Construction Cash Flow
How Construction Companies Can Manage Risk and Mitigate Problems
The most common cause of small business failure is poor cash flow. A company may have millions of dollars in accounts receivable but still go under—because it can’t use tomorrow’s revenue to pay today’s bills.
Construction companies are particularly sensitive to cash flow issues because of the complex, layered nature of the building process. A construction project typically consists of several stages, each one involving different subcontractors. Materials must be purchased at each stage, requiring large upfront cash outlays. And of course, workers must be paid in a timely way. To maintain solvency, companies must make sure their cash reserves are adequate to meet every demand.
Common Causes of Construction Cash Flow Problems—and How to Overcome Them
Here are some of the most common issues that can cause cash flow problems for construction contractors—and ways to address them effectively:
Delayed Payments from Clients
Payments on construction jobs often occur in phases. In theory, that enables both the project owner and the contractor to monitor progress and schedule payments based on specified milestones. And it enables contractors to access funds for successive phases as needed. But owners, like everyone else, sometimes have their own cash flow issues. When their money is tight, they may opt to delay payments, even when the terms have been agreed to in advance.
Construction contracts often include retainage clauses (also known as retention or hold-back), enabling the project owner to withhold payments until certain milestones are achieved. These attain particular importance when they apply to the end of a project. Owners can withhold final payment until work is completed and all agreed-upon terms have been met. This is a good safety mechanism for the owner but can put the contractor at a serious disadvantage when there are disputes about the status of the work.
But the terms of retainage are negotiable in the contract phase. Much trouble can be avoided by negotiating good terms, and specifying in detail the requirements that must be met for a completed project. Airtight contracts with clear payment deadlines can help defuse most of these issues. A contract may also include penalties for non-payment, a dispute resolution clause, and even a termination clause to provide more incentives for compliance.
Sometimes late payments are simply a result of poor billing practices on the part of the contractor. Construction jobs involve huge amounts of paperwork, and it can be easy to forget or delay sending invoices. Nowadays, sending invoices digitally rather than through the mail is the most efficient way of billing clients. Smart contractors, knowing that incoming revenue is the lifeblood of any business, make timely billing a top priority.
High Upfront Material and Labor Costs
For most construction jobs, materials costs are the largest expense. And it’s impossible to build anything without those materials. When contractors lay out large sums for materials without being compensated in a timely way, cash flow problems can result. Even though labor costs are usually a smaller percentage of total outlays, they can also create a cash crunch. Workers expect to be paid on time, regardless of the state of a contractor’s finances.
The solution to these problems lies in good planning. The projected costs for every building phase must be itemized in detail, and adequate cash secured to avoid disruptions.
Inaccurate Project Estimates
Construction jobs require a broad range of materials: steel, concrete, glass, copper, and PVC, to name just a few. The prices of all those items can fluctuate dramatically. The cost of fuel to transport all those materials can also change from day to day. Estimators must project what material prices will be at the time of purchase—not just what they are now. Labor costs can also vary wildly, as accidents, illnesses, or poor performance change the calculus. Contractors may underbid a project to get the job—and then regret it when expenses spin out of control. Contractors must be thorough in assessing possible expenses and include contingency funds to cover unexpected costs.
Change Orders and Scope Creep
The parameters of a project sometimes change midstream. This can be a perilous moment for contractors if they don’t accurately calculate the costs of the new requirements. It’s important to have a formal change order process in place to manage and charge for additional work.
Seasonal Work Fluctuations
Work slowdowns are a regular part of the construction industry. In many parts of the United States, construction work becomes impractical during winter months. But the fixed costs of running a company don’t disappear during those winter months. Inclement weather can also occur anytime, making work impossible. All these factors can create a cash crisis if not planned for ahead of time.
High Overhead Expenses
Fixed costs such as rent, utilities, and equipment loans remain, regardless of project activity. And they don’t always remain fixed either. Gas and electricity prices have been noticeably volatile in recent years. Loans may include balloon payments or variable interest rates that can rise. Lease agreements may expire and need to be renewed at a higher rate. If these changes happen during a time of low revenue, they can cause a cash crisis. Smart contractors don’t let these things catch them by surprise. They analyze overhead expenses regularly and look for areas to reduce fixed costs.
How to Avert Cash Flow Issues – Proactive Steps
1.Create a Cash Flow Forecast – Use a spreadsheet or accounting software to list all expected income and expenses for the next 3-6 months. Update it weekly to track changes and anticipate shortfalls.
2.Secure a Line of Credit – Apply for a business line of credit before you need it. This ensures financial flexibility during slow payment cycles or unexpected costs.
3.Schedule Project Start Dates Strategically – Plan timelines to avoid multiple large expenses hitting at the same time, preventing cash shortages.
4.Automate Invoice Reminders – Use invoicing software to send automatic reminders, ensuring clients pay on time and reducing outstanding receivables.
The professionals at FSE are experts at large-scale, division 13 construction projects!
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