A complete cash flow guide to the construction industry – how to’s and what not to’s

The circle of cash flow in the construction industry is tricky business. 

Although the cash flow principles in construction are no different to other industries, the type of cash flow problems differs depending on the kind of construction company. 

Using key processes and procedures are vital to maintaining longevity in the construction industry. 

Identify the payment cycle for your company.

When considering the principles of cash flow management, it is essential to understand the different challenges faced across companies within the construction industry and how the challenges feed into the flow of cash in a building construction project. 

Contractors 

In general, contractors are responsible for delivering a project from planning, executing, managing, and delivering the project. Management of cash flow for contractors is the lifeblood for all stakeholders involved. Contractors are responsible for the concrete payments to subcontractors and suppliers. 

Contractors face immense cash flow pressure to ensure they can align the client’s payment schedule with the project milestones. Insufficient flow of cash within a project delays payment to subcontractors and suppliers.

Subcontractors 

It’s often argued that subcontractors are in the most challenging position when reviewing the project cash flow cycle. Subcontractors need to appease the main contractor to build a relationship for future projects. 

Mismanagement or payment delays at the contractor level mean that subcontractors have to outlay their cash reserves to await payment. When a subcontractor needs to outlay more money than they’re receiving, it causes financial pressure and puts their business in a negative cash flow position. 

The imbalance of revenue, although sometimes necessary, drastically increases the business risk.

Suppliers

Suppliers are sometimes stuck in the thick of late payments and negative cash flow. Late payment from contractors and subcontractors creates bottlenecks across the industry as suppliers face insolvency, project costs increase, and schedules become problematic.

Sustainable cash flow all year round

Due to the nature of the beast and the cycle of cash in the construction industry, many businesses will look to other sources to make ends meet. Companies need to consider equity contributions, loans from the owner, or outside financing to improve their cash position and keep operations moving without profitability. 

Many businesses can fall prey to misconceptions and do not make the distinction between cash flow and profit. Taking on more jobs to increase profit does not mean you can afford to make ends meet during the project life cycle. 

Proper cash management equips businesses with the tools to decide how to settle debts, where to reinvest cash and if future viability is even possible.

To make these decisions, businesses need to be reviewing their cash flow report; inflows (billings, claims, charge orders and retentions) and outflows (materials, wages, cost of subcontracts and bids). Analysing inflows and outflows will provide the net cash flow position for a project. Likewise, knowing past trends means businesses can be better prepared for potential shortfalls in the future. 

While external factors can dictate inflows, cash flow analysis enables you to make decisions based on cash on hand, where to cut costs and how to utilise available credit. Even if you do not have the financial resources available, spending time on financial analysis is required to keep your business afloat. 

How to improve cash flow in construction 

Expediting cash flow feels easier said than done. Regardless of external factors impacting cash flow, there are methods contractors can use to accelerate cash flow. 

One of which is favourable contract terms. Favourable contract terms enable contractors to gain more control over billings throughout the project. Aligning the contracts billing schedule with the project timeline can ensure you have the adequate means to keep the job going. 

Within the industry, many contractors use front-loading billing terms within the contract to subside payment delays of other projects. Contractors receive large payments at the beginning of one project to subside the payment delays of previous jobs. Likewise, if contractors do not have a forward view of their cash flow, the influx of cash can detract from future outflow requirements. 

The methods above need to be monitored by contractors to manage the flow of overbilling and underbilling. Overbilling occurs when a bill is submitted for labour and materials which have not been completed in its entirety. In contrast, underbilling is the opposite when the entire bill is not submitted for the labour and materials. Overbilling and underbilling can speed or slow down billing practices. 

Despite the hectic nature of construction, a healthy cash flow means billing on time. To effectively bill, you need to capture and track everything that is happening on a project. This will ensure you’re on top of all project inputs (labour, supplies and administration). Being supported by software that can easily track inputs and outputs across a project will ensure you do not outlay unnecessary cash and bill accurately. 

Even the best project does not always go to plan. Process change orders and variations are all a part of the project cycle and impact cash flow. Changes need to be accounted for accurately to prevent disputes between parties. Using change order software will enable you to record changes quickly but streamline how information is shared between parties. 

Ultimately, billing does not translate to a positive cash flow if the collection is not successful. Active communication with project managers and the client ensure the delayed payments are highlighted quickly. Unfortunately, communication alone is not a guarantee for payment. Ensuring you have a process for collections, knowing when to escalate, and filing liens is necessary to survive in the industry.  

The bottom line in any industry’ cash flow is king.’

Understanding trends within the industry, using financial reports and setting good cash flow management practices will provide a foundation for success. 

Improving practices behind cash flow enable your business to take control of outflows and prepare for improved inflows. Going digital is one of the quickest ways to streamline cash flow management. 

Unsure if your business is supported by the right tools improving cash flow? 

Our team at Thrive are specialists across project forecasting, accounting and scheduling tools that can enable your business to take control of your cash flow; contact us today on 1300 868 474.

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