Check out our recent roundup of the best 12 construction accounting software and tools to find out how tech can help reduce your cash flow worries.
Cash flow problems in construction are everywhere. Even the most established contractors at some point have to work out how they’re going to fund a project between contract and payment.
Materials, tools, sub-contractors and staff all expect payment for their work. But as far as many clients are concerned, that’s not their problem until the work is complete.
In practice, this means contractors often work at risk, stumping up the funds for a project in the hope the client will pay on time. But if they don’t, you could easily find yourself up the creek without a digger. So, what’s the solution?
In many industries, expenses and payments come in and out at a fairly predictable pace. That means the amount spent and the money made can be closely aligned. In construction, the situation is much more complex:
In construction, the gap between work completed and work paid can be uncomfortably vast - with some clients insisting on payment terms of up to 90 days.
This often means contractors have to effectively fund projects themselves before payment is received.
Construction projects are infamously complex. Expenses can include materials, tools, subcontractors, employed labour and much more – each with its own payment cycles and timelines.
Balancing your books and getting these payments to line up can be a real challenge.
Contractors put a lot of work into estimating their project budgets before the contract is signed.
But it’s easy for these budgets to fall off the rails once the project starts, due to change orders, unpredictable material prices and the availability of subcontractors.
Projects often involve layers of contractors and subcontractors, each waiting upon the last for payment. The more moving parts there are, the harder it is to guarantee you’ll be paid on time.
While the ideal situation is to be paid ahead or during the project – this is often not the case. Many clients insist on holding back some or all of the funds until they’re satisfied the project is complete, further complicating cash flow.
Construction cash flow problems affect the kind of projects you can take up. Large projects, even those with good profit margins, might be off limits if you don’t have the up-front capital to fund them.
All these challenges add up to make construction a uniquely tricky industry when it comes to cash flow. If these issues aren’t managed correctly, it can affect your ability to grow your business, break even and, ultimately, make profit.
It can often seem like the only way to succeed is to already have bags of cash lying around to invest in big projects. Luckily, that’s not the case – and there are other solutions.
There are plenty of options available to contractors looking to manage their project costs, including loans, negotiated payment terms and much more. More on that below.
But before we get lost in the details of contracts and construction financing – it’s helpful first to pick the low-hanging fruit – or things you can easily control yourself. Here are a few tips for how to manage and reduce your internal costs.
It’s easy to lose track of expenses, whether that’s unnecessary subscriptions, tools or job costs.
One way to avoid this is to conduct a regular waste audit, perhaps once or twice a year. This involves carefully compiling all your expenses and assessing each on a cost/benefit level, to remove anything you don’t need.
Overheads can also be a huge drain on your finances. This includes any costs that aren’t project-specific like office rent and utilities, non-billable wages and insurance/fee costs.
Just with the waste audit, you should constantly monitor these to find opportunities to cut costs. Even when cash flow isn’t a big issue – this can help keep you flexible, agile and solvent when times get tough.
“A lot of my client base was decimated during The Great Recession. The ones that I remember that survived were the ones that kept their overheads low.”
Wade Carpenter, Carpenter & Company, CTAs
Diversifying your client base is a really important way to stay ahead. Different types of projects come with different payment cycles – some may spread payments across the project and others may offer only a fixed lump sum (often when the project is complete).
Try to strike a balance between high-risk, high-reward projects and more predictable jobs with fewer moving parts.
When it comes to managing the cash flow of specific projects, the situation starts to get a bit more challenging – since there are several variables outside of your control. But while this is more difficult, it’s not impossible – and there are steps you can take to manage your risk. Here are a few tips.
Perhaps the golden rule of working in construction is this: if you let costs spiral out of control, they probably will. So how do you avoid this? The key lies in budgeting and reporting.
“If there’s a change order with new adjustments to the initial estimate, say instead of 100 square feet of a certain tile, you now need 400 square feet of that tile…
You’re going to have to buy extra tiles and you did not estimate for that. So, are you going to have a change order for that 300, or are you going to have to eat the costs because you screwed up the estimate?
Those are two very different scenarios. But either way, your accounting team needs to know which one it is.”
As Suzanne explains, there are several solutions when your budgets start to unwind. But whatever option you choose, everybody needs to be clear on the approach and adjust the expectations to accommodate.
Regular reporting, clear budgets and collaboration between project managers and accountants are the best way to keep a handle on this.
Clients: Can’t live with ‘em, can’t live without ‘em... In all seriousness, too much construction cash flow chaos results from clients not paying the right amount on time. So what’s the solution?
Communication and expectation management. It’s not sexy, but trust us – it does help. Here are a few pointers:
In short, if you give the client an excuse to delay payment, there’s a good chance they will. So don’t.
While we wouldn’t advocate regularly robbing Peter to pay Paul, sometimes a bit of flexibility from suppliers and subcontractors on monies owed can really help. Here are a few options:
It can be easy to feel squeamish about asking for flexibility.
But ultimately, it’s the nature of the industry to work at risk – and any measures you can take to reduce that risk will make a big difference to your construction cash flow.
Not all suppliers will be willing to negotiate – but it doesn’t hurt to try.
Many contractors are wary of accessing credit or finance, seeing it as a slippery slope to bad finances and, ultimately, insolvency. And sure, that can happen - but there are plenty of sensible reasons to explore a construction-related loan.
Ultimately, there’s nothing irresponsible about needing to fund a project between now and when the client’s due to pay. Luckily, there are plenty of construction-specific loans designed to deal with precisely these issues. Here are some of the most important:
Whichever option you go for, loans can be a great way of keeping you solvent while you complete the project.
If you’ve made it this far, you’ll know by now that the solution to construction cash flow issues is rarely an easy one. Much of the time, it requires being scrupulous about your expenses and flagging anything that deviates from the plan.
If that sounds like a hellishly manual and time-consuming task… well it certainly can be. But Archdesk can help. Here’s how:
In short, Archdesk makes it easier to keep on track of what’s coming in and out, so you can identify and resolve issues before they ruin your budget.
And that, after all, is the key to getting on top of your cash flow issues once and for all.
Want to find out more? Book your demo today to get started.
To manage your construction cash flow, implement the following processes: 1) Report regularly on costs and payments, 2) Set clear expectations on payment terms with clients, 3) Consider spreading or delaying payments and 4) Get the right technology to help.
Construction cash flow problems cause several issues, including 1) Failure to make payments 2) Struggling to grow the business 3) Reducing your profit margins and risking insolvency.
The biggest mistake in cash flow is to not monitor or report on your costs. This makes it easy for your budget to spiral out of control without you realising, risking your profit margins and project stability.
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