Construction projects, whether residential, public or commercial, face cash flow challenges that can affect profits. The construction industry is prone to high financial risks due to factors like:
- Resource shortage
- The industry’s slow cash flow cycle
- Finance mismanagement
- Premium interest rates on loans
- Cash invested in large quantities of raw materials and equipment
Apart from this, there are a few practices or trends in the construction business that causes a cash flow crisis. These include:
Privately held construction firms usually wait longer for payments from customers. However, they cannot delay their loan payments or bills as this might affect their credit score. The cash inflow and outflow gap widens because of this.
Trade credit is another concept that affects a project’s cash flow. The idea of buying materials and paying for them later might look tempting, but your cash flow takes a hit when bills stack up in months when the inflow of money is less.
How to check a Project’s Cash Flow Health
Cash flow is defined as the amount of money entering and leaving a business or a project, but there are different components you should be aware of.
Operating Cash Flow
The cash flow associated with day-to-day operations is calculated under this. This will let you know if your business has enough money to take care of daily business activities.
Investing Cash Flow
Purchasing assets like equipment or hiring full-time resources are investments for your business. The profit or loss from these investments will determine if they are worthy of the money spent on them.
Financing Cash Flow
This is the cash flow through transferring money from profits to payables like loans or to investors. If you get sufficient cash to pay your loans without a backlog, then your business is doing well.
Ways to Streamline your Cash Flow
Have a Cash Flow Projection
Your business might be handling three different projects at the same time. The cash flow projections will vary with each of these projects. The prospect of project plans changing mid-way should also be considered before drafting your cash flow. There are many accounting software customized for construction projects that can help you come up with an accurate cash flow projection.
Sign Profitable Projects
As a construction firm, make it a habit to bid only on projects are sure to bring in profits. If you find initial costs high on a project that might bring you profits later, you can opt for financing options for construction businesses. This will help you get reserve cash, and maintain the cash flow on new projects when the overhead costs are high.
Workers in construction projects are usually paid bi-weekly, or once every week. To avoid this constant need for cash, you can hire subcontractors. This will improve your cash flow, as you only have to pay them once every four weeks. If you are constantly in need of workers, then it is better to hire full-time employees instead of subcontractors—they tend to do a better job.
Have you ever felt a project bringing good profits in the beginning and then going downhill? The reason for this, in most cases, is inaccurate billing. Some project managers tend to bill for additional hours, construction materials, etc., which might increase the cash flow in the beginning, but at the end of the project, cause a cash crunch.
Aggressively Collect Payments
Set up a payment cycle of 40 days or less, so you can maintain cash flow with less effort. Create accurate invoices, and make sure you send them to the right point of contact. Never hesitate to send constant reminders for payments. If you have a huge list of invoices every month, use an automation tool to schedule these invoices and their reminders. Also, set collection goals for every month. This will help you find out if all payments for a given month are received.
Handle Change Orders Immediately
Change orders are inevitable in construction projects. Process the change orders as and when each one comes, so you get a clear idea of the cash required to incorporate them. Also, make sure the contract clearly mentions the additional costs due to change orders.
How to Build Best Practices
A set process to manage your cash flow comes after a lot of evolution, iteration and unlearning. There might be a cash flow process that worked amazingly for one project, but did not go down too well for another. Every time you finish a project, make it a point to assess your accounts and cash flow management techniques. Note down what went wrong and what could have improved. List down common problems that you face across all projects and make company-wide amendments to rectify them.
Cash flow is as important as the profitability of your project. It helps in the sustainability of your business. Stay updated on the latest tools, software and financial practices that other construction businesses use to improve their cash flow.