Construction companies often experience cash flow problems. Caused by numerous factors, cash flow gaps can make it difficult for construction companies to pay their bills and employees or order equipment, materials, and supplies for construction projects. Cash flow problems can also impact a company’s ability to develop relationships with general contractors and project owners. Without the funds needed to handle existing projects, construction firms cannot take on more work and grow its business. They also cannot hire new employees or offer employee benefits and raises as labor market is competitive. This can seriously affect the firm’s ability to succeed. In fact, construction businesses with persistent cash flow problems often fail.
Proper Cash Flow Management
Proper planning and quality cash flow management practices help ensure positive cash flow throughout the entire lifecycle of construction projects. This provides numerous benefits. In addition to ensuring everyone gets paid and supplies get purchased, positive cash flow ensures timely project completion.
Cash flow management begins with a thorough analysis and prediction of the cash needs of a construction project. Taking a step back and looking at the project as a whole allows construction management to gain a better understanding of what they need and when. Using the information discovered during this analysis, the Project Manager can create a payment schedule that ensures adequate cash flow throughout the project’s duration.
Construction firms could benefit from seeking the consultation of an experienced accountant or financial adviser. An outsourced accounting expert can help organize and prioritize the influx and outflux of funds, while determining the amount of working capital required for each construction project.
In addition to contacting a qualified accounting partner, it’s important that construction companies consider the following cash flow management best practices.
Create a Cash Flow Projection
During the proposal phase, Project Estimators should carefully plan cash flows, and the schedule of values for each stage of the project. This becomes more challenging when unexpected changes in scope come into play and additional cash flow modification is needed for potential change orders. While it might not be possible to predict exactly, an experienced construction financial advisor can help Project Manager’s gain a general understanding of the potential cost of a project, which may not be easily visible to them.
Consider Other Projects
When developing cash flow projections, it’s important to consider the positive and negative cash flows for each project in conjunction with other projects. By considering the bigger picture, contractors put themselves in a much better position.
Make Sure the Project Manager Has a Clear Understanding of Cash Flow Management
The Project Manager oversees all phases of the project. They make sure the project runs on-time and on-budget. Since most of a construction company’s cash flow comes from work-in-progress, it’s important to make sure the Project Manager receives cash flow management training. This helps ensure they have the tools and knowledge needed to manage cash flow throughout the project.
Resolve Change Order Disputes Quickly
A common part of many construction projects, change orders can delay completion. It’s crucial that Project Managers resolve change order disputes quickly in order to ensure timely payments. A dispute resolution can take additional weeks or months to collect the money already spent for the project. The project may stall, but other projects must continue. Do you have adequate line of credit available for rainy days?
Overbill Whenever Possible
The construction industry is notorious for slow payments. In order to get ahead of project cash flow and offset the negative impact of late payments, construction businesses may bill for contracted labor and materials prior to the completion of work. This practice, known as overbilling, can benefit a construction company while they manage financial covenant ratios, if any, associated with debt.
Consider the Retention Provision
When deciding on a construction project, Project Estimator and Managers must look carefully at the retention provision. If the retainage totals more than the profit margin, (i.e. 5% retainage vs. 3% profit margin) the contractor should assume they are financing the project through its completion and consider whether they should take on the project and potential risk associated with low margin project
Allen Construction Group provides bookkeeping, financial advisory, and other outsourced accounting services to businesses in the construction industry. Our team has years of finance experience and understands the unique challenges faced by construction businesses today. Please contact us for more information about cash flow management for the construction industry.