Where is all my cash? You might have asked yourself this question before. Many contractors find themselves being profitable but still stuck with negative cash flow.
Why is that?
You may know that your profit depends on revenue, cost of goods and operational expenses, but the fact is that it will not impact your cash flow.
Your net profit may show $200,000 on your P&L but you are drowning in debt, your checking account shows multiple overdraft charges and you are having a hard time making the payroll.
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Cash flow problems affect everyone in construction
The 2019 National Construction Payment Survey conducted by Levelset and TSheets found that “42% of contractors say that they pay their subcontractors or suppliers before they get paid by their customers. To help with cash flow, they feel pressure to make financial concessions. They provide discounts, flexible payment options, and/or interest-free late payments. At the same time, they dip into their savings or taking out loans to cover shortages.”
I’ve had many contractors coming to me with the same exact problems. The business are drowning in debt and overdrafts. They have to spend half of each day chasing the payments for the jobs performed. They get to the point where they don’t want to continue this frustrating journey.
There are ways to fix this.
Cash flow strategies for contractors
To improve your cash flow situation, you just have to be open to change. You need to be willing to try new ways to do business for the sake of it. Many are not willing to commit, thinking that they cannot override the industry standards. They think they will lose the customers and opportunities that have been failing them in the first place.
So, what does the cash flow depend on?
There are some industry best practices you can implement into your construction business to ensure your cash flow doesn’t put you at risk of financial instability. Many of my clients have implemented these strategies and that has helped them confidently grow their business with plenty of money in the bank.
1. Deposits and Progress Invoicing
Most clients are not keen to make significant payment before work is completed. But if they pay nothing until the end, your cash flow can be seriously compromised.
Progress billing and payments should only be a few weeks in arrears based on the project’s progress, giving you working capital to invest in the next phase of the project.
Estimates are perfect to use in this situation. Break down the project into each scope of work. You need to identify the:
- amount of material
- subcontractor workers
- concept and design
- site work
- time required for each step
- associated cost of each step
Identifying the percentage of completion helps to compute the payment frequency.
It’s time to stop funding your client’s projects!
2. Accounts Receivable (A/R) and Accounts Payable (A/P) Timing
A/R are your receivables (invoices due from your customers), A/P are payables (what you owe). The timing between the two has to work to avoid cash flow problems. If you pay your vendors before you get paid, you will use up the cash, and that can result in negative cash flow.
See if you can negotiate better terms with vendors, like signing on to payment terms like paying upon invoice or a net 10-15.
Job Cost Detail report can help you figure out what the best way is to schedule both.
3. Getting Paid on Time
The accounts receivable aging report (A/R aging report) is a good way to track your billings, unpaid invoices, and accounts in collections. This report provides information on who hasn’t paid yet and you can compare that against your billing schedule and the job cost report.
If all accounts are billed out but the invoices are still outstanding for 60 to 90 days, that’s a collection problem.
There are many ways to avoid that.
One of them is to clarify in your contract that you will impose a 2/10 net 30, and a 2% late payment fee. Nowadays you can issue invoices electronically, send reminders, and receive a credit card payment all in one place. Easy and fast. Use that option! Yes, it will cost you a small fee, but it’s better than not getting your money on time. Be consistent with following up on bills.
Create an easy system so you don’t waste your time or the opportunities to bill your clients early. Studies show that if you wait longer than 48 hours to send an invoice, you have eliminated the “sense of urgency” that proves you’re serious about collecting what’s due.
4. Don’t use your cash as a financial tool
Contractors commonly use their future cash flow from jobs, or money from personal savings as a way to finance current projects. If you have to use financing options, consider the ones that give you affordable access to the amount of cash you need to do your work.
5. Watch your Numbers Closely
I know that as a construction professional you are wearing all these hats, trying to excel at everything, stressing out and trying to come up with extra time to complete all the business tasks. But you have to know your numbers! Hire professional help – or figure out the basic bookkeeping matters.
Pull up the necessary reports, like:
- Job Cost Reports
- Work in Progress Schedule
- Job Profitability Report
Make sure you don’t go over your estimates by comparing Estimates vs Actuals.
6. Work on your mindset
Be open to adopting new technology, it may seem overwhelming to learn how to use different software but it will make running your business easier and more productive in the long run.
Optimizing your systems and processes can improve your cash flow management but it is an ongoing process. With my clients, we constantly keep track of each project so we could assess what could’ve been improved and identify what lessons have been learned. They successfully use that information to improve their processes.
Cash flow management may be a challenging aspect of owning a construction business, but you must implement the best practices to build a financially stable business.