The construction industry has inherent challenges that make cash flow management and collecting and paying bills difficult. The unpredictability of an invoice-based business as well as the seasonality of construction work makes it challenging to properly track and prepare cash flow. Learn industry best practices to set up your business for long-term financial success.
When your business is in a positive cash balance, it’s easier to handle the seasonal ups and downs of the construction industry or disruptions to the market. Especially during this past year with COVID-19, it’s critical to establish financial security for your business. Kerri Richardson from VonLehman CPA & Advisory Firm walks through her top recommendations to build a healthy cash flow for your business.
Top 9 Best Practices to Build a Healthy Cash Flow
1. Build Reserves
First and foremost, remember that cash is king. Most companies learned during the COVID-19 pandemic that it was critical to have cash on hand to weather the storm. Review the length of time you can continue business right now without a cash flow, and begin to build from there. Aim to build up three to six months’ worth of cash on-hand. That way, regardless of when you receive payments for work completed, you have money available to pay your respective invoices.
2. Finance assets
Purchasing and owning your own assets and fleet is another way to build cash. Generally, interest rates have been low recently. Take advantage of the financing options available now to lessen the cash flow hit to your business. And, while interest rates are advantageous to look into right now, take into account prompt payment discounts being offered as well to see if that is a better option when purchasing assets.
3. Establish a Line of Credit
When choosing a lending firm, make sure you use a firm that treats you as a partner and that is there for you in times of cash crunches. Most lines of credit allow for interest-only payments with the outstanding balance due at maturity — make sure you establish an accurate amount of that. In early 2020, firms had multiple inaccurate lines of credit that went away from strains from the pandemic, so be sure to communicate with your bank to verify you’re within their parameters for that line.
4. Establish Purchasing Power
Even with current market prices as competitive as they are, take the time to leverage any, and all, competitive pricing. Make sure you’re doing your research for the best price and inquire about payment terms; if they allow prompt payment or install payments over time, leverage those relationships for future business.
5. Timely and Accurate Billing
The construction industry is one of the most susceptible to long lead times between billing and payments. It’s critical to agree to acceptable contract terms early, and follow those contract terms closely. Be as prompt with invoices and be flexible to more efficient means of payment, such as electronic transfers or payment portals. These paperless systems do not have the same potential delivery issues as postal delivery times and potential loss in the mail.
6. Review Your Contract Clauses
When finalizing contracts, pay special attention to contract clauses for Paid When Paid and Pay If Paid clauses to protect your company from having to pay money you may not have yet. By establishing these correctly, you can avoid potential negative cash flows in tight situations.
7. Manage Cash Flow at the Project Level
It’s a good practice to manage cash flow at the project level in order to identify cash flow issues early on in a project. Your goal should be to bill for the work as closely if not ahead of the project as possible. This helps predict future cash flow.
8. Manage Contract Changes Promptly
Change orders are inevitable in construction. Processing, agreeing on, and accepting Change Orders quickly allows you to submit the corrected invoice sooner and ultimately receiving that cash flow quicker. Additionally, closing out projects quickly leads to quicker final payments which in turn will affect your overall cash flow in a positive way.
9. Track Key Performance indicators (KPIs)
To quote the famous management consultant, Peter Drucker, “You can’t manage what you don’t measure.” By tracking cash-specific KPIs, you’re able to see how your business is progressing financially, and can make educated decisions then on how to improve it. Key KPIs for your business include:
- Accounts Receivable Turnover
- Working Capital
- Debt to Equity Ratios
- Project Gain/Fade
By leveraging these best practices, you can better predict how your business can overcome the unpredictable nature of the construction industry.
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