Construction is a risky business. Most contractors like to stay positive, but it can be productive from a strategic planning perspective to think worst-case scenario: What could cause the demise of your company? Here are four common reasons for construction business failure and how to prevent them.
1. Insufficient cash flow / working capital
Most industries adhere to 30-day invoice-payment terms. In construction, however, general contractors pay their subs when they get paid, and the money trickles down the supply chain from there. This often leads to 90 to 120 days of past-due receivables, making it all too easy to fall behind on bills, get in debt and jeopardize the company.
There are ways to both get paid faster and extend bill payment cycles. One option is to negotiate contracts to allow your company to bill work early. At the same time, try to negotiate payment schedules with suppliers to ensure you don’t pay for materials until your company is due to receive payments.
An effective long-term strategy is to open and maintain an operating cash reserve account. This is, essentially, an interest-bearing savings account that you create to relieve cash flow pressure from your business. You can fund it by allocating a nominal percentage of cash flows from each job and drawing from the account only when necessary.
2. Poor estimating / job costing
Accurate construction bids are an important part of a contractor’s financial health, as many project losses can be traced directly back to bid errors. Poor job costing and estimating practices often lead to low bids that just don’t bring in enough cash for the business to survive.
Regularly double-check and ensure that your estimators are accounting for all expected costs associated with a project. Shortcuts lead to bid errors. Additionally, actively updated job costing helps identify which jobs/tasks are making money, and which aren’t. Frequently compare actual vs. estimated project costs to determine where you need to control costs.
Another thing to check is whether your employees are all following consistent job costing / estimating processes. Also ensure any software you use to complete these tasks is up to date and providing the needed functionality.
3. Expanding too quickly
Sometimes ambition is a contractor’s downfall. Avoid the temptation of either taking on too many jobs (excessive backlog) or moving beyond your niche or geographic area without being sure your company has the expertise and resources to complete the work.
Do your research and understand the risks before making an unusual or “stretch” bid. For example, when crossing state lines, remember that each jurisdiction may have its own rules regarding licensing, building codes and tax liability.
4. Lack of succession planning
Construction companies often fail because the owner retires and there’s simply no one there to provide leadership. A formal, thoroughly plotted succession plan helps ensure your company will remain in capable hands.
This includes setting up a program to identify potential successors, develop their abilities and transfer knowledge to them. If you have business partners, a buy-sell agreement is highly advisable for easing an owner’s exit.
Stay in business
Running a successful construction operation requires not only mastering your trade, but also knowing how to run a business. This doesn’t mean expecting disaster at every turn, but it does mean making worst-case scenarios as unlikely as possible.
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