, with net-30 terms, you’ll have 30 days from the day you receive an invoice to pay the bill. This gives you more time to collect payments.
It might be difficult to negotiate terms and regulate construction cash flow if you’re placing a small order or working with a subcontractor for a specific job. However, if you place a particularly large order, are a frequent customer, or hire the same subcontractors for multiple jobs, you may have more leverage. Ideally, you can get to the point where you can negotiate terms that allow you to delay payment until your client pays you.
As for cash inflows (i.e., payments from clients), you can ask for an upfront deposit before starting a job and progress payments. Depending on how you want to structure the contract, you could invoice based on certain milestones, such as completing specific parts of a job. Or, a regular billing schedule, such as biweekly or monthly, creates a more predictable stream of cash inflows.
In either case of handling cash flow in project management, try to negotiate how long clients have to pay invoices — the shorter the term the better.
Cash flow forecasting can help you understand when cash comes into your accounts, when it will leave your accounts, and how much you’ll have leftover. Understanding the numbers and timing is an important part of financial planning and can help keep you out of hot water.
An example of predicting cash flow in construction projects is if you pay employees biweekly, suppliers on a monthly basis, and subcontractors throughout the month. By creating a timeline that shows when these project costs are due and when you expect your client to pay you, you can determine when you’ll have periods of negative cash flow or positive cash flow.
Perhaps you already know to expect negative cash flow at the beginning of a job. This is common as construction companies often have to front-load expenses. The projections can still help you determine exactly how much cash you’ll need to get through that phase.
The projections can also be important when you’re estimating job costs and bidding. And they can be particularly useful for growing construction businesses that might be making a profit on every job but lack the resources to get through the initial cost-heavy periods.
How you go about creating construction cash flow projections may depend on the size of your company and the type of projects you take on. If your business is large enough, you may have an in-house finance person or project management leads that create cash flow projections. Especially if you regularly take on multiple jobs at once, hiring someone who understands cash flow in project management can be important.
However, smaller companies could outsource the work to accounting firms or individuals who specialize in construction financing if it doesn’t make sense to bring on a new full-time employee.
Whether you hire someone or manage it yourself, you’ll want to create processes for sending and tracking invoices. Fortunately, accounting software can automate some of the work, such as sending regular invoices and late-payment reminders. However, administrative tasks can still be overwhelming when there are multiple jobs with many moving parts.
Ideally, you send invoices as soon as you can and follow-up on late payments right away. But a regular schedule, such as invoicing each Friday or at the end of every month, might work better for some business owners.
Because change orders are common in the construction industry, you’ll also want a plan for how you’ll make ad hoc invoice changes. Again, the sooner you send an invoice, the sooner you’ll get paid.
Additionally, offering incentives for clients to pay on time (or early) can help you avoid construction cash flow problems. For example, include late-payment fees as part of your contract and also offer a discount to clients who pay invoices early.
A job can be going well until the very end when a few finishing touches slow things down. If you’re too focused on finding and starting the next job, you might be delaying your final payment and retention.
For some companies and projects, retention — the money the client holds onto until a job is complete – may be equal to or greater than the profit from the job. Often, this accounts for five to 10 percent of the total amount that construction companies’ bill client and the retention can significantly impact the business’ bottom line.
Making efficient closing a priority can limit these delays and improve construction cash flow. Alternatively, you could ask for retention to be paid earlier in the contract, such as when you complete 50 or 75 percent of the job. But even when that’s the case, you want to focus on efficient closing to keep clients happy and increase referrals.
Sometimes, you need to borrow money to make money. But if you wait until the last minute, it can be difficult to secure financing with reasonable terms. Therefore, you may want to establish relationships with banks, credit unions, and other types of lenders before you need the funding.
Opening a business line of credit or business credit card can give you access to money without the obligation to borrow. They can be especially helpful during short-term cash crunches, but high-interest rates and fees might make these expensive options if you can’t quickly repay the loan. Invoice factoring could also help with short-term cash flow problems, assuming you have outstanding invoices from clients.
If you’re looking to borrow a large amount of money to fund a specific project, such as buying new equipment, a working capital loan could be a good option for improving construction cash flow. You can budget with certainty by taking out a fixed-rate installment loan because you’ll know how much your monthly payments will be and how long it’ll take to pay off the loan.
It’s easy to get compliant when business is going smoothly, but there are many examples of cash flow in construction projects leading to problems. A downward spiral can begin when incoming payments don’t align with your bills and your employees and vendors don’t get paid. But these can be avoidable problems.
You might not be able to predict oddball change orders, but you can create construction cash flow projections before you start a job and use these to inform your bid. Additionally, having a plan for navigating negative cash flow periods and getting early access to cash flow financing can go a long way toward keeping your business running through the ups and downs.