If you own a construction company, you understand the importance of effectively managing your cash flow. The more cash at your disposal, the better, considering you have to front the costs of most projects before you get paid. Unfortunately, if you get into a negative cash flow situation, you may be forced to scale back your business and slow down your growth.
In this guide, you’ll learn more about the significance of cash flow and how construction businesses can take steps to improve it.
What Is Cash Flow?
Cash flow is the measure of cash and cash equivalents that flow in and out of your business during a set period. It’s also a reflection of your construction company’s financial well-being and ability to make timely payments to creditors.
Ideally, you want to have positive cash flow or more cash flowing in than out. But if your cash flow is negative, that’s a sign of financial instability. You can view your cash flow statement to gauge where your construction company’s cash flow stands.
How To Calculate Construction Cash Flow?
Here’s how to calculate construction cash flow:
- Cash flow = Cash from operating activities +/- Cash from investing activities +/- Cash from financing activities
In case you’re unfamiliar with each of the components of the cash flow formula, below is a breakdown of each:
- Cash flow from operating activities: Net income + Non-cash expenses + Change in working capital
- Cash flow from investing activities: Sale or purchase of capital expenditures + Sale or purchase of marketable securities + Sale or purchase of a business or segment of a company
- Cash flow from financing activities: Issue or repurchase of a debt + Issuer or repurchase of equity + Dividend payments
Why Is Cash Flow Important?
Cash flow in the construction industry can make or break your business. You need cash on hand to fund new projects as you win new contracts. But if cash flow is a consistent issue, you could be forced to turn away lucrative opportunities or struggle to cover labor or material costs and meet deadlines on time.
Cash Flow vs. Profit
Cash flow refers to funds moving in and out of your business. However, net profit is how much your business earns after subtracting expenses from revenue. Therefore, you can have a net profit and negative cash flow or positive cash flow with a net loss. It depends on if your company uses the cash or accrual accounting method.
How To Improve Construction Cash Flow
Below are ways to improve the cash flow of your business.
1. Create Cash Flow Projections
It’s always ideal to be proactive with your construction company’s finances. By creating a cash flow projection in advance, you’ll know what to expect in terms of inputs and outputs throughout the year. You can use this information to manage your revenues and expenses more effectively to avoid potential cash crunches.
2. Get Paid For Materials Faster
Materials financing companies cover upfront material costs so you can focus on what you do best. It’s as simple as enrolling and ordering materials from the supplier.
3. Open a Business Line of Credit
A business line of credit is a pool of cash that you can draw from on an as-needed basis. Any time you’re in a financial crunch, you can make a withdrawal to avoid depleting your company’s reserves. Even better, it works like a credit card, so you can pay back what you borrow, and the funds will be available for you to use again.
4. Invoice Your Customers on Time
It can be challenging to keep track of billing customers if you’re juggling several contracts. However, delaying the billing process means payments will come in later, which leads to cash flow problems. If possible, hire an accountant who is well-versed in the construction industry to set up an effective invoicing system for your company.
5. Clarify Payment Terms in the Written Agreement
The contract between your construction company and the owner, architect or general contractor that hired you should clearly state the payment terms. It’s also best if you include detailed instructions on how to remit payment and what to do if the invoice you submit to the vendor, supplier or contractor is incorrect.
6. Incentivize Customers to Pay Early
Offer slight discounts to customers who pay invoices early. Of course, you’ll bring in less cash, but it beats delayed payments that could result in cash flow issues if you’re awaiting payment to fund costs for another upcoming project. On average, construction companies offer a two percent to five percent discount for early payments.
7. Pay Your Bills Closer to the Due Date
Paying your bills on time is the best thing to do. You’ll preserve your company’s credit rating and avoid late payment penalties assessed by vendors. However, paying too far in advance could leave you with little to no cash on hand.
8. Follow the Vendor or Supplier’s Invoicing Guidelines
If you’re owed money, be sure to reference the vendor or supplier’s guidelines on invoice submissions to request payment. Doing so helps prevent processing delays as you’ll know what documents to submit and what to expect in terms of the review and approval process to ensure a seamless process. It’s also important to read the fine print so you’ll know how to move forward if there are issues with the payment(s) you receive.
9. Avoid Ordering Excessive Amounts of Inventory
Do you already have a system in place to adequately assess inventory needs for your construction company? While it may be tempting to stock up on materials that you know you’ll need at some point, purchasing excessive amounts of inventory can place a dent in your cash reserves.
10. Assess Penalties for Late Payments
Consider charging penalties for late payments. Disclose the fee schedule in the contract, and include a statement about potential collection actions if the customer refuses to pay. This helps clarify expectations and prevent any miscommunication regarding payments later on down the line.
11. Hire a Professional to Assist with Tax Planning
It’s no fun being in the hot seat with the IRS. But if you fail to implement a tax plan, you could end up with a hefty bill when it’s time to file your company’s tax return.
12. Get a Business Loan
Some banks, credit unions and online lenders offer business loans with extended repayment periods. The amount you qualify for will generally depend on your company’s financials, time in business and creditworthiness. However, you could get competitive terms on secured loan products, even if your business is relatively new or your credit health isn’t up to par.
13. Consider Construction Material Financing
Ultimately, you want to maintain positive cash flow in your construction company to prevent operational issues and foster growth in your business. As mentioned earlier, Materials financing companies help you alleviate added stress by covering the costs of your commercial materials upfront.
It’s one of many strategies you can leverage to keep cash running smoothly, both in and out of your company. Plus, you’ll have instant cash buying power so you can negotiate more effectively with suppliers, along with the ability to plan your next move with confidence.
Frequently Asked Questions
Below are some frequently asked questions regarding construction cash flow and how it can be improved to operate more efficiently.
The individual or team you hire should be well-versed not only in project management but in cash flow management before coming on board. It’s also vital that they understand the specifics of the cash flow projection for the particular job they’re working on, along with the specific milestones. Otherwise, there’s a risk that the project will go over budget and negatively impact your company’s bottom line.
A construction company’s cash flow is calculated by deducting what’s spent, or the cash outflows, from the funds coming in or the cash inflows. This formula has three components:
Cash flow = cash flow from operating activities +/- cash flow from investing activities +/ cash flow from financing activities
Here’s a closer look at each part of the equation:
Cash flow from operating activities: net income + non-cash expenses + change in working capital
Cash flow from investing activities: sale or purchase of capital expenditures + sale or purchase of marketable securities + sale or purchase of a company or division within a business
Cash flow from financing activities: repurchase or issuance of debt + repurchase or issuance of equity + dividend payouts
It dives into all the components of your company’s cash flow statement to gauge how much cash is accessible to cover operating, financing and investing costs in the business. A cash flow analysis can be generated using construction accounting software, and not much effort is required on your part. Ultimately, the results of the analysis provide insight into the parts of your business that are causing cash flow issues and negatively impacting your company’s bottom line. Plus, it makes staying on top of your cash inflows and outflows, including revenues, accounts receivable and operating expenses, much easier.
