Tackling the Challenge of Construction Cash Flow Management

Tackling the Challenge of Construction Cash Flow Management

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Maintaining a healthy cash flow is imperative to the success and stability of all businesses, but those who work in the construction industry know the sector presents unique challenges. The volatile nature of construction billing means many companies become prone to the woes of poor cash flow management, which include lost productivity, reduced profitability, increased stress and more.

How Cash Flow Management Works

To best understand how to implement a cash flow management strategy, it’s important to know the basic ins and outs of cash flow. When money moves in and out of a business, whether it’s brought in through revenue or interest or exiting for payments, investments, operating expenses and more, all movement contributes to an organization’s overall cash flow. While a company can still be profitable despite a negative cash flow (meaning more money is exiting than entering), and many organizations may experience negative cash flow at some point, it’s best to maintain a positive cash flow long term.

Many companies elect to keep a minimum cash reserve amount of roughly three months’ worth of operating expenses ready to cover any unexpected costs that arise. For the construction industry, this is especially important. Expenses like employee payroll, equipment, insurance and more must continue to be paid on time, regardless of cash coming in.

Ultimately, cash flow struggles are a drain on any company’s resources. Inefficient billing practices and a lack of cash flow forecasting strategy mean more time is spent monitoring and following up on outstanding invoices when it could be spent on more valuable projects.

Common Construction Cash Flow Struggles

  • Lack of advanced payment agreements When advanced payment is not negotiated beforehand and construction companies only receive one lump sum payment when a project is completed, this leads to cash flow issues. Paying upfront for the entire project’s costs out of pocket while waiting for payment ties up a large chunk of a company’s cash reserve that could be used for other expenses.
  • Delayed payments Construction companies are no strangers to overdue payments. According to Chaser’s 2022 Late Payments Report, 100% of construction companies surveyed reported often receiving late payments from clients, with 36% of survey takers reporting that payments typically occur more than 15 days past the due date. Days sales outstanding (DSO), which calculates the amount of time it takes a sale to be converted into receivables, is a key metric that should be calculated and monitored continuously.
  • Weekly or biweekly payroll burdens — Companies with many employees on a weekly or biweekly payroll schedule are more prone to cash flow issues. Employees must continue to be paid on time, regardless of overdue client payments. On the other hand, subcontractors can often be paid once the client pays their invoice due to “pay-when-paid” clauses commonly included in contracts. For example, a full-time employee will require payment twice a month, whereas a subcontractor may only require payment within two weeks of receiving the client’s payment.
  • Paying cash for large purchases — While it can be tempting to pay in cash for assets like equipment, it may be wiser to finance large purposes to not drain your cash reserve and maintain adequate working capital.

Strategies to Optimize Your Organization’s Cash Flow

  • Implement artificial intelligence (AI) to assist with billing tasks The construction industry’s billing practices have vast potential to be improved by AI. AI tools can quickly send invoices, follow up with customers about overdue invoices, accurately estimate budgets to prevent cost overruns and monitor change orders and invoices to flag any potential fraud. When implemented well, AI is a great tool for removing the burden of time-consuming, repetitive tasks from your staff.
  • Negotiate early payment discounts with clients and subcontractors Many construction companies have successfully written early payment discount clauses into client contracts and subcontracts. When you factor in the extra costs associated with following up on and processing late payments, incentivizing early payment may make sense for your organization.
  • Consider if a 13-week cash flow model (TWCF) is right for you A TWCF is a versatile tool that can offer significant benefits beyond its common use during financial distress. Once companies have developed the expertise to use the TWCF model effectively, it can become a valuable addition to any dashboard, providing critical insights into short-term cash flow needs. By using this model alongside a traditional long-term forecast, companies can ensure that they can manage seasonal fluctuations in working capital needs while keeping vendors informed.
  • Review your cash flow forecasting model and assess gaps in strategyAmid inflation, supply chain issues and an uncertain economy, financial forecasting can be challenging even for seasoned business leaders. By making sure your financial forecasting model is up to date, your organization’s cash flow will improve as a result.

Connect With Us

Managing cash flow is essential for the long-term financial stability and success of your construction organization. At CBIZ, our resources are designed to help you stay agile while navigating variability and uncertainty. Our professionals welcome the opportunity to share ideas and best practices with your team to enhance this aspect of your financial planning and thinking. Connect with a team member today to learn more about our services.

Copyright © 2024, CBIZ, Inc. All rights reserved. Contents of this publication may not be reproduced without the express written consent of CBIZ. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly traded and privately held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ).

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