How many times have you heard the saying cash is king? The reason you hear it so often is because it’s true. A company that consistently operates at a loss and suffers from negative cash flow is doomed to fail. The solution, therefore, 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. This article looks at 10 strategies that construction and contracting companies can employ to improve their cash flows.
- Cash flow is the amount of money and cash equivalents that move in and out of a business at any given time.
- Positive cash flow means a company has more cash than liabilities, while a consistent negative cash flow means a business is doomed to fail.
- Construction companies can turn cash flow positive by spreading out their costs, sending out invoices immediately, accepting electronic payments, and avoid over- and underbilling.
What Is Cash Flow?
Cash flow is one of the most important measurements in business. It is the amount of money and cash equivalents that move in and out of a business at any given time. Companies that have a positive cash flow have more money than liabilities. This allows them to stay in the black and cover their bills every month. By contrast, those with negative cash flows don't have enough money coming in to fulfill their monthly obligations.
As mentioned above, having a negative cash flow means there may be financial problems for a business and, if not turned around, may lead to the ultimate downfall of the company. Doing this may be challenging, but there are a few strategies construction and contracting companies can employ to go from being in the red to getting back into the black.
Project Future Cash Flow
It isn't easy to make projections about your future cash flow. In fact, it's a little more complicated in construction than it is in most industries because of the varying degree of jobs and the change orders on current projects. One way to do this is by using cash flow management software. By taking advantage of these tools, construction companies can get a general idea about the income and expenses they expect to see in the future. Proper planning in anticipation of these events will help prevent payroll and payment problems.
Spread out Costs
Unless you're receiving a steep discount, never use cash to buy your supplies and materials. Instead, make sure you finance these purchases. Many suppliers provide contractors with financing options—credit cards, lines of credit, and loans. Of course, you will be responsible for finance and interest charges. But you won't be out of pocket for the full amount, since you'll have to make regular payments. This leaves more cash on hand for the business to continue operating. And you may even be able to write off the interest and other fees as business expenses.
Shop for the Best Prices
It's always a good idea to comparison shop between suppliers to make sure you're getting the best price. Every supplier wants your 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.
Shopping around for the best deal for supplies and materials can help boost your cash flow—just remember to finance your purchases rather than pay with cash.
Approach Payroll Correctly
This situation is different in construction than it is in most businesses. 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 better results from permanent, full-time employees. That higher-quality work reduces the odds of accidents and project setbacks and increases the likelihood of repeat business, referrals, and new clients.
Process Change Orders Quickly
Change orders are common in construction. They’re often the result of a project that requires 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.
Send Automated Invoices Immediately
Invoicing can be tedious. But they're an important part of your cash flow. You can definitely write up your invoices by hand, but you'd probably be better off by purchasing software to make your job easier. And remember, all invoices should be automated and sent as soon as possible. If you want to maximize cash flow potential, send invoices ahead of time.
Accept Electronic Payments
Cash may be king, but make sure your business accepts different forms of payment including electronic payments. This ensures that your business is paid faster, which increases cash flow and allows for more capital to be used for day-to-day operations, payables, and growth.
Train the Project Manager on Cash Flow Management
About 85% of cash in construction 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 package that's based on cash flow performance. This is likely to be effective.
Avoid Over- and Underbilling
Some project managers take pride in over-billing. Since this means the invoice will be higher than the job completed to date, current cash flow will increase. The downside is that it will reduce cash flow when the project is complete. Cash flow takes a hit in the near term for companies that decide to underbill their clients. So what's the best option? The best approach is to bill according to how much of the project has been completed.
Set a Goal for Outstanding Day Sales
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 invoices immediately, offering payment incentives, writing clear terms, checking credit reports before 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.