Cash Flow Strategies for Construction Firms

6 min read

July 9th, 2024

Cash flow is the lifeblood of every business. Healthy cash flow is vital to ongoing operation, growth, and success. 

Compared to businesses in other industries, construction companies face unique challenges with cash flow management, and poor cash flow can be disastrous if cash flow shortages are not mitigated with proper cash flow management.

Understanding the Basics of Cash Flow in the Construction Industry

What Is Cash Flow?

The term "cash flow" refers to the net amount of money flowing into and out of your business at a given moment. Cash flow is typically evaluated using a cash flow statement, which shows the net amount of money flowing into and out of your business over a set financial period.

A positive cash flow means that, over the financial period, more money has flowed into the company than out of the company, while a negative cash flow means that more cash has flowed out of the company than into the company. If a cash flow statement shows a value of zero, then the same amount of money has flowed into the business as out of the business. 

The Cash Flow Formula

You can use a variety of cash flow formulas to calculate and assess your company's cash flow, using its cash flow statement. 

• Cash Flow = (Cash From Operating Activities +/- Cash From Investing Activities +/- Cash From Financing Activities) / (Beginning Cash Balance)
• Free Cash Flow = Net Income + Depreciation or Amortization - Change in Working Capital - Capital Expenditures
• Operating Cash Flow = Operating Income + Depreciation or Amortization - Taxes + Change in Working Capital 

Understanding Cash Flow Challenges and Improving Cash Flow for Construction Businesses

When it comes to managing cash flow, construction businesses encounter several challenges including:

• Seasonality - Seasonality in construction firms can result in cash flow shortages during the off-season, when you're still operational but have fewer jobs and less money flowing into the business. 
• Change Orders - Changes to a project are inevitable during work. However, these changes often affect the scope of work, can increase costs above the initial budget, and quickly result in your company not having enough cash on hand to manage the change. 
• Estimates and Budget - About 90% of construction jobs go over budget. So, it's essential that you factor in unexpected costs and changes into your initial estimates, have agreements in place to help finance increased costs, and bill for the right amount after work is completed. 
• Inflation - Inflation devalues the money available in your business to spend on operations. As a result, your costs increase because each dollar has less spending power. 
• Materials Supply Chain - Supply chain issues can also lead to an increased demand for materials which can quickly elevate your costs. Additionally, supply chain problems can delay your work, lengthening the amount of time you're on a job and delaying the completion of work and your payment. 

10 Effective Cash Flow Management Strategies for Construction Businesses

1. Understand What's at Risk: The Importance of Cash Flow Optimization

Cash flow management can be a complicated and stressful process, so you must be properly motivated to manage your cash flow and keep a close eye on it. Understanding that poor cash flow management is essential to your business's survival should provide the motivation you need to start improving your cash flow management. 

Healthy cash flow is essential to making payroll, covering your materials and vendor costs, paying contractors, keeping the lights on in your office, staying insured, and paying investors in addition to growing and expanding your business. As a result, your cash flow management strategy is an essential component within every aspect of your business's overall strategy and operations. 

2. Limit Spending

This might seem obvious; saving money is good for your business. It's worth mentioning, though, that conservative spending practices are also vital to a good cash flow management strategy. The less you spend, the less money leaves your business and the healthier your cash flow numbers will be. 

3. Understand That Time Is Money

Knowing your true costs is essential in a service-based business where labor is typically your biggest expense. In construction, you must keep track of your direct materials, direct and indirect labor, and other indirect expenses (operating costs). While it's easy to tally up receipts for nails, screws, wood, hammers, hard hats, and other equipment, it's more challenging to keep track of your employees' time and how they spend it on and off the job. As a result, accurate time tracking is essential to understanding your true costs because, in a service-based business, money is time. More time on a job represents a higher cost and more costs on a job typically represent more time spent on the job. 

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When you implement an effective system for tracking employee time, you'll be better able to allocate labor costs to specific jobs, ensuring you have a handle on your profit margins, ROI, and costs for each job or client. This helps you optimize your pricing and estimates while also enabling you to evaluate specific categories of work for profitability. 

4. Optimize Your Prices

When you understand your true costs and have a good time-tracking system established, you can optimize your prices and be sure you're building healthy profit margins into the bids you make and estimates you provide to clients. Optimized prices will ensure you have more money flowing into your business than out of it with every job you take on, improving your cash flow.

Read More: Don't Be a Pricing Coward! Get This Under Control...

5. Negotiate Better Contract Terms

Whether it's a job contract or a contract with a vendor, supplier, or subcontractor, you need to read the fine print. Leverage contracts to benefit your business. Read contracts thoroughly and negotiate to make sure you have favorable payment terms and timelines in place that work for you. 

Read More: Bid Smarter on Construction Jobs With Sage Intacct

6. Automate Accounts Receivables

Time is money, and you shouldn't have to spend time on making sure your company gets paid for the work it has completed. Automating your accounts receivable management will help improve cash flow by automatically sending invoices and providing clients with several means of paying. This helps ensure your clients pay you on time, as promised. It also means that you'll be notified of late payments so that you can immediately take action to keep the cash flowing into your construction company. 

7. Focus on Strong Revenue Streams

Categorize and allocate all of your costs to specific jobs and clients so that you can pull profit and loss statements by class. When you look at individual jobs, clients, or categories of jobs and clients, you can better assess your revenue streams for profitability. You might be surprised to find that a particular type or scope of job or a certain category of clients costs you more than it's worth or that other jobs or clients generate a surprisingly robust profit margin. When you can use unit economics to evaluate your revenue streams in this manner, you can redirect your construction firm's focus on the types of jobs and clients that are most profitable for your business, increasing profits overall and improving your cash flow. 

8. Always Be a Step Ahead

Cash flow forecasting should be a routine process in your cash flow management strategy. With forecasting, you use historical financial data in addition to revenue and cost projections to predict your future cash flow. (The longer you track cash flow, the more accurate your forecasts will be.) 

With cash flow forecasting, you can better anticipate potential cash flow shortages, giving you ample time to implement strategies and make changes to avoid shortages and keep your business operational. 

9. Have an Umbrella for Rainy Days

Every construction firm should have a plan for managing cash flow shortages. This could be in the form of a business savings account that's earmarked for weathering cash flow shortages, an investor's cash flow injection, or a revolving line of credit at your bank.

10. Address Bigger Problems

If you decide to take on debt to manage a cash flow shortage, make sure you can handle the increased expense (interest and future repayment). Additionally, be sure you have a good plan in place to repay the debt that won't cause another cash flow shortage in the future. In other words, make sure you aren't using debt to put a bandaid on a bullet wound. If you have a cash flow shortage, you need to understand why and determine whether the shortage represents a temporary, one-time issue or a systemic problem in your business. 

Establish Your Business's Best Practices for Cash Flow With Outsourced Accounting for Construction Firms

Effective cash flow management can literally make or break your construction business, and that's why it's essential that you establish a back-office system designed to help you improve cash flow management and forecasting with a variety of cash flow best practices.

That's why we recommend teaming up with an outsourced accounting provider that has extensive experience working with construction companies. Experienced client accounting service providers understand the ins and outs of construction firms, the unique challenges they face, and the kinds of opportunities that can be leveraged within the industry. 

At GrowthForce, we work with our clients, providing them with the team, tools, and technology (i.e. powerful accounting software and integrated applications) that can help them get a handle on their cash flow, strengthen their financial strategy, and grow their businesses to the next level.