Managing cash flow is difficult for any company, but cash flow problems for contractors are some of the worst. Construction payment takes 83 days on average, according to PWC. (That’s the longest of any industry in the world.) On a construction project, cash trickles down from the property owner or lender to the lowest tier subcontractors and suppliers. With each step away from the top of the payment chain, the later payments get. Contracts generally push the risk for late payments down, rather than up the payment chain. So contractors end up struggling to pay their employees, and, oh, make a profit.
It’s no wonder that, according to the 2019 National Construction Payments Report, 98% of contractors said they have threatened to file a mechanics lien to get paid. And 58% actually had to file a lien.
Discovering where your cash comes from and where it goes can be an eye-opening experience. Most owners focus only on the operational activities of a company. They may not see how decisions like financing purchases and selling assets can also make a difference in how much cash is available on a daily basis.
Let’s look more closely at cash flow problems in the construction industry – and possible solutions.
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What is cash flow?
Cash flow is your business’s wallet. A cash flow report will show how much money you actually have on hand at a certain point in time. You can send invoices to customers and receive invoices from suppliers and subs, and these will show on your financial statements as income and expenses. But until you actually deposits a payment from a customer or until a supplier deposits yours, those activities do not reflect in your cash flow. You can’t pay your electric bill with Accounts Receivable!
Contractors cash flow statement is an analysis of all the cash that came in and went out for a given period (usually one month). The period can be in the past or a projection for the future. Past reports are good to have around because they can help you spot trends and predict future report amounts. After all, the best predictor of future activity is past activity.
7 problems that affect contractor cash
1. High payroll burden
If your company does work that is labor-intensive, the financial stress of having to pay your employees every week or two can make cash flow difficult. The Construction Payment Report I mentioned earlier found that employee paychecks are the biggest casualty of poor cash flow caused by late payments.
You can’t tell your employees that you’ll have to delay their paychecks until your customers pay their bills. Companies who use a lot of subcontractors may not have as much of a problem. Their payments come only once a month and they can pass any payment delays down to their vendors.
2. Paying bills early
If you always pay your bills as soon as they come in, this can leave you cash-strapped. Waiting until more cash is available, or until the end of the payment terms, gives you more money to work with during the days in between.
Retainage – also called retention – is money withheld until the end of a project. A practice common in commercial construction, retainage is typically 5-10% of the total contract. If you are not used to having a portion of each progress payment held until the end of a job, and don’t budget accordingly, you can be left short of cash. With average profit margins of only 5%, a 10% retention holdback means there isn’t any room to pay overhead or other expenses once payments come in.
4. Paying cash for assets
If you are buying equipment or vehicles with cash, you are stealing money from yourself. Financing large purchases frees up your cash to cover other necessary costs such as payroll or supplies. Yes, you’ll pay interest, but it’s a small price to pay for the cash that interest buys you today.
5. Slow paying customers
The longer you must wait for payment from a customer, the longer you are without the cash you need to run your business. It can also cost you more, as late fees and finance charges add up fast.
6. Being slow to invoice customers
Customers aren’t going to pay you until you invoice them. If your invoicing is slow or inconsistent, it is costing you money.
7. Using cash for other investments
It is a good idea to invest excess cash so you can earn more through interest and investment gains. However, if a sudden cash emergency comes up, you are often left with no quick way to recoup that money.
Solutions: How contractors can improve cash flow
Now let’s look at some ways to improve your cash flow. The good thing about this list is that all these ideas are things you can do yourself, and they don’t require changing your customers’ payment habits.
Finance fixed asset purchases whenever possible.
Giving away all your cash to avoid interest payments doesn’t make sense when it comes to cash flow. By making smaller payments over time you free up cash each month which can be used for necessary business expenses, such as payroll.
Shop for the best deals
Talk to your suppliers about how to get the best deals on the materials you need. This may include buying in larger quantities or even threatening to change suppliers to get better pricing. Make sure you are getting the best prices and the best payment terms you can from all your vendors.
Ask the GC or property owner to purchase materials directly from the supplier
Down payments are rare – according to the Construction Payments Report, only 4% of contractors say they get an upfront deposit regularly on jobs. If the GC isn’t willing to give you a deposit, ask them to buy the materials you’ll need. After all, they’ll be paying for it either way. If you can get them to pay for it up front, you’ll keep more cash in your own pocket for later.
Invoice promptly and regularly
Make sure you have a system for sending out invoices or payment applications promptly. Avoid delays in payment by knowing when invoices are due and what documents need to be turned in with each one. Get confirmation that invoices have been received.
Be visible on the job by filing preliminary notices
Contractors and suppliers who file these notices are generally going to be the first ones paid. The owners want to prevent a lien being filed! This can significantly shorten the time from invoice to payment. More and more companies are using these documents to leverage their lien rights and improve cash flow, so sending them doesn’t have the negative connotation that it used to. Implement a payment funnel to help you know when to act.
Offer payment options and/or discounts for early payment
Your accounting software or bank can help you set up merchant services so you can accept credit card payments. There is a transaction fee for each charge, but it can be worth it to get your cash faster. Offering discounts for early payment will encourage your customers to pay quickly. However, don’t make the discount so steep that it negatively affects you if your customers choose to use it.
Avoid over and under billing
If you overbill a project, you’ll have an influx of cash up front, but nothing to cover expenses at the end of the project. Underbilling doesn’t help either. It is best to keep your billing as close to your costs as possible, so you will always have enough cash to cover your expenses.
Process change orders as quickly as possible
Get additional costs approved as fast as possible so you can bill for them and get paid as the costs come in. If you wait until the end of the job to bill, you won’t have the cash to cover the extra costs while they are being incurred.
Create accurate estimates
Using your estimates and job schedule, you should be able to plan for your cash needs ahead of time. The more accurate your estimates are, the more accurate your cash flow projections will be.
Speed up your closeout process
Waiting months on final retainage payments, which might represent your profit on the job, isn’t good for cash flow. You need those funds to pay business expenses and invest in your company. Speed up collection by turning in your closeout documents as promptly as possible.
Cash is king, as they say, and that means getting paid for the work you do. Making it easier for your customers to pay you, spreading out your payments for assets, and invoicing promptly are only a few of the things you can do to help improve your company’s cash flow. And always make sure your payment rights are protected.