How to manage cash flow in the construction business

Many construction business owners overlook the importance of cash flow in construction. Without sufficient cash flow, your business may be unable to pay vendors on time or continue work on projects.

But what is cash flow in construction? Why is it so important and how can you improve it? We'll answer all of this and more in our detailed guide.

In the construction industry – and any other business – cash flow refers to the amount of cash coming into and out of the company over a specified period of time.

Cash flow is calculated by subtracting your cash outflows (expenses) from your cash inflows (income).

In the construction industry, cash flow is crucial if the company hopes to stay in business.

Why is cash flow important in construction? Because cash flow is a key measurement of a company’s financial health.

• When a business has more money coming in than going out, it has positive cash flow. Positive cash flow means you have the ability to pay your bills and overhead to keep your construction business in operation.
• When a business has more money going out than in, it has negative cash flow. Negative cash flow means that you may not have the funds to pay your bills and could face challenges keeping your business up and running.

Depending on the chosen accounting method, a business can still be profitable but have a negative cash flow. It may seem like a healthy business on paper, but its negative cash flow may cause it to run into issues paying its bills.

By monitoring cash flow in construction, construction businesses can predict their needs, identify potential issues and take action to correct problems before they face a cash shortage.

Construction companies can face a wide range of cash flow problems. Here are some of the most common ones.

• Slow Paying Customers: Sales and agreements mean very little until you have the cash in your business bank account. The longer it takes for customers to make payments, the more likely you are to run into cash flow shortages. In addition, if you can’t pay your bills on time because customers are slow to pay, then you could also face late fees and penalties from vendors and creditors. Simply put, slow-paying customers can ultimately cost you more money.
• Invoicing Customers Too Slowly: You can’t get paid until customers receive their bills. Delaying invoicing only extends the time until you get paid. Failure to send reminders for payments will only further delay payments.
• Paying Bills Too Early: Paying bills as soon as they’re received can leave you without cash to cover your expenses. Delaying payment until the due date or until you have more cash will help prevent cash flow problems.
• Payroll Intensive: If your construction business is labor-intensive, having to pay employees weekly or bi-weekly can leave your company strapped for cash. You can’t delay paying employees, so poor cash flow in construction can create personnel issues for a construction business.
• Not Budgeting for Retainage: Some construction companies, especially in the commercial sector, fail to budget for retainage. Retainage is the money withheld at the end of the project to ensure that it’s completed properly. It typically equates to 5-10% of the contract’s value.

How To Deal with Cash Flow Problems in Construction Business

Bad cash flow in construction can lead to big problems for a business later on down the road. But how do you deal with problems relating to cash flow in construction?

One of the first and most important things is to start managing your cash flow properly. Without proper management of your cash flow, you won’t be able to identify potential problems and have an accurate picture of your business’s financial health.

Managing cash flow in construction can be challenging, but it’s not an impossible feat. Here are some helpful tips on how to manage cash flow in construction.

Use Your Right to File a Mechanics Lien

A mechanics lien can be a powerful tool in ensuring that you get paid for your work. Here are a few important things to know:

• Mechanics lien laws vary from one state to another. Therefore, make sure that you understand the rules and deadlines for each relevant location.
• Send preliminary notices when you begin work to protect your payments.
• Send a notice of intent to lien when payments are late.
• File lien claims before the deadline to avoid running into issues.

One of the most important aspects of cash flow in construction is ensuring that you get paid on time. Taking action with a mechanics lien is one way to protect your payments and ensure you’re paid what you’re owed.

Finance Asset Purchases

Rather than purchasing new assets in cash, consider financing them instead. Yes, you will have to pay interest on the purchase, but you can avoid running into cash flow issues.

Financing allows you to make smaller payments over a longer period of time, which frees up cash for your business’s expenses.

Along with improving the management of cash flow in construction, financing your asset purchases will also help you build your business’s credit. If you ever need to take out a loan in the future, having good credit will be imperative.

Negotiate Payment Terms

Another effective way to improve the management of cash flow in construction is to negotiate better payment terms. This means:

• Negotiating the best payment terms for client contracts.
• Working with suppliers to get the best possible offer on the materials you’ll need for the job.
• Trying to secure payment terms with suppliers that are equal to or longer than those you give to customers.

Negotiating favorable payment terms can go a long way in improving the management of cash flow in construction.

Create Accurate Estimates

Creating more accurate estimates will allow you to confidently project your cash flow needs for projects ahead of time. Accurate estimates will help you create accurate projections, making it easier to manage your cash flow.

Along with improving the management of your cash flow, it’s also important to know how to improve cash flow in construction.

There are several effective cash flow techniques in construction. Some ways to improve your cash flow include:

Include Payment Terms in Your Contracts

Make sure that your contracts clearly state your payment terms as well as late fees. Clear payment terms ensure that customers know when to pay. Late fees also reduce the risk of late payments, as customers do not want to incur additional fees.

Invoice Promptly

Make sure that you’re sending out invoices as soon as the work or a milestone is complete. Delaying invoicing will only delay your payments from customers. If you struggle to remember to invoice customers, set aside time once a week to take care of this task. Pencil it into your schedule so that you don’t forget.

Give Customers Multiple Payment Options

The easier it is for customers to make payments, the quicker you’ll get paid. Give customers multiple options for making payments, including:

• Online, over the phone, in-person or via mail.
• Credit cards, cash, checks or even online payment apps like PayPal or Venmo

If customers have to jump through hoops to make payments, they’ll be less likely to pay on time.

Open a Line of Credit

Opening a line of credit can help you manage gaps in cash flow in construction. If you run into negative cash flow territory, you can rely on this line of credit to keep your business afloat temporarily.

You know to better manage and improve your cash flow, but how do you get better control over your cash flow?

Create Cash Flow Forecasts

One of the best ways to control cash flow in construction is to create cash flow forecasts. A cash flow forecast will predict what your business’s cash flow will be in the future, so you know whether you need to take action now to avoid a cash shortage. Forecasts can also help you predict the impact of an investment or other business decision that may impact your cash flow.

Cash Flow Frog takes the guesswork out of managing cash flow in construction. From one central platform, you can:

• Create cash flow statements and forecasts to gauge the financial health of your business
• Compare your actual results versus your estimated results to see where you need to make changes
• Create what-if scenarios to see how your decisions will affect your cash flow
• Identify potential cash flow issues and take action now to avoid them

Cash Flow Frog integrates with the most popular accounting software, allowing you to use the most accurate and up-to-date data when planning your cash flow.

Want to see Cash Flow Frog in action? Here’s a snapshot of a cash flow statement for a construction business.