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Most construction businesses do one thing really well: build stuff. This isn’t surprising, given that the primary job of any company is to satisfactorily complete whatever they are contracted to do. Other issues, such as getting paid or back office processes, sometimes fall by the wayside.
Unfortunately, construction businesses that have cash flow problems often struggle to perform maintenance on equipment or have extra money to spur growth. Worse, there are contractors who go out of business every year because cash flow issues have become so bad that they no longer make expenses. This can affect labor costs, supplier invoices, or both. Fortunately, there are ways to boost cash flow and help your business thrive. Here are a few of them.
No matter how well customers are vetted, many of them are slow to pay for services. On average, general contractors wait almost three months to get paid on each invoice, which is the longest wait in any industry. Subcontractors can face an even longer wait, especially if they are only paid after the GC gets their money. Waiting for payment, however, is deadly for cashflow. Instead, experts recommend that you insist on payment within six weeks.
To achieve this goal, it’s critical to have a strong collections policy. Invoices should be sent out promptly with the expectation of getting paid within a month of invoicing. Clearly write this down in the contract and be sure to include statements to the effect that your company is willing to file liens if it’s necessary to get paid. Liens are a strong incentive to pay in most states because they allow you to force the sale of a property.
Short of liens, there’s sending an account to collections. Just threatening to do so often results in a customer paying up, because they can’t afford to have their credit ruined. Keep in mind, each state has different rules on how long you must wait before sending an account to collections. Always ensure that you are compliant, or aggressive collection techniques can backfire.
A major source of late payments is disputed invoices. Like most people, construction clients are often on a tight budget and don’t take kindly to large surprise bills. Even when the problems are related to problems beyond your control, they might balk at paying for your services.
Luckily, avoiding this problem is relatively easy. When estimating and writing contracts, be sure to include provisions that cover the unexpected. For instance, when estimating for a new roof you might tell the owner how much each extra piece of plywood is going to cost if needed to fix holes. You won’t know about the plywood until the shingles are scraped off, so plan for the contingency. This way, the homeowner will immediately see why a charge was added to the bill.
One way that a project can lose money or miss profit targets is if materials costs are higher than expected. When estimating, make sure that you know the current going rate for everything you intend to use. Yes, even the nails and pieces of chalk. At the same time, know how much you will spend on labor. If you aren’t sure, then use an average for your area. Include these figures in your estimating, along with any markup.
Sometimes things change as a project progresses. For instance, the customer might not like certain trimmings and request that something else be put in. Or, you might start a project and find there are termites everywhere. Situations like these are typically not written into the original contract, because they go beyond the typical contingency.
When these situations happen, make sure to get a change order in writing. Additional costs that are agreed to up front are unlikely to be disputed. Not only that, but if the customer will have an opportunity to determine how to pay for these changes. Even if they don’t have much option to approve them, as with the termites, they at least will have time to raise money before the invoice arrives.
Cash flow in construction is often challenged when a lot of materials must be purchased with company funds. Often, they are ordered a significant amount of time before work begins, and before the first client invoice. Buying materials is the biggest expense that contractors must pay upfront, and it shows.
Fortunately, this problem is easy to fix. If you are a general contractor, try to negotiate a down payment or deposit in your agreements. Tell the customer that this is used to buy materials, and that it is a credit towards their project cost. Subcontractors can do something similar by asking the general contractor to purchase the materials used. This way, a subcontractor is only out labor costs if payment from the GC is slow.
Although cash is usually king, that is not always the case with materials and equipment purchases. When you can’t get a materials deposit from your client, put it on the company credit account instead. You will probably pay interest on the loan, but this is cheaper than having troublemaking payroll. With the extra cash on hand, it will be easier to deal with contingencies such as equipment breakdown.
Likewise, finance equipment as appropriate. Hammers and sawblades aren’t a big deal but replacing a busted backhoe can really cause problems. Put the repair on credit or purchase a new one with an installment loan. This way, the cost is spread out over a larger period. It makes sense todo this because, especially with large purchases, you will use the equipment for years.
When it comes time to bill clients, there are two errors people make. The first one is underbilling. With underbilling, you charge the customer less than the percentage of total costs that corresponds with the amount of work done. In other words, if you are billing with 25% of the work done, but bill the client 20% of the costs, then you have underbilled. Underbilling hurts cash flow because it frequently results in a contractor getting less money from the client than has been spent up to that point.
Likewise, overbilling can kill cash flow even though it brings in more money sooner. If you bill a client 30% after 25% of the work has been done, then you end up with a 5% surplus now. However, later on you will get less money from your client, eating away at the surplus. Keep in mind, overbilling can also cause friction with a client who is on a tight budget.
Rather than billing the wrong amount, cash flow is maximized when contractors bill the exact amount of a contract that has been fulfilled. This way, there is a little bit of cash left to keep the expenses paid, but the contractor still gets some money at the end. In the meantime, there aren’t any cash shortages or surpluses to worry about.
Contractors sometimes have trouble tracking how much money has been spent on a project, especially if accounting is done on paper. Small parts like screws and nails cost money but are often bought in large quantities that can last over multiple projects. Over time, these small expenses can eat into your cash flow and profit margin.
Fortunately, there are construction-specific computer programs that can help. Consider purchasing a license and training your office staff to use it properly. This will help with estimating, because the total cost will be more accurate. At the same time, make sure that everyone on your team is accountable for expense management. If a project runs over budget, you need to know why and correct if possible.
In the past, contractors were paid almost exclusively by bank check. However, these days people don’t pay by check like they used to. If you offer electronic payments, then it is easy for your clients to do an online bill pay or use a credit card. This encourages prompt payment by making it easy to fork over the funds. It also helps out with recordkeeping for both you and your client.
Lastly, not every client is a good one. Some clients are known for paying late or for skipping out on bills. Worse, the same people are often the ones who change their minds easily, don’t communicate, and contest charges. If you want better cash flow these aren’t the people you want to work with.
Luckily, if you do some research you can often avoid this kind of customer. If the client is a business, then get permission to run their business credit report. Multiple delinquencies show a problem with paying bills, so they are best avoided. Then, look for liens in public records and ask around to see if other contractors have had issues with payment. Finally, if a bank is involved with financing then check to make sure there is enough money available to pay the bills.
Construction is a cash-heavy business, both in terms of materials and labor. Being in the industry requires careful cash management to ensure that everyone gets paid in a timely manner. Fortunately, by following these ten steps you can make cash flow better than ever.