Construction companies, contractors and subcontractors have to keep a watchful eye on their cash flow. Construction projects are complex, requiring expert management of people, materials, government permits and even the weather. Many construction companies fail because while managing all of these variables they forget the most important one—cash. Cash shortfalls in construction can be serious, and finding willing lenders in the middle of a cash crisis can be extremely difficult. A delay on one project because of a cash shortage will lead to delays on other projects. It could eventually put your entire business at risk. That's why it's important for construction company owners to learn how to calculate cash flow in their business. These tips may help you get a grasp on what's coming in so you can calculate cash flow.
Improve Your Estimation Process to Streamline Cash Flow Management
When a client asks for an estimate, they expect the builder to have a firm grasp on the costs associated with the project. But some contractors may not pay enough attention at this stage of the process and use “guesstimation” to produce an estimate. Some even lowball the estimate to win a bid only to have to go back to the client during construction to request more cash for the project.
The delays and headaches associated with this approach aren’t usually worth it. It's better to have a precise estimate for both labor and materials. Consider breaking down the construction project into stages. You may want to make sure each stage has the specific costs for each type of skilled laborer, how much of their time you need to purchase and what current prices are for the materials needed. The more granular your approach, the more likely you are to produce an accurate estimate and, ultimately, will help you manage and calculate cash flow better.
Time Your Payments Wisely to Manage Cash Flow for a Project
Many contractors request a simple payment plan from their clients that is usually based on a fixed schedule or upon completion of milestones, like 25 percent on contract signing, 25 percent when the project is halfway through and 50 percent when it's completed. This may be simple, but it may not benefit you. With this type of setup, the project's incoming cash flow won’t match the cash that needs to go out, creating cash shortfalls throughout the construction that could create delays or require you to find additional cash from other sources.
When pricing a project, you may want to set up a timetable that shows when you will require more cash and time the payments to match those cash needs. It may be even better to negotiate a front-loaded contract where more cash is paid at the start of the project, giving you a cushion to account for unexpected delays.
Don’t Borrow Cash from Peter to Pay Paul
When payments aren’t timed properly, a cash shortfall may ensue, making it difficult for a contractor to manage cash flow, purchase the labor and materials needed to complete the next stage of the project. Most clients won’t accept a request for additional cash payment because of your poor cash flow management. Sometimes construction companies solve this problem by signing up another client and then using the down payment from that project to cover the cash shortfalls of previously started projects. This may create a vicious cycle of cash shortfalls and cash flow problems that never end—one late payment from a client may freeze progress on all of your projects due to your inability to manage cash flow.
One way to address this is by making sure each project’s cash is handled separately. Consider creating separate bank accounts for each project if needed and don’t mix cash between projects. If a cash shortfall does occur, you may want to consider using a line of credit for that project. Depending on your situation, it may be worth it to pay a little interest than to risk multiple projects because of imprudent cash shuffling.
Have Your Paperwork in Order to Collect on Time
Your cash flow projections for a project should take into account late payments from clients on your submitted invoices in order to help you calculate cash flow. Usually it's best to call the client a week before you plan to submit an invoice so they know to expect it and to address any potential issues that could delay payment of the invoice. There may be a disagreement with the client regarding how far along the project is and whether or not it's time for an invoice. Or perhaps the client expects that the lien release be prepared before they pay the invoice instead of after. Issues like these are better handled before an invoice is submitted to ensure that it will be processed in a timely manner. It’s up to you to make the effort to resolve any outstanding issues and to manage the cash flow for your construction business effectively.
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