Since the start of 2022, construction costs have jumped by just over 8%. This increase contributes to the 33% increase in costs since the pandemic’s start.
For construction businesses, these rapid changes are forcing reevaluations of how they run their business and especially how they manage their cash flow.
A successful business demands a strong cash flow so as prices continue to rise, it’s essential you make it a priority.
You can do this by identifying where problems begin and how those problems connect back to cash flow.
This article will cover common problems in the construction industry and how prioritizing cash flow will help solve them.
Common Problems in the Construction Industry (and How to Prioritize Cash Flow to Solve Them)
Payroll is a large portion of construction costs, often making up 20-40% of the total job cost according to The Construction Labor Market Analyzer.
This means you have to have a significant amount of cash on hand to cover the labor costs as paying your workers should be a top priority for your business.
However, many businesses run into trouble in this area because they don’t collect payments from clients until after the project is finished. This means they are required to dip into cash reserves to pay their employees and if they don’t have the proper amount of cash set aside, they can’t pay.
How to Prioritize Cash Flow in this Situation:
To avoid this problem, prioritize your cash flow by:
- Collecting a down payment and/or progress payments for your projects.
- Collecting a down payment will give you the flexibility you need to pay your labor costs throughout the project.
- Collecting progress payments ensures a steady inflow of cash throughout the project, again giving you the flexibility to pay your workers as you go.
- Work with subcontractors
- Many construction businesses outsource their labor because they don’t have to pay the labor costs throughout the project. Instead, it’s typically one lump payment after the job is complete. This means you won’t be paying for labor until after you’ve collected the full payment from the client.
Change Order Inaccuracies
Change orders are common in the construction industry. However, many businesses fail to create a sound process for managing them, which often leads to cash flow problems.
In one scenario, the change to the project requires more work than what the client is paying.
In another scenario, the cost of additional supplies isn’t properly accounted for.
How to Prioritize Cash Flow in This Situation:
To avoid this problem, prioritize cash flow by solidifying your change order process.
First, you need to verify that the change makes logical sense for your business i.e. are you still profitable?
If the answer is no, you’ll need to rework the contract to ensure the change is still positively impacting your cash flow.
If yes, then the key is efficiency. When a change is made, make sure you are quickly managing and processing the change order so you can resume work as normal and continue building your cash flow.
Mishandling Progress Payments
Most good job contracts will include progress payments. These are great tools to help you prioritize your cash flow, however, they can also lead to problems if:
- You’re falling behind on work
- You’re not allocating the cash properly as it comes in
- You’re not collecting them on time
How to Prioritize Cash Flow in This Situation:
To avoid this problem, prioritize cash flow by:
- Staying as close to “on track” as you can during the project
- Many clients won’t make their progress payments unless your work is on track. If you’re not holding up your end of the deal you can’t expect them to hold up theirs.
- Planning out how you want to use the cash
- Know exactly how and what you plan to use each progress payment for. Keep your cash flow in mind as you do this by timing expenses when they make the most sense for your cash reserves and completing the project.
- Creating clear payment schedules and terms
- Make sure you’re clients are aware of when progress payments are due and the repercussions of missing or falling behind on payments.
- Also, provide payment methods that the client prefers.
Prioritize Cash Flow with the Help of a Trusted Accountant
Prioritizing cash flow can be challenging in the construction industry. Many factors play a role in creating and maintaining a strong cash flow.
This means that as problems arise, like the inability to pay for labor, unprofitable change orders, and unaccounted-for progress payments, a focus on cash flow is often the solution.
If you’re struggling to prioritize your cash flow or simply want better guidance on how to improve it, turn to Argento CPA.