Every business has its slow periods, but construction companies are particularly susceptible to ebbs and flows in income.
For this reason, cash truly is king for contractors. In fact, more construction companies go out of business because they run out of cash than because they don’t show a profit, according to the Construction Financial Management Association.
What this means is that cash flow management often matters more than profitability.
A cash flow projection
When money is tight, your first instinct may be to go after more work. That’s logical, but it may not be the best approach if doing so only ties up more cash.
Bear in mind that what makes up job costs on any given project can significantly affect the working capital needed for that job. For instance, labor and equipment costs generally need to be paid currently before contractors are paid for their work.
Meanwhile, materials and subcontractor costs often don’t need to be paid until the construction company collects from the general contractor or owner. Remember that billings for jobs typically follow a linear path while costs tend to have peaks and valleys as the job progresses when looking at the typical cash flow.
Before you submit another bid, put together a realistic cash flow projection, including cash flow by job, to help you decide whether you are ready to move onto another project. Such a projection can also enable you to pinpoint precisely what type of job would be within the grasp of your current cash flow.
To develop a projection, look at the jobs you have scheduled for the next year. Keeping in mind that circumstances could change, lay out your expected cash flow needs, by month if you can, for each job.
Don’t overlook your expected nonjob outlays, such as labor overhead, insurance, taxes and permits. Then look at your expected revenue by month. Timing may be difficult to predict if you’re doing a job for a new owner or are planning a project on spec, but you can use your historical payment data to calculate an average for planning purposes.
This same data, accumulated over time, can give you an idea of how quickly certain owners typically pay their bills. When you’re finished, you should have a better idea of when you might run short of cash in the next 12 months – and you can plan accordingly.
Strategies to ease negative cash flow periods
Of course, a sound projection alone probably won’t be enough to keep cash flow problems at bay. Other possible strategies include:
Finance long-term purchases. Generally, avoiding debt is a good thing. But when trying to procure long-term assets such as heavy equipment, it’s often unavoidable – and helpful to match those long-term assets with long-term debt.
In other words, if you’re going to own something for an extended period, pay for it during that time frame and save your cash for other purposes.
Improve your change order management. Change orders should make you more money but claims can cost you. If you’re having trouble in this area, devise a better system for getting change orders approved and paid more quickly.
Get work orders for changes signed before doing the work, and submit the pricing as soon as practicable. Try to get a feel during contract negotiations as to how change orders will be handled. Be sure to increase your margins on change orders to compensate for your cash outlays.
Tighten up your billing. Most contractors know that they don’t want to underbill. But be strategic with your overbilling: Doing so requires discipline and strong cash management skills.
Get paid faster. Make sure your billing and collection procedures are fast and efficient, and that you have follow-ups in place to deal with any slow payers. Submit your bills on time. You may even need to be more aggressive in collecting your receivables, being careful not to bite the hand that feeds you.
Watch your inventory. You need a certain amount of materials on hand to keep your jobs rolling smoothly, but you may not need to keep quite as much as you think. Plan your orders so you can keep your inventory as close to zero as possible without jeopardizing project timeliness.
Resist temptation. Before you invest in something that will affect your cash flow, ask yourself whether it’s really necessary. If it’s just something that would be nice to have, look at your cash position to consider whether you can actually afford it.
“Think cash” – always. Whether you’re negotiating contracts, budgeting for a project, buying office supplies or doing any other business activity, think of it as a chance to improve your cash flow. Make cash flow management a routine endeavor rather than a once or twice a year activity.
The lifeblood of your business
Like motor oil in your vehicle, cash flow is the lifeblood of any construction business. So if yours is going strong, give yourself some credit. But don’t take it for granted – one mismanaged job can put a choke hold on even the strongest of cash flows.