Tips for Sustainable Construction Cash Flow

Everyone has heard the saying… Cash is King. The point of this saying from an accounting perspective is that it is not enough for a business to be profitable in order to be successful. In addition to profitability, a business must be well capitalized and have proper cash management to even stay in business, let alone provide worthwhile returns to ownership. In the world of construction, these points are magnified by the unique and complex cash management challenges faced by the industry.

Management of cash flow begins for the contractor well before a job actually starts. There are important decisions which need to be made in developing a bid and in entering into a contract. Here are a couple important cash flow factors to consider before committing to a new construction contract:

Retainage

Many large jobs require retainage which can be a serious drag on cash flow. For those who are unfamiliar with the concept: Retainage is an amount of billings which the owner or general contractor will hold back until a job is complete. Commonly 10% of billings are held back until a job is complete or specific punch list items have been completed. In an environment where it’s a challenge for contractors to put 10% income on their bottom line this means that at best a job may break even until the retainage is paid out.

If your company is not used to having retainage held back on a job, then careful consideration should be given to whether the company can afford to dedicate its resources to a job in which the profit is delayed until completion. For all contractors, it is obviously beneficial to negotiate retainage out of a contract or mitigate its impact by having various milestones at which a portion of retainage is released.

Job Financing

The cash flow for all construction jobs is not created equal. Various factors can affect whether a job’s cash flow will keep up with its profitability. Beyond retainage the most prominent factor that will determine how well the cash flows is the owner or general contractor. The person paying your bill obviously has a huge influence on your cash flow and in this industry, the decision to work with certain groups is more important than any other industry considering the complex billing procedures.

Before committing to a job, a contractor should understand the extent to which they will need to finance the job and ensure they have the resources to do so. When working within an existing relationship, the contractor has all of the information needed to estimate the financing that will be required however this analysis is rarely completed. Preparing a job-level cash flow analysis by retrofitting the job schedule for this purpose can provide very meaningful data in determining the cash impact a new job will have. Having this information available can be a great tool for understanding if a particular job could create an unsustainable cash crunch or simply additional interest expense that may be avoidable if working with another owner or general contractor.

It is critical that the management of closely held businesses understand all the factors that impact their cash situation because mismanagement of cash can be a fatal flaw even for companies who may otherwise appear to be profitable. Careful consideration should be given to the cash flow implications of accepting new work and cash flow management should be at the top of mind throughout the life cycle of each contract. Paying attention to the concepts discussed in this article can help you provide a better cash return to your owners and avoid cash flow pitfalls. MKS&H can assist with a job level analysis that can provide information for these front end decisions, as well as maximizing cash flow during the life of a job. Let us know if we can help!