They say cash is king because it is the lifeline of every business. Positive cash flow helps a business grow and prosper. Without satisfactory cash flow, a business will inevitably fail and go broke. For more on cash flow in construction management, read below:
This statement holds even more importance for construction and trade businesses. Paul Harlond, Director at KPMG – Restructuring and Insolvency considers the building and construction industry as one of the toughest industries in Australia. In an article last year, KPMG Newsroom reports that Australia saw 1,515 companies in the construction sector fail, an increase of 12 percent from the year before.
In this article, we discuss the main causes of cash flow issues and strategies to manage them.
Main causes of cash flow issues
Lack of planning
Poor estimating and quoting is a major reason for cash flow issues because you could be accepting unprofitable jobs. This has further reaching implications for the business as a whole. You could then lack the sufficient cash flow to pay the support arms of the business such as admin and marketing. Taking the time to adequately plan cash flow is good practice and critical to keep your business afloat. Without this planning process, your business wouldn’t have the adequate information armed to make accurate quotes for jobs.
Clients not paying their invoices on time is a major pain point for any business but especially relevant for construction and trade industries. It is not as clear cut as receiving goods and paying upon delivery. There are potential obstacles getting invoices signed off and approved due to ambiguities on project outcomes or variations along the way.
Similar to poor estimating and quoting, variations could be detrimental to cash flow. Variations could increase the costs of building materials, increase labour required, without adequate compensation on the revenue side.
Benjamin Franklin famously said “nothing is certain except death and taxes” It is safe to say, there is no hiding from paying taxes so they should not come as a surprise to your business. A sudden change in business performance means a flow on effect for taxes and the cash outflow. Poor tax planning and lack of education (e.g. could your business be eligible for tax payment deferrals?) can be detrimental to cash flow.
Cash flow in construction management: Strategies
Invoicing more regularly and in smaller amounts
High dollar value invoices may take longer to receive payment for; clients may have their own cash flow management difficulties or high value invoices may have more stringent approvals like two authorisations in the bank instead of one. For these reasons if you can, create more regular invoices that are smaller in value. This will not only improve your cash flow but improve your relationship with clients by easing their burden of paying large invoices.
Have a rainy day fund for emergencies and variations to projects
Whether it is a credit card, line of credit or business overdraft, it’s important to have a contingency plan for out of the blue scenarios. Cash flow might be strained due to delays in projects or variations. Sudden extreme weather might mean construction is halted but wages are still paid. Sure, these options come with account keeping fees and interest, but it is definitely the better option compared to having a halt to construction on a project because you’ve run out of cash to pay for building materials.
Use financing and interest free periods
Take advantage of financing options and maximise cash flow by delaying payments that do not have any financial penalty. Most business credit cards have interest free periods up to 55 days. This can help boost cash flow as well earn some frequent flyer miles. Visit Canstar’s Business Credit Cards comparison to compare different options.
Follow key ratios
Key trends on how your business’ cash flow is tracking are all available in your financial data. They just need to be calculated and analysed. If the number of days it takes for an invoice to be paid is high, then perhaps a deeper dive into the collection process is required. Are invoices being sent to the right email? Invoices being recognised as spam is another common issue? Are there banking approval limits preventing timely payment of your invoices? Other cash flow relevant financial ratios include:
Accounts Receivable Turnover: Sales divided by average accounts receivable balance retainage balances: Cash that clients hold back until the project is complete
Working capital: Current assets minus liabilities
Debt-to-equity: Total liabilities divided by owners’ equity
If analysing financial ratios isn’t to your liking, let the team at Trendsight help. Trendsight specialises in helping construction and trade businesses with admin, bookkeeping and forecasting. We create cash flow forecasts by projects specifically tailored to the construction and trade industry. Book a free call to learn more.