Cash flow is the lifeblood of every business, but it’s especially vital for construction companies. In an industry characterized by razor-thin profit margins, solid cash management practices can make the difference between success and failure.
And healthy cash flow is even more important today in light of the Federal Reserve’s recent interest rate hikes. As of this writing, interest rates have reached their highest levels in more than 15 years — substantially increasing borrowing costs. Suppose, for example, that a construction company has drawn $1.5 million on its line of credit. If the interest rate rises from 3% to 8%, the business would see its annual interest expense increase by $75,000.
So, while credit lines remain a valuable tool for weathering financial shortfalls, your construction company should still take steps to improve cash flow and minimize dependence on bank credit. Here are some strategies to consider.
Prepare forecasts
Regularly forecasting cash flow can help you identify potential drains and anticipate problems before they get out of hand. Doing so also enables you to better understand the impact of various activities and practices on cash flow, again allowing you time to make needed adjustments while there’s still time to turn things around.
In addition, forecasting helps you match cash inflows to outflows to the extent possible. For instance, you may be able to negotiate payment terms with your vendors that are designed to coincide closely with receipts from customers.
Front-load billings
Construction contracts often call for progress payments from project owners as specified milestones are reached or as certain phases are completed. Unfortunately, these payment schedules rarely correspond to the contractor’s job-related cash needs.
As you’re no doubt aware, projects typically involve substantial up-front costs for mobilization, labor and supplies. So, if possible, negotiate a front-loaded billing schedule that recognizes your greater need for cash at the beginning of a job.
Eliminate or reduce retainage
Many construction contracts allow the project owner to retain a certain percentage of the total price (usually 5% to 10%) until work has been completed. Because retainage can have a big impact on cash flow, try to negotiate a lower percentage or ask the owner to phase out retainage over the course of the project.
For example, the contract might call for 10% retainage but release half of that amount to you when the job is 50% complete and the remainder when the project reaches 75% completion. In some cases, you may be able to eliminate retainage entirely by providing the owner with other forms of security, such as a letter of credit or performance bond.
Stay on top of receivables
Make sure payment terms are clearly spelled out in your contracts. Have policies, systems and procedures in place to ensure that your construction company issues timely invoices. Reinforce with owners that payments are expected on a scheduled basis — don’t wait until a payment is past due to remind them.
Consider offering discounts for early payments if it makes sense from a cash flow perspective. To help owners pay promptly or even early, offer a variety of payment methods. If you haven’t already, explore the feasibility of today’s popular payment apps such as Zelle, PayPal and Venmo.
Work with vendors and suppliers
Vendors and suppliers may offer discounts or more favorable payment terms in exchange for bulk purchases or cash payments. Of course, keep in mind that ordering too much of certain items can consume available cash and increase storage costs.
Also, by coordinating with vendors, you may be able to spread out payables by arranging staggered payment dates. Don’t pay vendors earlier than required unless you’ll receive a discount for doing so.
Manage change orders
Change orders are a fact of life in the construction business. However, if you don’t manage them properly, you’ll risk delayed payment for the additional work — or you may not get paid at all.
Be sure that your contracts establish clear terms and procedures for approval and payment of change orders, and that your employees understand and follow those procedures. To avoid cash flow disruptions, it’s critical to submit the necessary documentation and bill for change orders in a timely and accurate manner.
Think continuous improvement
Although profitability is the ultimate goal of every business, healthy cash flow is just as important. Even a construction company that’s highly profitable on paper can fail if it lacks the cash it needs to complete current projects and competitively bid on new ones. Your GBQ representative can help you track your cash flow and identify optimal ways to continuously improve it.
