Getting a big project can be a big win — but it also has downsides. Bigger projects require more materials and more labor, which means higher cash requirements. Contractors can take on more work than their cash flow will let them perform, leaving them scrambling for cash to pay their bills or their employees. Ensuring consistent cash flow throughout a project is the key to scaling your contracting business. In this article, we’ll explore some strategies to help you keep money in the bank.
Why contractors run out of cash
Most construction businesses focus on their profit margins — making sure that revenue exceeds costs for each job. But what about cash flow? Do you project how much money will be going in and out of your company at any given time? Do you look at your cash flow before starting a large job, or do you just jump in and hope the payment arrives in time to pay your suppliers?
Cash flow is the number one reason why construction companies go out of business. You can think of cash flow like your company’s wallet. You have to get money in from your customers before you can send it out to your suppliers and other vendors. Otherwise, you could be overdrawn on your account. A cash flow projection is useful to ensure that you have the cash you need when you need it. By predicting your cash requirements ahead of time, you know just how much work you can afford to take on and budget accordingly.
There are several reasons a contractor may run out of cash on a construction project:
Slow payments
Depending on where you are in the construction payment chain, it can take 83 days or more to receive payment for your work. And in construction, you can’t bill for the work until you’ve completed it — which means there’s an even longer delay from when you purchase materials or provide the work and get paid. This delay can cause serious cash flow problems for you and your suppliers or vendors.
Poor planning
Stuff happens. Even if you budget your expenses and analyze your cash flow, unexpected expenses may arise, or you may have missed something in your initial planning. These unexpected costs can ruin your cash flow plan and leave you strapped.
Overbilling
Overbilling occurs when you bill for more costs than you have incurred on a project. You may overbill at the beginning of a project to create a cash influx to cover expenses. It becomes a problem when you reach the end of a project and have nothing left to bill with costs still coming in. Without incoming revenue to cover those costs, you’ll have to overbill another project to cover them. This starts a perpetual cycle that is difficult to get out of.
Underbidding
This is happening a lot these days, especially with the rise in building materials costs. If you don’t have an escalation clause in your contract, you could be stuck carrying the added costs. It’s important to lock in materials costs early or request a change order to cover price increases. Otherwise, you’ll have to use another project’s profits to cover those higher expenses.
5 strategies for contractors to help hold onto cash
One way to address cash flow issues is to hang onto the cash you have. If you can delay payments or get money in from other sources, you can meet your cash needs.
Being proactive about managing cash flow ensures that you never come close to running out of cash on a construction project.
1. Forecast cash flow
If you don’t perform a cash flow projection for your business, you have no way of knowing how much cash you’ll need or how much you expect to bring in. By analyzing your cash flow over past months, and projecting needs into the future, you’ll know exactly how much cash you need and when. Then you can use one of the other strategies here to delay payment or bring in cash.
2. Finance material purchases
Material financing can help you delay the payment of material invoices for up to 120 days. A financing company pays your vendor directly, and you pay the financing company once you have enough cash on hand. Terms usually extend up to 120 days from date of purchase, and financing charges are typically better than credit cards and other short-term options.
Financing material purchases is especially important for a company that is growing quickly or taking on a more capital-intensive project. You can save your existing cash reserves to cover payroll and overhead costs, and the extended repayment terms ensures that you’ll have project income in the bank when the bill comes due.
3. Ask your customers for a deposit
One way to get a quick influx of cash is to ask your customers to provide a deposit before you start work. This ensures you’ll have the cash you need to start their project, order materials, etc. The amount you should ask for depends on your cash needs and how quickly you will complete the project.
Of course, general contractors aren’t always eager to give deposits to subcontractors, for a number of reasons. You can often overcome those objections by proving your value and building a stronger relationship with the GC. After all, the GC has a vested interest in making sure all of their subs have enough cash to complete the job and avoid delays.
4. Get paid faster
Slow payments are a drain on cash flow. Every day you have to wait for payment is another day you.
Fortunately, there are a number of simple actions any construction business can take to get paid faster. First, send them a preliminary notice to let them know you’re on the job and expect to be paid. Often just sending this notice is enough to speed up payment.
Read more: The construction business guide to getting paid on time
Next, improve your billing process (if you have one) to include sending invoice reminders before payments are due. (Hint: Many software programs allow you to set up automatic invoice reminders.)
Last but not least, establish and follow your company’s mechanics lien policy. This policy lets you know when to send notices and file a lien.
5. Get funding for other job costs
Besides material financing, there are multiple options for financing construction costs. They include leveraging trade credit accounts from vendors, bank lines of credit, credit cards, invoice factoring, and equipment financing. Which one is best for you will depend on the types of costs you incur and your cash flow needs. These financing options vary in price, so be sure to do your research before deciding on the route to take.
Cash flow is king
To keep your business in the black when it comes to cash flow, you must first know where your cash goes each month. After you’ve completed that analysis, you can project your needs into the future and predict your cash requirements. Select the strategies that work best for your business to either delay spending or increase payments coming in, and you’ll be able to take on larger projects and expand your business without fear of running short on cash again.