The effective management of a company’s cash flow is critical to its success and profitability. This is particularly true in the construction industry, where projects are typically cash-intensive in nature, and contractors face frequent accounting challenges associated with slow payments and long billing cycles.
On a lot of their projects, contractors must make significant cash outlays for operating costs like materials and supplies, labor and trade subcontractors, and other job-related expenses. This spending generally continues over the life cycle of the project, regardless of the timing of incoming payments. Cash flow challenges are common as a result of the delays in revenue typical of the construction industry. In fact, recent reporting indicates that payment of accounts receivable on the typical job averages more than 60 days versus less than 30 days for the average contractor’s accounts payable. Given the ongoing expenses most contractors face on the job, like payroll, supplies, and materials, it’s clear that cash flow management and maintaining sufficient working capital are critical to surviving slow payments and ensuring a company’s profit targets are met.
The importance of proper cash flow management is highlighted by the number of business failures every year. According to statistics from the Small Business Administration (SBA), a significant number of companies close within the first year, and many more are forced to suspend operations soon thereafter. While business failures can be attributed to a number of reasons, improper cash flow management is a leading cause behind many construction company closures.
Fortunately, despite the many challenges related to effective cash flow control, contractors have various resources, strategies, and tools at their disposal to help ensure the proper tracking and management of their expenses and revenue. With solid accounting practices in place and accurate forecasting, monitoring, and analysis of cash inflows and outflows, contractors can better prepare their businesses to overcome financial obstacles and position themselves for overall success.
Cash Inflows and Outflows
Accurately tracking and managing inbound and outbound cash is vital to proper construction project accounting and, ultimately, the financial viability of the business. Best practices include incorporating clearly defined payment terms in the contract, providing incentives for early payment, and offering clients multiple payment options.
Contractors should specifically spell out the timeframe for the review, approval, and release of payments. In some cases, they may elect to incentivize early payments by offering discounts, and, in a similar fashion, the contract might stipulate penalties for past-due payments through the assessment of late fees and interest.
Consistent billing practices are also helpful in ensuring solid cash flow management and maintaining healthy project finances. For instance, invoices should always be issued according to the agreed-upon schedules. Contractors are also advised to avoid overbilling or underbilling in an attempt to manage their financial position. Better solutions include providing clients with multiple, convenient remittance options to encourage on-time payments. It’s also beneficial for contractors to practice proactive cash flow forecasting to facilitate improved business planning and decision-making.
Cash Flow Forecasting
Effective cash flow forecasting involves the accurate prediction of revenue and spending over the course of a contractor’s project calendar. It’s a vital step in properly planning and managing a company’s fiscal resources. Good cash flow forecasting allows contractors to identify possible shortfalls and make decisions to steer clear of potential financial obstacles over the life cycle of their jobs.
Components of construction cash flow forecasting include income, expenses, timing, and working capital reserves. Income in cash flow forecasting is described as the combined total of revenue for completed work and progress payments received throughout the project. While expenses generally include all spending on line items such as labor, materials, subcontractors, and other job costs, accurately estimating all job costs is important for projecting both cash inflow and outflow.
Timing is an equally important element in the forecasting of cash flows, particularly since revenue and expenses don’t normally coincide. It’s also important for contractors to maintain sufficient working capital to manage any unforeseen shortfalls or expenses. Such cash reserves generally include credit lines, cash on hand, and other readily accessible sources that can be relied on as necessary.
Working Capital Management
Solid management of a company’s working capital and cash reserves is crucial to a construction contractor’s success. Sometimes referred to as net working capital, NWC is the delta between a company’s assets and its liabilities and is considered to be a measure of the liquidity of the business.
In addition to cash on hand, other current assets to be managed include accounts receivable, inventory, and raw material stockpiles. Liabilities are generally defined as expenses to be paid within 12 months or less. Examples of a company’s current liabilities might include short-term debt like credit card balances, wages owed for completed work, and payments due to vendors or subs. The simple formula for calculating working capital is essentially subtracting liabilities from assets, revealing the remaining funds the contractor can use to cover upcoming expenses or otherwise uncover any shortages.
It’s important not to confuse working capital with cash flow. Cash flow relates to inbound and outbound payments based on revenue and expenses, whereas working capital is the difference between a company’s current assets and its current liabilities. In simple terms, cash flow is an indication of financial health at the project level, while working capital is a barometer of longer-term business viability.
How to Manage Cash Flow Challenges
Construction businesses face a number of industry-specific challenges related to cash flow management. Such obstacles highlight the importance of accurate income and expense forecasting as well as giving appropriate consideration to things like payment terms and timelines and any other areas that pose a risk of delaying the timely receipt of revenue. Fortunately, there are a number of best practices available to contractors for helping overcome these and other cash flow challenges.
As discussed before, maintaining sufficient cash reserves is an important step in a contractor’s ability to cover unexpected expenses. Companies are also encouraged to request more favorable payment terms from their vendors and suppliers. It’s also a good idea for contractors to establish and maintain a good relationship with their banks and lending institutions. As it relates to billing and invoicing, companies should establish policies and procedures for mitigating late payments, including regular follow-ups and reminders.
Many construction contractors understand the benefits of utilizing today’s tools and technology to manage their accounting. For instance, industry-specific software like CrewCost is designed specifically to help lessen the risks tied to improper cash flow management by streamlining the invoicing process, accurately tracking expenses, and providing real-time financial insight into both project health and overall business success.
Cash Flow Monitoring and Analysis
Regular monitoring and analysis of cash flow is vital to a company’s ability to identify trends, risks, and opportunities related to its ongoing financial health and profitability. Typical cash flow analysis involves developing a cash flow statement to define a company’s position relative to its available operating funds, as well as cash accessible for investing and financing. This provides the business with necessary insight into the current financial health of its operations as well as helping to define future fiscal needs and improvements.
The effective and efficient monitoring and analysis of a company’s cash flow are best supported by purpose-built construction accounting software like CrewCost, with customized reports and real-time dashboards to provide instant insight into a contractor’s inbound revenue and outbound spending. CrewCost also helps to define the underlying issues that lead to cash flow challenges, making them easier to identify and correct.
Cash Flow Optimization Strategies
Various cash flow optimization strategies and best practices exist to help contractors manage the specifics of construction accounting. Among the most vital are those efforts aimed at controlling spending and maintaining sufficient cash reserves to address any unanticipated expenses. Another strategy contractors should pursue in the interest of optimizing cash flow is the favorable negotiation of payment terms and timelines in order to mitigate delays in the receipt of revenue. Contractors should also strive to eliminate pay-if-paid, pay-when-paid, or any other clauses or contingencies that might cause payment delays.
Other strategies contractors can employ for managing their financial health on construction projects include detailed tracking of income and expenses, as well as accurate estimates of the cash required on a given job. In some cases, it might make sense to finance the purchase of materials or other assets on the job in order to preserve working capital.
One of the best cash flow management tools any construction contractor can have in their kit is the construction accounting and job costing software platform developed by the industry professionals at CrewCost. CrewCost automates and streamlines cash flow management and connects the job site to the back office, freeing contractors to focus on the business of construction while allowing administrative personnel to deal with accounting.
Key Takeaways
As we’ve seen, cash flow management is integral to the success and profitability of construction projects as well as the long-term financial outlook of a contractor’s business. Done right, controlling cash flow requires careful tracking of both revenue and expenses on current jobs as well as the ability to accurately forecast cash flow needs on future projects. Best practices include negotiating contract terms favorable to the contractor as well as taking advantage of available tools and technology like the cloud-based construction accounting software platform developed by the experts at CrewCost.
Contractors interested in spending more time on the job and less time crunching numbers owe it to themselves to uncover the many secrets to project and business success found in CrewCost, including functionality to:
- Manage project expenses with streamlined job costing.
- Accurately and automatically track labor costs.
- Track and control material purchases and vendor payments.
- Effectively capture and manage change orders.
- Reduce risk and maximize profit on every job.
Construction contractors ready to experience the benefits of solid cash flow management and improved business success are invited to try CrewCost accounting software for free today!