To meet the unique demands of the construction industry, you need a foolproof plan for managing the cash moving in and out of your company
The project-based nature of construction presents many challenges, particularly when it comes to cash flow management. Some key points to keep in mind when considering how to best handle your cash flow are:
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Even profitable companies can have cash flow problems.
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Many cash flow problems are the result of inefficient internal processes and a lack of coordination between accounts receivable and accounts payable.
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Many cash flow issues can be contained if they are identified and addressed early.
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Software offers a comprehensive project planning and financial management solution tailored specifically to the construction industry that can make staying on top of your cash flow challenges easier.
Common causes of cash flow problems
Simply put, cash flow is the amount of money and cash equivalents that moves in and out of a business at any given time. If more cash is moving out than moving in, a business may encounter financial difficulties. A negative cash flow for an extended period may leave a company unable to meet its financial obligations.
It is important to remember that net profit is not the same thing as cash flow. That is why even businesses positioned to end the year with a sizable profit could face negative cash flow before its outstanding bills are paid. Net profit is what’s on the balance sheet, whereas cash flow refers to what has been physically attained.
There are several reasons general contractors, even the most successful ones, experience challenges with cash flow. Some cash flow issues are the fault of inefficient collections and billing processes that cause delays in getting paid, coupled with unreasonable vendors and late-paying clients. Unexpected and ballooning costs, especially toward the end of a job, can contribute. Another factor is the practice of retainage, in which a client withholds 5-10% of the amount due on a job until after the job is completed.
Effective tools, cash management strategies, and expert advisors are available to help contractors find the best way to manage their cash flow and stay out of the red. If you have been experiencing cash flow difficulties, here are five suggestions to get things moving in the right direction.
1. Get all your processes in order
First, start by looking at your company’s internal procedures for estimating jobs, managing contracts, and handling accounts payable and accounts receivable. Having standard processes in place and revisiting those processes frequently can help avoid confusion and delays that may lead to cash deficits.
Identify and eliminate any possible causes for delays in your billing process. Common billing problems contractors face include:
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allocating purchases and expenses to the correct job
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underbilling (particularly if a project’s scope expands and change orders are issued)
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waiting too long to close out completed projects
Make sure your back office is fully trained to manage these challenges.
2. Use planning tools
There are many software products that address the construction industry’s financial management and project planning needs. Finding the right solution for your company may require an initial investment and bringing in some outside help, but the payoff can be tremendous.
Regardless of which tools you use — cutting-edge tech or old-school spreadsheets — cash flow projections need to be built upon detailed and accurate budgets. Your record-keeping methods will determine how well you are positioned to estimate future job costs and margins. Many software applications combine bookkeeping functions with project planning. Proper project planning is fundamental to effective cash flow management.
3. Shorten and coordinate cycles
Your goal is to make every dollar on hand work its hardest. One way to do this is by setting flexible terms with your clients and vendors during the contract stage.
Using a boiler-plate approach for each project without taking the time to build in controls and allowances for each project’s unique circumstances is a common mistake. Putting in the work to frame out a contract as efficiently as you would a construction project can safeguard against unnecessary financial worries. This type of research is even more important in the estimating stage of a project.
Make sure your terms match your clients’ and subcontractors’ terms before you start the job.
For example, if your clients are known to pay within 45 days, and you know you will be purchasing from vendors who demand payment in 30 days, do some upfront negotiations so you are not caught short while the project is progressing. Similarly, if you can predict there will be additional expenses for a project that will be difficult to cover before payment is due, prepare for some backup financing.
If you can compress the cash out-cash in cycle into the shortest timeframe possible on each project, your company’s resources can go further. Companies that manage the cash flow process and leverage their working capital tend to be the most successful ones.
4. Get creative with financing
If you know your capital will be tied up in a lengthy project, safeguard against a negative cash flow situation by having some cash in reserve. Using alternative financing methods, exercising smart tax planning, and strategically managing retainage can help ensure against running out of cash.
Any small business should have a good working relationship with a bank and should be able to access a secure line of credit when needed. For very large projects, it may make sense to secure long-term financing for materials and fixed assets. Leasing fixed assets is also something to explore.
Effective tax planning can help your company stay in the black as well. A small business tax expert can help you put in place strategies to minimize your tax burden. Knowing how to time major purchases and understanding how depreciation works will positively impact your company finances.
When faced with the inevitability of retainage imposed by your client, it’s important to have that option with your subcontractors as well. In some cases, such as when working for public entities, you may be able to substitute interest-bearing municipal bonds for retainage, which can generate some income.
5. Choose your partners wisely
Research your client. You only should work with clients that can process your paperwork, sign off on completed work, and pay promptly. Research your potential client by getting a financial statement or get references from contractors who have worked with the owner in the past. The goal is to make sure they have the financial capability and mindset to pay you on-time for completed work.
Know when expert help is required
Financial statements are more than just numbers; they tell a story about the job. Reading key ratios can help identify significant issues early, enabling contractors to remedy potentially negative situations before they do real damage.
Cash flow is just as important to a contractor’s business as profitability. Cash flow planning is challenging and inexact, but it is critical to be aware of potential problems to minimize their impact on the business.
Your construction business has unique needs that should not be handled with cookie-cutter accounting approaches. Managing cash flow is never easy but having the proper financial tools at your disposal makes it much easier.
This starts with using the most appropriate project management and accounting software for your business. Equally important is having experienced professionals to guide you and your small business.
At Franco Blueprint, we specialize in guiding small and medium-sized businesses during startup and assist with managing your company’s accounting needs as it grows. We will help you strategize for success and help you cover all the bases for tax management and financial compliance.
It is our business to assist small business owners and help them secure their livelihoods. Contact us for a free consultation today.