Rising inflation is on every business owner’s radar — and contractors are no exception. Although you obviously can’t control where the national economy goes, much less what happens globally, you can build up your defenses to rising costs by maintaining a strong cash flow.
Tools to deploy
Construction business owners have a wide variety of tools they can deploy to stabilize or improve cash flow in both the short and long term. Here are nine strategies to consider:
1. Formalize your approach to billing. Setting and adhering to a formal billing schedule that helps ensure prompt billing can reduce lags in the receipt of payments. Where feasible and appropriate, look at your billing method as well.
For example, if you haven’t already, consider progressive invoicing. This is where you bill as phases of work are completed, rather than waiting until project completion. Just bear in mind that progressive invoicing will call for strong communication between project managers and the billing department.
2. Establish a payment schedule. Stick to a regular schedule for paying your own bills, too. Paying early may be virtuous, but you could create a negative cash-flow situation if prices have risen and you don’t have revenue coming in to cover early payments.
Of course, you don’t want to pay late and suffer penalties, interest or damaged vendor relationships either. So, pay on time generally and pay early only if it’s feasible and perhaps qualifies you for a discount.
3. Require some upfront payment. Construction businesses often incur costs before work gets underway. For some projects, you might want to start requesting an advance payment from project owners. Otherwise, you could end up in the hole when your bills come due because of rising prices. Alternatively, under some contracts, you may be able to have the vendor bill the owner directly for certain materials and supplies.
4. Work retainage into your budget. As you’re no doubt aware, retainage remains a relatively common practice in the construction industry. Yet some contractors fail to account for it in their budgeting. This can lead to cash shortfalls when overhead, indirect costs or other expenses come due. Be sure to accurately allocate retainage amounts in your job budgets.
5. Think twice before stockpiling inventory. With ongoing shortages in critical supplies and materials, many contractors are buying in bulk when they can. After all, no one wants to delay bidding on or starting a project simply because supplies or materials are unavailable.
However, stockpiling can take a serious bite out of your cash flow — especially when it comes with carrying costs. This doesn’t mean you should reject the idea, but plan purchases carefully and assess the risks.
6. Encourage early payments. General contractors have two basic motivational tactics to prompt timely or even early payments from owners: late penalties and early bird discounts. The latter are more customer-friendly, but will mean less revenue coming in. The former could increase the odds of payment disputes. Either way, ensure your contracts and invoices state payment terms clearly.
7. Develop a formal change order management system. Properly handled change orders can mean a more profitable job if you can contain the costs. Don’t manage change orders on an ad hoc basis. Establish a formal system to expedite the process of creating, processing and receiving the added payment for a change. The system should dictate the timing and steps to collect necessary documentation and obtain owner approval.
8. Finance purchases. From a cash-flow perspective, you’re generally better off financing equipment, materials and even insurance. You’ll have more cash on hand and could be able to deduct interest payments at tax time. Naturally, you still must keep an eye on your debt load.
9. Don’t put off tax planning. While juggling multiple projects throughout the year, taxes probably aren’t top of mind. A lackadaisical approach to tax planning, however, can hurt you. A hefty tax bill could seriously inhibit cash flow when you least expect it. Work closely with your CPA to incorporate tax planning into your strategies for managing cash flow.
As the construction sector continues to adjust to changes wrought by the pandemic and events overseas, one thing remains clear: A strong cash flow is and always will be vital to running a successful business. Implementing some or all of the measures described above, as well as others specific to your operations, should help protect your construction company from the economic storms ahead.
Envision the future with cash-flow forecasts
You probably already prepare a statement of cash flows as part of your construction company’s financial statements. Although valuable, this statement provides only a historical snapshot of your cash position at the time.
To get advance warning of cash shortages, as well as to perhaps enjoy the pleasant surprise of an unexpected surplus, regularly perform cash-flow forecasts. Armed with this knowledge, you can preempt problems meeting your payment obligations or, on a brighter note, explore how a potential investment of extra dollars might work out.
Say you’ve had your eye on a new vehicle or piece of equipment. Accurate forecasting can give you a clear idea of how much more revenue you’ll need to bring in to cover the payments without compromising your overall cash position.
Be forewarned, however, that cash-flow forecasting for construction companies tends to be more complicated than it is for other types of businesses because of the variable nature of projects both current and future. Your CPA can help.
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