Good cash flow management for a construction company means better predictions, operations planning, growth, and business continuity. However, managing cash flow is often easier said than done. With so many variables in place, a lot of construction companies have trouble with their cash flow, which often leads to project disruptions, lack of growth, or in worst cases, business closure.
Here are some of the most common problems of cash flow management for construction companies, as well as the solutions on how to avoid them:
1. High payroll burden
For many construction companies, clients pay when the work is done. And even then, there may be a lot of delays in payments that can result in even worse cash flow. However, you cannot withhold your employees’ paychecks, and this makes the financial stress on your cash flow a lot greater.
Hiring a construction company factoring service can help ease this burden. Since obtaining a loan is difficult for a high-risk industry like construction, and getting clients to pay is often easier said than done, a factoring service can help ease your cash flow and keep your payroll in check at the same time.
2. Poor project bidding
Bidding is the process wherein construction managers estimate the project’s revenue, expenses, and profit margin from which they will price their bid. When the bid is accepted, it becomes the contract’s total value and the maximum amount of cash that the project generates.
When construction managers fail to price their bid accurately and it gets accepted, this can lead to little to no profit and even a negative cash flow. Even if it cost them extra to complete the job, the client will only have to pay the amount stated on the bid. There are even some companies that are willing to take jobs with very small profit margins due to high competition. However, this can lead to the project using up the company’s reserves or resulting in negative cash flow in case of unexpected expenses.
The best way to avoid this mistake is to accurately determine revenue and expenses, which entails a highly skilled and experienced construction manager. It also helps to have another person evaluate the job to provide a second opinion and increase the accuracy of the bid. Moreover, construction companies should avoid bidding on jobs that have very low profit margins that can break even at best or otherwise result in negative cash flow.
3. Failure to budget for retainage
Retainage refers to the money that is withheld until the project is completed to ensure that the job specifications were followed. Oftentimes, it accounts for five to ten percent of the total contract price.
If a project is going to have retainage, you can avoid cash flow issues by budgeting for whatever amount is going to be withheld until the end of a phase or the entire project. In this way, you can pay for materials, overhead, labor, and other necessary expenses even without that portion of the payment in your hands.
4. Paying bills too early
You might think that there is nothing wrong with paying bills early, but when you run a construction business, doing this can risk you getting strapped for cash. Avoid paying your bills as soon as they arrive unless you already have the money for them. Instead, wait until more money is available so that you have more cash to work with until the date that you have to pay the bill.
As long as you pay the bills on time, withholding payments until the deadline is perfectly okay. Just make sure that you don’t forget to avoid adding unnecessary debt in the form of late payments or penalties.
5. Unforeseen change orders
Change orders are official changes made to the initial scope of work of the project. They are common in the construction industry and are almost always a part of any construction project, which is why all companies should have a good change order management system in place.
Change orders can either increase or decrease a project’s contract and revenue. Either way, there is a risk of messing up cash flow, especially if resources have already been bought. A great way to reduce the impact of change orders is by processing them quickly and negotiating changes that can bring about negative effects on profit and cash flow.
In a financially-industry like construction, cash flow can be incredibly difficult to manage. What we’ve highlighted in this article are the most common cash flow problems that construction companies face. If you want to keep your cash flow optimal, always be on the lookout for these problems and be proactive in avoiding them.