Many companies can fall into financial turmoil because they focus on profits and don’t give enough attention to their cash flows. Construction companies cash flow can be particularly vulnerable to this since they have to cover many project costs immediately before sending the first project invoice to the client.
To avoid an uncomfortable financial position, construction firms should actively manage their cash flow. To help, this article covers five strategies for construction companies to improve cash flows, strengthening their financial position as they strive for new projects.
5 Strategies to Improve Construction Companies Cash Flow
1. Negotiate Better Client and Supplier Terms
On the client side, you could offer discounts for early payment, trading some revenue (and thus profit) for better cash flows. You may also offer volume discounts for larger upfront payments or simply try to shorten regular payment terms.
Include late fees in your contracts to encourage faster payment and compensate for any lost potential returns if you don’t receive timely payments.
Things flip on the supplier side. You’d want to negotiate longer payment due dates to hold cash longer. You can also try negotiating discounts for bulk purchases, reducing cash outflows if all else is held equal.
2. Leverage Small Business Financing To Increase Construction Companies Cash Flow
Small business financing options let you stretch your purchasing power beyond your cash on hand, improving your cash flow.
For example, a small business line of credit offers flexible working capital to cover short-term expenses while awaiting clients to pay outstanding invoices. This helps you maintain good relationships with suppliers and avoid missing payments on bills without tapping into cash reserves.
Credit lines can also support growth and expansion. For example, a lucrative potential project that could turn into long-term work may come across your desk, but you don’t have the cash for certain necessary equipment.
A line of credit can help cover the shortfalls so you can get that equipment and impress the client, locking in future potential projects. The returns here could potentially outweigh the interest on your small business financing.
3. Handle Change Orders Promptly
Change orders are fairly common in construction since the scope of a big construction project may shift over time. However, any of these changes require change orders.
Failing to address change orders promptly, including handling the paperwork and billing, slows the project down and results in a longer timeline for payment. Also, failing to process the change order may cause you to underbill the value of the project if the project’s scope has increased or become more complex.
With all this in mind, dialing in your change order management is crucial for efficient projects that maximize cash flows and please your clients.
4. Use Progress Billing To Improve Construction Companies Cash Flow
Progress billing involves setting project milestones and invoicing the client upon completion of each milestone. So, instead of receiving a lump sum at the end of the project, you receive steady payments over time. This improves cash flows and protects against payment delays that may occur if you collect the entire payment upon completion.
Progress billing doesn’t just improve cash flows by allowing you to collect on work sooner. It also helps you cover operational costs without dipping into cash reserves or leaning on your financing sources.
5. Implement Retainage
Retainage, a common construction industry practice, involves withholding part of contractors’ or subcontractors’ payments until they complete the project. It’s like how clients may withhold payment until you complete portions of the project.
Typically, companies maintain a 5-10% retainage amount. That means you’d pay 90-95% of the payment up front and release the last 5-10% when the contractor or subcontractor finishes their work.
By implementing retainage, you can hold onto cash longer before paying contractors and boost your company’s liquidity.
One other benefit of retainage is that it incentivizes contractors and subcontractors to complete their work faster to get the retainage amount. That means you’ll finish projects faster, improving cash inflows and helping you take on more projects. Retainage and progress billing together are a powerful way to increase cash flows.
Improve Cash Flows to Strengthen Your Constructions Company
Much of cash flow management entails delaying outflows for longer while collecting cash inflows sooner. You can negotiate better payment terms on the client and supplier sides, implement progress billing, and use retainage.
Beyond that, obtaining small business financing can increase your purchasing power while delaying cash outflows, while dialing in change order management helps you finish projects quickly and efficiently.
Staying on top of cash flow management can help construction companies complete projects more efficiently, leading to greater project success, stronger financials, and happier clients and vendors.
