Methods for Cash Flow Management in Construction Businesses

  • Editorial Team
  • Heavy Construction Equipment
  • 26 September 2023

Cash flow empowers construction companies to initiate costly new projects, sustain ongoing operations, cover immediate expenses, and fuel related costs. That is why effective cash flow management is very, very important. Today lets look at strategies that construction businesses can employ to improve their cash flow.

Utilize Cash Flow Forecasts

Cash flow forecasts are invaluable tools for identifying surpluses and shortfalls. They enable businesses to plan ahead, managing their cash flow effectively. Forecasts provide insight into seasonal variations, helping companies prepare for lean periods, such as the winter season. Moreover, they help assess the impact of proposed expenditures, such as vehicle acquisitions, on cash flow.

Define Payment Terms in Contracts

Clearly stipulate payment terms in all construction contracts. Payment terms specify the duration within which clients must settle their invoices, typically ranging from 30, 60, to 90 days. Detailed billing agreements should outline necessary documentation, approval processes, and conditions for final payments, such as the provision of a project completion certificate.

Incentivize Early Payments

While collecting early payments can improve cash flow, making advance payments can strain liquidity. Offering discounts for early payment is a strategy to motivate clients to expedite their payments. Discounts typically range from 2% to 5%, though businesses should carefully weigh the trade-off between lower profits and improved cash flow.

Implement Payment Schedules for Bills

Establish and adhere to regular payment schedules for bills, including operating expenses and material costs. Consistency in paying bills helps businesses avoid late payments, interest charges, and strained client relationships. Leading financial and accounting software can facilitate efficient payment scheduling.

Diversify Payment Options

Offer a variety of payment options to clients, including credit cards, payment apps like PayPal and Venmo, as well as traditional cheques and cash. Providing multiple payment methods simplifies the payment process for clients and may expedite the receipt of funds.

Negotiate with Vendors

Negotiate rates and payment terms with vendors, especially for substantial projects involving bulk purchases or cash payments. Collaboration with vendors can yield mutual benefits and cost savings, ultimately boosting cash flow.

Maintain a Smooth Billing Process

Streamline the billing process by sending invoices promptly and according to a predetermined schedule. Utilizing accounting systems that automatically generate invoices and reminders helps businesses stay on track with billing timelines.

Secure a Bank Line of Credit

A business line of credit provides access to working capital during cash shortages, helping mitigate negative cash flow. Obtaining a credit line involves submitting an application and securing approval for a specific credit limit.

Consider Long-Term Financing

Long-term financing, often linked to expansion, involves payback periods exceeding one year and sometimes extending to 20 or 30 years. Businesses typically acquire major assets like buildings and construction equipment through long term financing, using these assets as collateral for loans.

Choose Equipment Financing or Leasing

Select equipment financing or leasing based on your business needs and available cash. Equipment financing entails securing a loan from a lender, with equipment serving as collateral. Leasing, on the other hand, involves lower initial cash outlay.

Avoid Overcharging or Undercharging

Billing practices should align with the actual work that was completed to maintain a healthy cash flow. Overcharging can lead to a cash surplus early in the project, while undercharging generates short-term negative cash flow. Billing based on project progress and actual costs is the ideal approach.

Enforce Late Payment Penalties

Clearly specify penalties for late payments in construction contracts. Penalties, which may include late fees or collection actions, encourage clients to adhere to payment deadlines and reduce disruptions to cash flow.

Expedite Project Closeout

Accelerating project closeout minimizes delays in receiving final payments, including retainage. Efficient closeout includes not only completing the physical work but also meticulous administrative tasks like documentation gathering.

Manage Retainage Efficiently

Retainage is a common practice in construction where clients withhold a portion of payment until project completion. Efficient management of retainage helps businesses anticipate cash flow and budget accordingly.

Plan for Tax Liabilities

Proper tax planning is needed to prevent large tax payments from impacting cash flow during slow periods. Understand tax deferral options to manage tax liabilities effectively, ensuring consistent cash flow.