Effective Cash Flow Management in Construction

By Andrew Coletti

Effective cash flow management is paramount in the construction industry—it can mean the difference between a thriving business and one that struggles to stay above water. Fortunately, there are several simple principles and practices that construction companies can implement in short order to strengthen their cash flow.

Here are seven strategies to help maintain a healthy cash flow and ensure the liquidity needed to fund ongoing and future projects.

1. Front-loading Costs

Front-loading is assigning costs to the project elements that occur early in the schedule. Doing so can help contractors accelerate cash inflow, allowing the customer to fund the project and relieving the contractor of a portion of that financial burden. Front-loading costs can significantly improve liquidity early in the project lifecycle.

2. Timely Billing

Timely billing is a critical but often overlooked element of effective cash flow management. Billing customers as soon as the billing period ends can expedite the payment process. The sooner the invoice is sent, the sooner it can be processed and paid, enhancing cash flow.

3. Accepting Electronic Payments

Instant electronic payments eliminate the common refrain of “The check is in the mail.” They’re also processed faster, clear the bank more quickly, and save the time and effort of depositing checks manually. This not only accelerates cash inflows but also reduces administrative burdens. Additionally, less dependency on physical checks can help eliminate check fraud, provided that team members are trained and additional controls are in place to mitigate electronic fraud.

4. Aggressive Processing of Change Orders

Change orders are a constant in the construction industry, and it’s vital that companies process and bill for these orders immediately. Often, work must be performed before change orders are approved, meaning cash is already being spent. Delays in billing and processing can lead to extended periods before approval and collection, negatively affecting liquidity. Waiting until the end of the project often requires extra administrative time to compile information relating to the change order, leading to longer wait times for customer approval. Prompt processing ensures quicker reimbursement and minimizes the impact of project changes on cash balances.

5. Utilizing Financing Options

Paying cash up front, whether for materials, equipment, supplies, or other expenses, can strain cash flow. Instead, utilize financing options to help maintain liquidity at a strategically significant level, determined by key stakeholders with a holistic view of relevant construction and contracting commitments. Financing equipment, even if it costs more in the long run, helps preserve cash flow for other operational needs. In terms of materials and supplies, businesses would be wise to negotiate credit terms with suppliers to delay cash outlays, allowing those funds to be used for immediate necessities like payroll. If credit terms are not available, paying with credit cards can offer similar benefits, an advantage that’s somewhat undercut by the administrative burden of needing to pay off balances regularly to avoid high interest charges.

6. Understanding Payroll Outlays

Payroll is a significant weekly or bi-weekly expense that can suffer when cash flow is poor, particularly when clients are slow to pay. The financial demands of meeting payroll obligations can force contractors to rely on short-term financing, an expensive option in today’s high-interest rate environment. Using subcontractors can help alleviate this burden. By engaging subcontractors subject to a “pay-when-paid” clause, payments can be issued when the contractor is paid, helping to preserve cash flow and resulting in a strategy that is potentially more cost-effective than high-interest financing options.

7. Offering Early Pay Discounts

Incorporating early pay discounts into contracts is one way to incentivize faster payments. A 2% discount for early payment can be more cost-effective than paying interest on a line of credit. Additionally, those able to effectively incentivize early payments also reduce the administrative costs associated with following up on overdue invoices and stretching working capital.

For sustainability and growth, construction companies need effective cash flow management. By implementing the strategies outlined in this article, construction companies can support healthy cash flows, helping to ensure the funds necessary to continue operations and invest in growth opportunities. Additionally, contractors will be better equipped to manage the financial challenges of the industry and achieve long-term success.