How many times have you heard the saying, “cash is king”? The reason you hear (or read) it so much is that it’s true. For example, a construction or contracting company that’s consistently operating at a loss might fail. However, a company that’s consistently suffering from negative cash flow will fail.
The solution is to generate positive cash flow on a monthly basis, which will allow employees to be paid and payments to be made on time. One obvious key to success is to prioritize income and expenses, but that’s a broad statement.
For more depth on how a construction or contracting company can improve its cash flow, consider the following 10 strategies:
1. Project Future Cash Flow
This is a little more complicated in construction than it is in most industries because of the varying degree of projects and change orders on current projects. That said, by taking advantage of cash flow management software, a construction company still will have an opportunity to gain a general idea about what income and expenses should be expected in the future. Proper planning in anticipation of these events will help prevent payroll and payment problems.
2. Spread out Costs
Unless receiving a steep discount, a construction company purchasing materials and supplies should use financing. This will come with interest, but it will spread out required payments, which will leave more cash in the business for operations.
3. Shop for the Best Prices
Every supplier wants business. If you let them know you’re shopping for the best offer, a supplier is likely to give you the best deal possible, especially if you’re not bluffing and willing to walk away. By reducing costs, you’re freeing up cash.
4. Approach Payroll Correctly
This is a much different situation in construction than in most businesses. In construction, employees are almost always paid on a bi-weekly basis. To improve cash flow you can hire subcontractors, which often are paid every four weeks. This should only be done in special situations, however, as you'll get higher-quality results from permanent, full-time employees – and that higher-quality work reduces the odds of accidents and project setbacks and increases the likelihood of repeat business.
5. Process Change Orders Quickly
Change orders are common in construction, and they’re often the result of a project requiring more time, money and/or resources than originally thought. Extreme weather also can play a role. The project manager should process a change order immediately, rather than waiting until the project is complete. That money needs to be received quickly, which will positively impact cash flow.
All invoices should be automated and sent as soon as possible. If you want to maximize cash flow potential, send invoices ahead of time.
7. Accept Electronic Payments
By accepting electronic payments, money will be received faster, increasing cash flow and allowing for more capital to be used for day-to-day operations, payables, and growth.
8. Train the Project Manager on Cash Flow Management
In construction, 85% of cash comes from project work in progress, which means cash flow performance depends on the project manager’s cash flow management. In addition to training, you can offer an incentive based on cash flow performance. This is likely to be effective.
9. Avoid Over-Billings and Under-Billings
Some project managers will take pride in over-billing. Since this means the invoice will be higher than the job completed to date, it will increase current cash flow. The downside is that it will reduce cash flow when the project is completed. If under-billing, cash flow will take a hit in the near term. The best approach is to bill according to how much of the project has been completed.
10. Set a Goal for Day Sales Outstanding
Having a goal greatly increases the odds of success. The average number of days it takes to get paid in construction is between 60 and 90. Strongly consider setting a realistic goal to reduce that number to 50 days. You can do this by sending immediate invoices, offering payment incentives, writing clear terms, checking credit reports prior to making any deals, and restructuring terms with non-payers.
The Bottom Line
Construction companies operate differently from most businesses because no project is the same. Therefore, improving cash flow requires some different strategies. A lot will depend on the project manager’s ability to manage cash flow. That being the case, be sure to hire a qualified project manager or to offer comprehensive cash flow management training to a current project manager.
Aside from having the right project management, a construction company should do everything in its power to increase the speed of receivables, which will improve cash flow. (For related insight, read about how agile project management works.)