The success or failure of most businesses relies, in large part, on sound financial management and healthy cash flow. The construction industry is certainly no different. It’s a cash-intensive endeavor, often fraught with the challenges of long billing cycles and slow payments. As such, strong cash management skills are critical to a contractor’s bottom line. Read on to learn more about the importance of healthy cash flow in construction and discover tips and tools for improved financial management and profitability.
In This Article
The Cash-Intensive Nature of Construction
It’s no secret that the construction business runs on cash. Contractors are frequently required to make significant outlays for the purchase of materials and supplies, maintenance of tools and equipment, and paying for labor and other operational expenses. This outbound cash flow is typically ongoing throughout the life of a construction project. Unfortunately, incoming payments are often delayed, with slow payments generally creating problems for a contractor’s cash flow and, ultimately, challenging a company’s ability to stay in business.
The Challenge of Slow Payments in Construction
It’s not uncommon for progress payments in construction to be delayed significantly after the initial invoice. According to the 2022 Construction Financial Management Association (CFMA) Benchmarker Report, the average accounts receivable takes more than 60 days to be paid in, versus an average of just 26 days for accounts payable. As one might expect, slow payments can be detrimental to any business’s financial health and cash flow, particularly in the construction industry, where ongoing expenses like weekly payroll and materials are par for the course. That disparity between incoming payments and outgoing spending requires effective cash flow management and sufficient working capital in order to mitigate any adverse impacts and ensure a thriving business.
The Impact of Cash Flow on Business Longevity
The importance of maintaining a healthy cash flow in the construction industry is evident, judging by the number of contractors that go out of business every year. The U.S. Small Business Administration reports that 20% of companies fail within their first year, with 60% of small businesses closing by year six. While various factors play a role in such failures, cash flow mismanagement is a significant cause for the untimely closing of many construction companies.
An even more painful picture emerges in a study conducted by a leading business credit reporting platform. Almost 30% of businesses close due to the depletion of their cash reserves, while 60% of failed companies report cash flow issues as a significant factor in their collapse. From these statistics, it’s easy to understand the importance of healthy cash flow in a construction company’s ability to survive and thrive. And it’s equally clear that ineffective cash management can lead to financial strain and potential business failure.
Proactive Cash Flow Management
Proactive planning is critical to avoiding cash flow mismanagement. It’s essential that contractors accurately forecast inbound and outbound cash, giving proper weight to job timelines, payment terms, and possible roadblocks that might cause delays. Contractors should also consider maintaining enough money on hand to cover any gaps between incoming payments and outgoing expenses. Following are some best practices to help accelerate payments and prevent delays:
- Request better payment terms from vendors. Try asking for a net 45 payment structure versus the industry standard of net 30.
- Maintain a good working relationship and line of credit with your bank. Businesses just starting out should be sure to regularly revisit the interest charged on their credit line and attempt to negotiate a better rate.
- Focus on faster payment of accounts receivable. Establish policies to ensure billings are received and accepted by the party being billed, schedule follow-ups a week prior to the due date, and have procedures in place for pursuing unpaid invoices. Remember, the squeaky wheel gets the grease.
- Build and maintain a healthy cash reserve sufficient to overcome the inevitable slow payment.
The Role of Technology in Cash Flow Management
Successful contractors understand the importance of using available tools and technology to assist with cash flow management. For example, construction accounting and financial management software like CrewCost can help track expenses, manage invoices, and provide a clear view of the company’s financial health. Such purpose-built applications offer real-time functionality that aids in accurate forecasting and better cash flow management. Software solutions like CrewCost typically feature integrated analytics, providing the data necessary for better proactive decision-making and helping contractors predict and prevent potential cash flow problems before they get out of hand.
In Construction, Cash Flow is King
Cash flow is king in construction. A project’s success or failure relies largely on effective cash flow management, and contractors quickly discover that healthy cash flow is critical to growing their construction business. Though finances in the industry are often challenging, understanding cash flow, maintaining necessary cash reserves, and taking advantage of available tools and technology can help overcome fiscal obstacles and pave the way for success and sustainability.
To learn more about financial management in construction, including elements like contracts and Schedules of Values, explore our comprehensive collection of resources for mastering construction billing. You’ll discover the information you need to manage cash flow, overcome monetary shortages, and build and maintain a successful business.
Yancy Lassiter, a CPA with a degree from the University of Texas, has 12 years under his belt as a Controller and CFO in the construction industry; he’s your go-to guy for finance in the building industry.
