Here's what to do when your construction firm's cash flow is low.
As construction is a feast-or-famine industry, every construction company has experienced cash flow shortages. Most firms plan ahead, but contingency plans are never foolproof. Even cash reserves run out, and managing working capital becomes a huge challenge. The key is finding solutions before it's too late. Here are four ways construction firms can work through and survive cash shortages.
Re-examine cash flow and bookkeeping
The first step to surviving a cash flow shortage is to look internally. Re-examining your cash flow and bookkeeping practices will help you identify the sources of the shortage, where your money is going and where you can cut back.
"Lots of businesses are troubled by their cash flow, so the first thing to do is to closely examine the cash flow and see if there are some visible, or not so visible but significant, obstructions," said Alex Bar, a human resources and operations officer at Rosh Metal Ltd., a structural steel fabrication and installation company.
For instance, businesses should examine if customers are paying on time and whether late payments or nonpayments are a chronic problem – and if too much is being spent on operational costs, Bar said.
"Management should also see if employees are living up to industry standards," Bar added. "Answering some or all these questions can create a clearer picture and tell the owner(s) of the firm whether they are dealing with hard times or bad management and resource allocation."
To effectively assess cash flow, however, businesses must make sure their bookkeeping is accurate.
"It is important to have accurate and up-to-date books so you can understand how much is coming in and how much is going out," said Scott Applegate, chief operating officer of CapitalPlus, a financing company that specializes in construction accounting and cash flow management.
Doing so will help you understand margins, as well as balance accounts payable and accounts receivable, Applegate said.
Explore financial options
Many businesses turn to credit cards during a shortage, but construction firms can also benefit from working with a lender or a factoring service.
"Due to recent new developments in small business lending, there are multiple ways to deal with a cash flow shortage," said Nik Lahiri, principal at Essel, an environmental engineering and real estate development firm. "One of the most common types are companies like Kabbage that lend at a typical higher interest rate, but provide funds within 1-2 days."
Construction firms should also consider factoring, an alternative financial solution that involves selling invoices to a third party, known as a factor. Factors typically pay anywhere from 70 to 90 percent of total invoice values, and then collect payments directly from customers for the remaining balance.
"By partnering with a factoring company that specializes in the construction industry, you can get immediate access to the funds from those receivables and eliminate the wait to get paid," Applegate said.
In addition to finding solutions, construction companies should find ways to mitigate risks and prevent losing even more money.
Manage by the numbers
One of the best ways to mitigate risks is to manage by the numbers, said Matthew Hinson, principal at Live Oak Advisors LLC and a CPA who works with construction companies. He finds that too many project managers go with their gut in estimating costs, which is detrimental to a company facing financial issues.
"During a crunch, managers need to be laser-focused on project costs and job profitability so that no surprises arise and jobs are completed smoothly," Hinson said.
Taking billing shortcuts is also a costly mistake, especially during a shortage. Hinson advises construction companies to pay even closer attention to the details of a project.
"Know your contracts inside and out," he said. "When you are in a cash crunch, you can't afford to leave any money on the table. That's why it's extremely important to know exactly what you can bill for and what you can file a change order for."
Other things to look out for include billing terms and if there are penalties, such as payment discounts and liquidated damages for failing to bill within a certain window, Hinson said.
Avoid large projects
Another way to mitigate risks is to forgo large projects. Although saying no to a project isn't a popular approach, especially when you need the cash, this isn't the time to take on a huge investment, Bar said.
"While large projects naturally bring in more money, they also come with greater risks and with greater investments," Bar explained. "Large projects and financially tumultuous times can be the boulder, rather than the straw, that broke the camel's back."
Require a deposit
Businesses that don't want to turn away projects have another option: requiring a deposit upfront.
"One tried-and-true method is getting 50 percent deposits upon mobilization for projects," Lahiri said.
A deposit enables you to cover your materials and hopefully some of your employee costs, Lahiri added.
Some companies hide that they are going through a financial crisis, but experts say being open and honest about the problem is key to finding a solution.
Keep everyone in the loop
To make it through a financial crunch, people have to be on the same page, Hinson said. This means informing everyone from the ground up, including bidders and field workers.
"It's a competitive industry, and if the folks compiling bids don't have an accurate picture of the company's financial situation, they may be more willing to let margin slide to win a job, [which is] usually detrimental," Hinson explained.
Workers in the field should also be notified so they know that they need to monitor labor and materials like a hawk, Hinson added.
Talk to creditors and vendors
Creditors have different options that may be able to help a company stay afloat, and many vendors are open to negotiating better terms – given that they know about the problem.
"It is a very good idea to warn or notify creditors about the financial woes in a timely manner, and they would surely be of some help," Bar said. "After all, you not having money means [they are] not getting their money either."
More importantly, businesses shouldn't wait until the last minute to ask for assistance.
"The ones who make it through unscathed are the ones who acknowledge and plan for it in advance," Hinson said. "Don't wait until you are in a pinch to talk to your banker about a revolving line of credit or to approach your vendors about better terms."