We hear this question a lot.
Managing cash flow is a critical aspect of construction project management. It's often said in the industry that cash flow management can make or break the success of a project. Effective cash flow management ensures that a construction firm maintains healthy financial operations, enabling it to fund current projects and secure future ones.
The good news is that managing the cash flow on a construction project doesn’t have to be difficult. The unwelcome news is that if you don’t manage your construction cash flow, it can impact not only your current job but future projects as well. If you want to ensure viable profit margins, you need to stay on top of your cash flow.
First, let’s clearly define what we mean by cash flow. On a construction project, it’s a simple definition: cash flow is the art (or science?) of making sure you are using the customer’s money – and not your own - to build their project.
The best – and simplest way – to ensure you are doing this is to bill your customer timely and accurately. Effective cash flow management requires the balance of timely customer billing, accurate project expense tracking, and strategic financial planning. But how else can you manage cash flow? Here are some other tips of the trade about various factors affecting the cash flow of your construction job.
Positioning major project costs at the beginning of the project timeline is a strategic move. In other words, put your biggest project costs at the beginning of the project. You’ll receive your customer’s money earlier and can continue to use it to pay for the rest of the job. This way you are not digging into your own pockets to cover expenses. It’s a tactic that keeps the company’s own capital intact and reduces the need for external funding.
Review your job costs monthly so you have a good understanding of where you are on a project, and if you are accurately billing out expenses. Also, you should ensure that you are always billing and collecting on your change orders. Change orders have a way of creeping up, and if you don’t stay on top of them, they can cause quite a financial headache. Accurate billing ensures that the cash flow matches the project's financial needs at every stage.
Establishing agreements with vendors and subcontractors where payments are made only after the firm receives payments from clients can significantly ease cash flow pressure. This is an immensely helpful cash flow tool. When you negotiate this type of agreement, you are not spending money you don’t have to pay vendors, subcontractors, or anyone else you might owe money to. Instead, you get cash in so you can send cash out. This arrangement aligns outgoing payments with incoming funds, reducing the risk of cash shortages.
It’s a simple statement and might go without saying. Effective cost management involves understanding, creating, and tracking a precise project budget. Comparing actual expenses against the budget regularly allows for identifying discrepancies and making necessary adjustments. This attentiveness to your costs helps prevent overspending and ensures that the project remains financially viable.
There are some incredibly useful cash flow reports within select construction software tools. Utilizing advanced construction software tools for cash flow reporting can provide valuable insights. You should make use of these reports – but understand that these reports are only as good as the data added to them. We can’t emphasize this enough – it is well worth the time spent at the start of a project to make sure that all of your budget data is entered accurately into your software tool. These tools can track and analyze cash flow trends, forecast future cash needs, and highlight potential financial issues.
It’s easy to get excited when a big check comes in, but chances are that check will be needed to pay for other job-related expenses. Maintaining strict discipline in financial matters is crucial. It’s essential to resist the temptation to spend incoming funds prematurely. A significant portion of the funds received will likely be allocated to covering project-related expenses, such as payments to vendors and subcontractors.
Another question we often hear is: “What might happen if you don’t manage your cash flow?” Failure to effectively manage cash flow can lead to several adverse outcomes.
Most likely you’ll need to use credit to build a project, which will end up being more expensive due to the interest you’ll owe. In addition, if you don’t have the funds to cover your costs, you can end up having bonding issues. If you aren’t bonded, it will be extremely difficult to get future projects. Bonding issues can hinder a firm's ability to secure future projects, as many clients require assurance that a construction firm is financially stable and capable of completing a project. To sum it up, you need good cash flow to be solvent, to get bonded, and to continue to win future jobs.
Maintaining a healthy cash flow is vital for the solvency, bonding capacity, and long-term success of a construction firm. It requires a combination of strategic planning, disciplined spending, accurate billing, and effective use of technology. By mastering these aspects of cash flow management, construction firms can ensure the financial health of their current projects and set a solid foundation for future business opportunities.
With our narrow focus on a few key industries, Plumb’s extensive knowledge of cash management and our commitment to serving our clients can help ease your business project. We are here to help guide you through the process with our outsourced accounting experts and to answer any questions you may have. Please let us know if you’d like to schedule time for a free consultation. We’d love to help.