Maintaining good cash flow in the construction industry is vital to completing a project and staying afloat. The problem is, the nature of doing business in the construction sector makes achieving positive cash flow harder than other areas.
This article is all about understanding what these challenges are and how you can overcome them.
Cash flow is a common issue in the construction industry due to incorrectly quoted work, changing scope of projects, high wages and long payment terms on invoices. Invoice finance helps to overcome short term cash flow issues by lending based on invoices yet to be paid.
Cash flow in the construction industry
The construction industry typically involves large scale projects that require expensive equipment and materials. For construction businesses, having the finance to be able to cover such costs is the challenge, especially when you throw in other overheads such as equipment rentals and wages.
Generally speaking, cash flow issues account for more than 80% of business failures. In construction, cash flow is considered one of the main reasons why businesses go under.
This makes it vital for construction companies to use cash flow projections to monitor the money they have on hand to stay in business.
How to calculate cash flow in construction?
Calculating cash flow seems simple, but it’s often not. Cash flow is the difference between money coming into a business and money going out and how much cash is in your bank account on any given day.
There are three categories of cash flow, and each is calculated slightly differently. Combined, this makes up overall cash flow.
Cash flow = Cash from operating activities, PLUS cash from investing activities PLUS cash from financing activities. See below for details on what each of these are. Note cash flow measures the actual cash received or spent.
Operating cash flow is cash flow relating to your core business activities. It does not take into account expenses that exist on your balance sheets but that don’t actually impact your bank balance, such as depreciation of assets.
Net income + Non-cash expenses + Change in working capital = Operating cash flow
Investing cash flow shows the monetary gain or loss from any long term or capital investments the business has, including equipment, stocks and business acquisitions.
Purchase or sale of capital expenditures + Purchase or sale of marketable securities + Purchase or sale of a business = Investing cash flow
Financing cash flow includes all forms of funding, such as a cash injection from the owner, investors and lending, as well as money paid back through dividends.
Issue/repurchase of debt + Issue/repurchase of equity + Dividends paid = Financing cash flow
As well as calculating cash flow in real time, it’s useful to forecast construction cash flow in advance. This can help to identify pinch points or times where you may need to stimulate cash flow and find cash to meet a shortfall. See more with this checklist for positive cash flow.
Reasons for cash flow problems in the construction industry
So what is it about the construction industry that creates cash flow issues? There are a few key challenges…
Inaccurate quoting and tendering
When quoting or bidding for projects, the price you come to needs to be realistic. It can be tempting to offer a competitive quote in order to secure work, but if that price is too low then you’ll earn less than the job is actually worth.
This is a fine balance, and the nature of competitive bidding almost works against your business interests. It may be worth including a buffer in any quotes for unexpected expenses, in order to have something of a safety net during a project.
Unforeseen change orders
Change orders are adjustments to the original scope of a project. They often end up creating more work, and more money, for a contractor or business, but they also can put pressure on short term cash flow.
For example, if you’ve hired equipment or purchased materials for a job that then becomes unnecessary through a change order, you’ll need to carry the cost yourself.
Wages are often the highest expense a business has, and in construction can account for 30% or more of the value of each project.
Generally speaking, when money is tight, improving cash flow by reducing expenses is one of the first things any business will look to do. In construction, where contractors are common, there are often more opportunities to do this. However you still need to ensure you have the labour required to get jobs done well and on time.
Long payment periods
Cash flow for construction projects that go on for months, or even years, can be complicated. Invoices are often payable within 30-60 days, during which time there can be a lot of overheads to pay.
On top of that, invoicing in the middle of ongoing projects can create difficulties, and clients can retain payment until work is completed to a satisfactory standard.
All of this leads to long periods of time where businesses need to cover operating expenses out of their own pocket before being paid.
Components of construction project accounting
Project accounting has an important role to play in managing cash flow for construction projects. These techniques inform invoicing terms, quoting and cash flow forecasts and monitoring to give your business the best chance of completing a project with positive cash flow.
Planning is about mapping out the path the project will take, including:
- Key milestones
- Recognise dependencies and constraints on pieces of work
- Forward plan material and labour supplies at the right times
- Establish the project scope
- Set budgets and timelines
- Assign tasks ahead of time
It’s vital businesses compare actual progress to forecasts regularly and accurately, particularly in terms of expenses and time. If anything changes, stakeholders should be informed.
Tracking budgets involves a few different aspects that are worth mentioning explicitly:
- Manage and control expenses
- Compare costs to budget regularly
- Recognise potential cost overruns as soon as possible
- Mitigate overspends where you can
Read more: What supports better business cash flow?
Being able to identify, mitigate and eliminate risks in advance, particularly when it comes to cash flow, can help to avoid worst case scenarios.
- Recognise risks as soon as possible
- Identify the impact on project cost and timeline
- Identify possible solutions
- Create a response plan
- Continue to monitor the risk and its impact on the project
The costs of resources, particularly staff, can easily go over budget without careful management. This includes:
- Monitor staff workload
- Track availability and assigning tasks accordingly
- Forecast future staffing needs
Strategies to improve cash flow in construction
Knowing what the challenges are and how to create a construction cash flow forecast, what can you actually do about it?
These are the most effective tips to improving cash flow in a construction project:
- Include payment terms in your contracts. This dictates how long customers have to pay invoices and can be referred back to if need be.
- Incentivise prompt payment. Offering an early payment discount will cost you a small amount of money, but it can create huge benefits by enabling better cash flow.
- Schedule payments when they’re due. If your own bills don’t have an early payment discount, pay them as late as possible. This doesn’t mean pay them late – this can attract late fees and affect your reputation – but keep cash on hand by waiting to make payments until you really have to.
- Invoice regularly. Send out invoices whenever they’re due. The sooner you invoice, the sooner it’ll be paid.
- Use contractors. Sub-contractors help cash flow by enabling businesses to buy themselves time in paying wages. Rather than paying wages every two weeks, contractors send invoices that are generally payable in 30 days from when they’re sent.
- Use invoice financing. Invoice financing enables construction businesses to essentially get invoices paid immediately. This removes the cash flow pressure from bills that are due while you’re waiting for invoices to be paid.
Take home message
It’s vital that construction businesses are mindful of cash flow in their operation. As we’ve mentioned, the construction sector faces greater cash flow challenges than many other industries, and the consequences of getting it wrong can be catastrophic.
This is where invoice financing helps the construction industry, both by creating a safety net and enabling construction businesses to grow. Having invoice finance set up through FundTap means you can focus on running your business.
You don’t have to use it – there’s no penalty if you don’t – but when you need a cash flow injection, it’s there. You can have funds in your account the same day you apply for it. This is one of the ways FundTap offers more simplicity and flexibility than other invoice finance providers.
FundTap is a proven solution to cash flow problems. FundTap’s clients grew their revenue by 54% over two years by not having to worry about their cash flow, enabling them to take opportunities as they arise.
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